A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student may be either an undergraduate or a graduate.
Table 1-1 provides an overview of the tax treatment of amounts received as a scholarship or fellowship (other than amounts received as payment for services). Generally, whether the amount is tax free or taxable depends on the expense paid with the amount and whether you are a degree candidate.
Table 1-1.Tax Treatment of Scholarship and Fellowship Payments1
A scholarship or fellowship is tax free only if:
Candidate for a degree. You are a candidate for a degree if you:
Eligible educational institution. An eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.
Qualified education expenses. For purposes of tax-free scholarships and fellowships, these are expenses for:
However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.
Expenses that do not qualify. Qualified education expenses do not include the cost of:
This is true even if the fee must be paid to the institution as a condition of enrollment or attendance. Scholarship or fellowship amounts used to pay these costs are taxable.
The information at left comes from Pub 970 Tax Benefits for Education
The information in the table at left is also reproduced in Tab D, page 3 of your Pub 4012.
The general rule: all income is taxable unless specifically designated as taxfree.
If the scholarship or grant recipient is a degree candidate, then the taxable status of the scholarship or grant depends on what the money is used for.
If a degree candidate uses the money for tuition, required fees, required books, required supplied, or required equipment, then the income is TAXFREE.
If a degree candidate uses the scholarship money for room, board, or travel, then the income is TAXABLE.
If the scholarship or grant recipient is not a degree candidate, then the income is TAXABLE, no matter what it is used for.
One more important point: financial aid that comes in the form of a student loan is NOT taxable, regardless of what it is used for or the degree status of the borrower. (Why not? Because a loan is not income.)