Are my scholarship funds reportable to the IRS?
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Have you considered applying for a scholarship to make college education more affordable? If you have, then, this article is just what you need! Scholarship funds are often a welcome relief for millions of students pursuing undergraduate or postgraduate studies in the United States. However, many do not know or understand the regulations, as well as the tax obligations that scholarship funds may attract.
So, what is a scholarship fund? Basically, this refers to any amount of money remitted to a recognized educational institution to aid in the facilitation of studies or research of an undergraduate or a postgraduate student. Your scholarship may or may not be taxable depending on what you spend it on. The IRS is very clear on the circumstances under which your scholarship funds may be taxed, therefore, you have to ascertain your tax obligations in regard to your scholarship funds. Remember, ignorance is no defense.
Are my scholarship funds reportable to the IRS?
By design, scholarship funds are meant to be used solely on educational expenses. If it’s used for any other purpose, then, it’s considered taxable and must be reported and the applicable tax remitted to the IRS.
How Do I Know if My Scholarship is Taxable?
As I mentioned earlier, tax scholarship funds are strictly for educational expenses. Any amount of the scholarship fund used outside the defined educational expenses such as living expenses is taxable. According to the IRS, a scholarship fund is still taxable if:
- The amount received in a year exceeds the qualified educational expenses for the beneficiary in that year.
- The beneficiary of the scholarship is not pursuing a degree or postgraduate program in an institution of higher learning.
- The scholarship fund is considered payment for a service rendered by the beneficiary, then it is considered income earned and is therefore taxable.
When are scholarships not taxed?
IRS does not tax scholarship funds if:
- It is in a non-monetary form, for instance, a student benefitting from reduced tuition fees for a service he or she is rendering to the institution of higher learning.
- A student is benefitting from small research funds from his or her school.
- The scholarship amount is strictly used for educational expenses as enshrined in IRS 970 publication.
- The scholarship is from the armed forces scholarship programs or any Health Service Corporation within the country and is to be used strictly for the purchase of books, school equipment, or tuition fees.
Reporting Taxable Scholarship Grants and Fellowships on Your Income Tax Return
Your employer may report your taxable scholarship or fellowship on the IRS form W-2 which makes things so much easier for you. Usually, the institutions of higher learning will report income received which includes the scholarship funds used for tuition fees and other qualified educational expenses on box 1 and box 5 of the IRS 1098-T form.
As an individual, you can report the part of your scholarship that is taxable when declaring your income using the Line 7 of IRS Forms 1040 and 1040A or Line 1 of IRS Form 1040EZ.
Note that sometimes your institution of higher learning may only indicate the amount of the scholarship fund used for tuition fees. You must declare other qualified education expenses on books, and school equipment to help reduce the taxable amount of your scholarship or fellowship.
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What are qualified educational expenses?
A qualified educational expense is an amount payable by an individual to a recognized educational institution to facilitate his or her enrollment, and studies at the learning institution. Some examples of qualified educational expenses include enrolment charges, tuition, school fees, and purchases of books among other school learning equipment. Note that living expenses or the purchase of personal items such as laptops or cell phones are not considered qualified educational expenses which makes them taxable.
Estimated Tax Payments
This is the tax payable quarterly by persons who do not have tax applicable deducted from their paychecks automatically. Estimated tax payments are made by freelancers and small businesses based on their earnings in a year. The tax must be accompanied by an IRS form 1040ES.
What is IRS Form 1098-T?
The IRS has different types of forms that different groups of people can use to report their income and the 1098-T is just one of many. This form is often generated by educational institutions of higher learning as a tuition remittance statement that is forwarded to the IRS. As a student, you are entitled to a copy of the IRS Form 1098-T.
Scholarships vs. grants
The world is full of donors and foundations that offer scholarships and grants to a varying number of beneficiaries. While a scholarship is solely meant to be used in the advancement of higher learning and research, grants are awarded for other purposes such as the expansion of businesses, support of certain groups, or humanitarian activities among others. For this article, however, we are going to focus on scholarship vs. academic grants. In the U.S., both scholarship and academic grants are considered tax-free as long as they are used to pay for fees, tuition, books, academic supplies, and equipment required for the study.
Despite the possibility of having to pay taxes on your scholarship fund or grant, you should familiarize yourself with ways of enjoying tax deductibles. One way to do this is through the student loan deduction interest. Well, you are entitled to a tax deduction for a student loan you took out specifically to pay for education expenses in an institution of higher learning. The maximum deduction is either $2500 or the actual interest you paid the whole year whichever is less.
American Opportunity Credit and the Lifetime Learning Credit
Both the American Opportunity Credit (AOC) and the Lifetime Learning Credit (LLC) are tax credits meant to offset post-secondary education expenses. However, there are key differences between the two credits. First, the AOC can be used for tuition and other course materials such as books and supplies. While the AOC is capped at $2,500 per annum, LLC is capped at $2,000. While the AOC is only available for the first four years of post-secondary education, the LLC can be claimed for an unlimited number of years by an eligible student.
Since both the AOC and the LLC are tax credits, they are used to reduce the amount of taxes owed by a student or taxpayer. In other words, when you claim the AOC or LLC on your tax return, you’ll automatically reduce the amount of taxes you owe dollar for dollar until you hit the maximum credit amount. But what happens if the amount of taxes you owe? Well, you can receive a refund for a portion of the credit since AOC is refundable, but LLC is non-refundable and it can only reduce your tax bill it will not result in a refund if the credit is greater than the amount of taxes you owe. It is important to understand that AOC and LLC are mutually exclusive and both cannot be claimed by a single student in the same year.
How to maximize your scholarship and tax credits?
Perhaps the best way to maximize your scholarship fund is to spend it on qualified education expenses leaving little or nothing to the IRS to consider income. This will reduce the amount of tax payable significantly. Since you don’t have to be a full-time student or a degree student to benefit from the Lifetime Learning Tax Credit, why not take advantage and claim Lifetime Learning Tax Credit for any number of years?
Conclusion
It is a requirement that any money earned from the sale of products or services has to be declared to the IRS and the applicable tax remitted. But what happens in the case of a scholarship fund or grants? As long as the funds are used for the intended purpose (supporting academic activities) then, they are not reportable to the IRS as taxable. However, if you use it to cover other related living expenses, be sure to report it to the IRS. Finally, always stay on top of your tax reporting and remittance to avoid incurring IRS penalties.
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