Navigating Scholarships and the 1098-T Form: Understanding Tax Implications

Every year, countless students embark on their higher education journeys, often relying on scholarships to alleviate the financial burden. Scholarships and fellowships can be a significant source of funding for students pursuing higher education. However, the tax implications of these funds can be complex and sometimes confusing. It's essential to understand the rules surrounding scholarships, fellowships, and the IRS Form 1098-T to ensure accurate tax reporting and avoid potential pitfalls. This article aims to demystify these aspects, providing clarity for students and their families.

Understanding Scholarships and Fellowships: Taxable vs. Tax-Exempt

For tax purposes, a fellowship is considered the same as a scholarship. The tax status of scholarships and fellowships hinges on whether they are "qualified" or "nonqualified."

Qualified Scholarships: Tax-Exempt Funds

A qualified scholarship is tax-exempt, meaning it is not subject to income tax. To be considered qualified, the scholarship money must be used for specific expenses:

Tuition expenses
Required enrollment fees
Books
Supplies that are required as part of the normal coursework for a semester.These expenses must be required for enrollment or attendance at an eligible educational institution. An eligible educational institution is one whose primary function is the presentation of formal instruction and that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it regularly carries on its educational activities.

Nonqualified Scholarships: Taxable Income

A nonqualified scholarship is any portion of the scholarship money that exceeds qualified expenses. This typically includes funds used for:

Room
Board
Living expenses

Any scholarship or fellowship grant that is used to pay for room and board, or something else that is not considered qualified tuition or a related expense, is taxable. In addition, a scholarship may also be taxable when the scholarship is earmarked for a nonqualifying purpose such as room and board or travel. In these situations, the amount of the earmark is taxable.

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Reporting Scholarships and Fellowship Grants

If your only income is a completely tax-free scholarship or fellowship grant, you don’t have to file a tax return and no reporting is necessary. If all or part of your scholarship or fellowship grant is taxable and you are required to file a tax return, report the taxable amount as explained below. You must report the taxable amount whether…

The Role of IRS Form 1098-T: Tuition Statement

The IRS Form 1098-T, also known as the Tuition Statement, is an informational document issued by colleges and universities to students. This form is required by law and is used by students and parents to compute and claim educational tax credits on their individual tax returns. It provides a summary of payments received for qualified tuition and related expenses, as well as any scholarships or grants the student received.

Interpreting the Boxes on Form 1098-T

Box 1: Payments Received for Qualified Tuition and Related Expenses: This box lists the total amount of payments the college or university received for qualified tuition and related expenses from all sources. Other expenses paid, mainly room and board, are not QEE.
Box 4: Adjustments Made for a Prior Year: Box 4 of the form shows any adjustments the school has made to qualified expenses reported on a previous year's 1098-T. If it turns out a previous year's expenses were lower than initially reported, the student may be responsible for additional tax. You must recapture (repay) any excess credit received.
Box 5: Scholarships, Grants, and Fellowships: This box shows the total amount of scholarships, grants, and fellowships the college or university is aware of. But, these scholarships, fellowships, and grants are not necessarily limited to the qualified tuition and related expenses reported in Box 1. If a scholarship, grant, or fellowship is available for living expenses but not restricted to living expenses, the student can choose to use the money to pay for qualified tuition and related expenses, which would cause the money to be excluded from income.
Box 6: Adjustments to Scholarships or Grants for a Prior Year: Box 6 shows any adjustments the school has made to scholarships and grants reported on a previous year's 1098-T.
Box 7: Expenses for an Academic Term Beginning in the Next Year: Schools must check Box 7 if the amount in Box 1 or 2 includes expenses for an academic term that begins in the first three months of the year following the year covered by the 1098-T.
Box 8: At Least Half-Time Enrollment: A check mark in Box 8 indicates that the student is enrolled at least half-time.

Using Form 1098-T for Tax Reporting

The amounts reported on IRS Form 1098-T are a guide that can help you figure out the taxable portion of your scholarships, grants, and fellowships, but they are not necessarily a definitive answer.

Generally, you should consider the amount in Box 1 as the maximum that can be excluded from income (not taxable) and the amount in Box 5 as the scholarships, grants, and fellowships the college is aware of. If Box 5 exceeds Box 1, the IRS knows you have taxable fellowships, scholarships, and grants equal to at least the difference between Box 5 and Box 1.

The simplest approach is to report the difference between Box 5 and Box 1, plus any fellowships and scholarships your college or university is unaware of as taxable income on your federal income tax return.

But, sometimes, you will need to modify this figure. For example, some colleges report only tuition and fees in Box 1 and don’t report course materials. Or they may report an average figure or an allowance for course materials.

If your actual spending on required textbooks, supplies, and equipment is higher, keep receipts and base the calculation of the taxable portion of your scholarships, grants, and fellowships on the actual qualified tuition and related expenses.

Accessing Your 1098-T Form

In January of each year, the university issues an IRS 1098-T information return to most of our enrolled students. Most students opt to receive this form electronically when they enroll for classes. Copies of the current and prior 1098-T forms can be obtained online by using your assigned student user name and password. Questions about this form should be referred to the Office of Student Finance representative listed in the First Contact information.

Scholarships Exceeding Tuition: Navigating Taxable Income

A common scenario arises when the amount of scholarships, grants, and fellowships reported in Box 5 of Form 1098-T exceeds the qualified tuition and related expenses reported in Box 1. This situation often leads to taxable income for the student.

Determining Taxable Scholarship Income

When Box 5 exceeds Box 1, the difference is generally considered taxable income. This is because the excess scholarship funds are likely being used for nonqualified expenses like room and board.

Example of Taxable Scholarship Income

A full-time student attends a private liberal arts school during the calendar year with qualified tuition and fees equal to $32,000 and room, board, and other unqualified expenses equal to $18,000 per year. If the student receives a full-ride scholarship of $50,000, the $18,000 received to cover room, board, and other unqualifying expenses is not an amount received as a qualified scholarship. Therefore, the student will recognize it as unearned income for kiddie tax purposes.

Reporting Taxable Scholarship Income

If all or part of your scholarship or fellowship grant is taxable and you are required to file a tax return, report the taxable amount as explained below. You must report the taxable amount whether…

Educational Tax Credits: Opportunities for Tax Relief

The IRS encourages taxpayers who may or may not have received a scholarship to take advantage of the educational tax credits on their individual tax returns. There are two primary education tax credits available: the American Opportunity Credit (AOC) and the Lifetime Learning Credit.

American Opportunity Credit (AOC)

The American Opportunity Credit (AOC) is a credit for qualified education expenses paid for the first four years of higher education.

Lifetime Learning Credit

The Lifetime Learning Credit is for qualified tuition and other expenses for undergraduate, graduate, and professional degree courses.

Coordination with Scholarships

It may benefit you to choose to include otherwise tax-free scholarships or fellowship grants in income. This may increase your education credit and lower your total tax or increase your refund.

The Kiddie Tax and Scholarship Income

The "kiddie tax" refers to the tax rules that apply to the unearned income of children. The law known as the Tax Cuts and Jobs Act amended the rules for the tax on children’s unearned income, commonly called the kiddie tax, so that it no longer is calculated at the parents’ top marginal rate and is instead calculated at modified trust and estate tax rates. Students subject to the kiddie tax may need to file Form 8615, Tax for Certain Children Who Have Unearned Income. In some situations, students will need to use information not provided on Form 1098-T, Tuition Statement, to properly fill out Form 8615.

Understanding Earned vs. Unearned Income

The Code defines earned income as “wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered.” In essence, it includes all forms of compensation that are paid for work the taxpayer performed. Any compensation that does not fall into the earned income category is considered unearned income, which by default includes any income that is not earned.

Kiddie Tax Implications for Scholarships

An often-overlooked form of unearned income for a child is taxable scholarship income for which a Form W-2 is not issued because it is not earned income.

When Does the Kiddie Tax Apply?

As of 2018, the kiddie tax affects anyone who meets the following criteria as outlined in Sec. 1(g)(2):

The child is: Under the age of 18; 18 and has earned income that is less than half the person’s own support; or 19 to 23, a full-time student, and has earned income that is less than half the person’s own support.
Has at least one living parent; and
Is not married and filing a joint return with the spouse.

Change in Tax Rates

The amount of tax owed by a child who is subject to the kiddie tax differs from the amount that would have been calculated under the pre-TCJA rules. The amount of the difference depends on the type of unearned income (whether the income receives preferential tax treatment granted for long-term capital gains and qualified dividends) of the child and the tax rate of the parent. Whether the new rules produce a more favorable or more unfavorable result than the old rules depends on the circumstances.

Strategies for Managing Scholarship Tax Implications

While it's impossible to completely eliminate the tax burden associated with scholarships exceeding tuition, there are strategies students can employ to minimize their tax liability.

Maximizing Qualified Education Expenses

Students should keep detailed records of all qualified education expenses, including tuition, fees, books, and required supplies. If your actual spending on required textbooks, supplies, and equipment is higher, keep receipts and base the calculation of the taxable portion of your scholarships, grants, and fellowships on the actual qualified tuition and related expenses.

Utilizing the American Opportunity Credit

There is a tax “loop hole” available to claim an education credit, for the parents of students on scholarship. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), as income on his return. That way, the parents (or himself, if he is not a dependent) can claim the tuition credit on their return.

Seeking Professional Tax Advice

Navigating the complexities of scholarship taxation can be challenging. Consulting with a qualified tax professional can provide personalized guidance and ensure accurate tax reporting.

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