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Are college scholarships and grants taxable? – Councilor Forbes

By on June 23, 2021 0

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If you are trying to save money on college fees, scholarships and grants are essential tools. According to Sallie Mae’s How America Pays for College study, scholarships and grants covered 25% of students’ university expenses in 2020, or an average of $ 7,626 per borrower.

Unlike student loans, scholarships and grants are a form of donation and do not need to be repaid. By using a gift aid to cover some of your expenses, you can reduce the amount you have to pay out of pocket for your education.

While you don’t have to worry about repaying donations, you might be wondering if scholarships and grants are taxable. In some cases, scholarships and grants must be reported on your income tax returns. Here’s what you need to know to file your return if you received gift assistance.

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Are grants and scholarships taxable as income?

If you got scholarships or grants, you probably won’t need to borrow that much money in student loans. Whether grants and scholarships are taxable or not depends on a few important factors.

Grants and scholarships are tax free, which means they are excluded from your gross income, if the following criteria are met:

  • You are pursuing a degree at an accredited college or university
  • The price does not exceed your eligible education costs, such as tuition
  • The price is not allocated to other expenses, such as room and meals
  • The scholarship or grant is not paid in exchange for teaching, research or other tasks

If you receive a scholarship or grant for a certificate program, or if you take courses that do not lead to a diploma, the full amount of the scholarship is taxable.

What are eligible tuition fees?

A scholarship or grant is tax-free as long as it does not exceed the amount you need to cover your eligible educational expenses. According to the IRS, eligible education expenses include:

  • Tuition and registration fees imposed by the school
  • Course fees and mandatory expenses, such as lab fees, textbooks, or equipment. In order for supplies and equipment to count as an eligible expense, they must be required for all students in the course.

What does not count as eligible education expenses?

When you go to college, the total cost of attending is way more than tuition and school fees. You may also need to pay for room and board, travel, or other supplies like a new computer.

While these expenses may be part of your overall education costs, these items are not considered eligible education expenses for tax purposes. If you receive a scholarship or grant that covers these costs, the portion of the scholarship that paid for these items is taxable as income.

When taxes apply to grants and scholarships

If you are trying to determine which college scholarships are taxable, it is important to know that the IRS rules apply to all sources of grants and scholarships. Whether your prize is from the federal government, state, your college, or a private organization, the prize is only tax-exempt if used for qualifying education expenses.

The rules do not change if the price is based on merit or financial need; it doesn’t matter if you got the scholarship because of your athletic ability or if you received a grant because of your income, the same tax rules apply.

This doesn’t mean that you should turn down scholarships or grants that give you more than you need for tuition; it just means you have to report that amount on your taxes.

For example, Pell Grants are a form of federal financial aid for low-income students. For the 2021-2022 award year, the maximum amount you can receive in Pell Grants is $ 6,495, and it can be used to pay for the full cost of attending your school, not just tuition. and fees.

Let’s say Ben is an undergraduate student who qualifies for the maximum Pell Grant. He uses $ 5,000 of his Pell Grant to cover the rest of the tuition he owes. He then uses the remaining $ 1,495 to pay his apartment rent and a bus pass to get to school. Because room and board and transportation do not fall under the IRS’s qualifying education expenses, Ben would have to pay taxes on his $ 1,495 grant.

How to report scholarships and grants on your income tax return

To report scholarships or grants that paid ineligible tuition fees on your income tax return, you will need to complete one of the following forms depending on your situation:

In most cases, the scholarship or grant provider will send you a W-2 form showing the taxable scholarship amount.

Enter the taxable amount from your Form W-2 on the wages, salaries, and tips line. If the taxable amount was not included on a W-2 form, write “SCH” and enter the taxable amount on the dotted line next to the salary box.

If you need help filling out your forms or calculating the amount to report, consult a tax professional. The IRS maintains a database of tax preparers who have IRS-recognized credentials or who hold a record of annual production season program completion. You can use the database to find a qualified professional near you.

Education tax credits and deductions that can lower your tax bill

While it can be daunting having to pay taxes on your scholarships and grants, there are often other ways to lower your tax bill based on your student status through tax credits and deductions. for studies.

1. US opportunity tax credit

Using the American Opportunity Tax Credit (AOTC), you can get a tax credit worth up to $ 2,500 for money spent on qualifying education expenses. The credit is refundable, so if the credit reduces your tax bill to zero, you can get 40% of the remaining amount back as part of your tax refund.

To be eligible for the AOTC, you must be enrolled in an accredited school and be pursuing a recognized diploma or diploma. You can only apply for AOTC for the first four years you are in school.

There are income restrictions; the credit is phased out from the time you earn $ 80,000 per year (or $ 160,000 if you are married and file jointly). If you earn more than $ 90,000 ($ 180,000 if you are married and complete a joint return), you are not eligible for the credit at all.

2. Lifetime learning credit

Like the AOTC, the Lifetime Learning Credit (LLC) is a tax credit that reduces the amount you owe when you file your federal income tax return. Under the LLC, you can receive a credit worth 20% up to $ 10,000 in eligible tuition, up to a maximum of $ 2,000.

Unlike AOTC, LLC is non-refundable, so you won’t receive any refund if your refund brings your tax bill down to zero.

You can apply for the LLC if you are taking courses to earn a degree or to improve your professional skills. You can apply for the credit even if you return to school or take professional development courses.

There are income restrictions, so check with the IRS to see if you are eligible. You cannot claim both the AOTC and the LLC for the same student in the same tax year.

3. Interest deduction on student loans

If you took out student loans to pay for your college education and started making payments, you may be eligible for the student loan interest deduction.

The interest deduction on student loans reduces your taxable income. You can deduct the lesser of $ 2,500 or the amount of interest you paid on your student loans in the tax year.

To claim the deduction, you must be required by law to make payments on the loans. You must fall under the deduction income restrictions.

For more information on how to offset your tax bill, read the available tax credits and education deductions.