Navigating Taxes on Scholarships and Grants: A Comprehensive Guide

Congratulations on winning a scholarship, grant, or fellowship! These awards can significantly ease the financial burden of education. However, it's essential to understand the tax implications of these funds. This guide will help you determine whether your educational award is taxable and how to report it on your tax return.

Are Scholarships and Grants Taxable?

The short answer is: it depends. Scholarships and grants may count as income, which means they may be taxable. The IRS has specific conditions for a scholarship not to be taxed. To avoid a scholarship being subject to taxation, you’ll need to spend the funds on qualified educational expenses.

Tax-Free Scholarships: What Qualifies?

A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution for the purpose of study. A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. If you receive a scholarship, a fellowship grant, or other grant, all or part of the amounts you receive may be tax-free. Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant.

Scholarships are tax-free only if you meet the following criteria:

You are a candidate for a degree at an eligible educational institution. The IRS defines a candidate for a degree as someone who either attends primary or secondary school (K-12) or attends college to pursue a degree.
The award covers tuition and fees to enroll in or attend an educational institution.
The award covers fees, books, supplies, and equipment required for your courses. The key requirement for having scholarships cover these course-related expenses tax-free, is that they must be required of all students in your course.

The award is tax-free only as long as you use it for the purposes outlined above.

When Scholarships Become Taxable

Some scholarship funds are subject to taxation. If you have money left over after covering your qualified education expenses and use it on other costs, these funds generally count as taxable income. If you have scholarship money left over after covering your qualified education expenses, you'll need to include that amount as part of your gross taxable income. If you receive scholarship funds that exceed your qualifying educational expenses, the amount above these necessary costs is subject to taxation.

Here are some situations where scholarship funds are typically taxable:

Funds Used for Non-Qualified Expenses: If your award covered both tuition and room and board, the amount you use for tuition is tax-free. However, the amount you use for room and board is taxable. Likewise, if you receive a scholarship that you use to pay for room and board, books or supplies that aren't required, these funds are generally subject to taxation. Funds used for non-qualified expenses, such as room and board, travel, or optional equipment, are taxable.
Payment for Services: In some cases, a scholarship is really more of a stipend, providing compensation for services while you’re in school or for services you’ll provide in the future. Any portion of a scholarship representing payment for teaching, research, or other work is considered taxable wages, even if used for tuition or other qualified expenses. If you receive a scholarship with the condition that you provide services in the future, you’ll typically need to count the scholarship as income in the year you receive it.
Scholarships Exceeding Qualified Expenses: If you receive scholarship funds that exceed your qualifying educational expenses, the amount above these necessary costs is subject to taxation.

Reporting Taxable Scholarships on Form 1040

If your only income is a tax-free scholarship or fellowship, you're in the clear. You don't have to file a tax return or report the award. However, if all or part of your scholarship is taxable, and if that money is not recorded on your W2 form, you must report it.

Here's how to report taxable scholarships on different tax forms:

Form 1040 or 1040-SR: If you file Form 1040 or Form 1040SR, include the taxable amount in the total on the “Wages, salaries and tips” line. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount in the space to the “Wages, salaries and tips” line.
Form 1040NR: If you file Form 1040NR, include the taxable amount in the total on the “Scholarship and fellowship grants” line. Gross income from box 1 should be reported on Form 1040-NR - Schedule 1, Ln 8r Scholarship and fellowship grants not reported on Form W-2. Entries on Schedule 1, Ln 8r will flow to line 8 of your Form 1040-NR. Fran would report $2,250 as "Scholarship and fellowship grants not reported on Form W-2" on Line 8r of Schedule 1.
Form W-2: Note: Any tuition reduction that is taxable should be included as wages on your W-2 form. If filing Form 1040, Form 1040-SR or Form 1040-NR, and the taxable portion was reported to you in box 1 of Form W-2, include the taxable portion in the total amount reported on Line 1a of your tax return.

Understanding Form 1098-T

Each year, educational institutions like St. Lawrence University issue Form 1098-T (Tuition Statement) to eligible domestic students. This form reports payments for qualified tuition and related expenses, as well as scholarships and grants received during the tax year. It’s used to determine eligibility for education tax credits such as the American Opportunity Credit or Lifetime Learning Credit.

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Important note: The 1098-T does not show taxable scholarship income.

Tax Planning Strategies for Scholarships

The IRS has provided some helpful guidance on how to maximize your scholarships and tax credits, delivering you the most savings possible for your situation. One tax optimization strategy works by considering some of your scholarship money as taxable income by using it for living expenses rather than applying it toward your tuition expenses. This can allow for some of your tuition expenses to be eligible for an education credit that otherwise would have been paid by the tax-free scholarship money.

In some cases, you might be better off excluding all of the scholarship from your taxable income by applying it only toward tuition expenses. For example, if you have a grant or scholarship that fully covers all of your tuition, fees, and books, then you can't claim the American Opportunity Credit because you didn't actually pay for qualifying expenses. If, instead, you claim some of the grant or scholarship as income and don’t use it for your eligible expenses, this then leaves you with some qualified expenses to pay and gives you the ability to claim the tax credit. Since up to $1,000 of the American Opportunity Credit is refundable, you can take part of a scholarship and choose to make it taxable income.

Additional Tax Benefits for Education

Scholarships and grants aren’t the only ways to get financial assistance to pay for higher education.

American Opportunity Credit: The American Opportunity Credit allows students or their parents an opportunity to reduce the cost of attending college through claiming qualifying education expenses as a tax credit on their federal income taxes. To claim this education tax credit, the student must be at least a half-time student who hasn’t completed the first four years of college and is working toward a degree. In addition to required tuition and fees, the credit applies to other expenses like books, supplies and equipment, but not room, board, transportation expenses or medical insurance. The credit is equal to 100% of the first $2,000 of qualifying expenses plus 25% of the expenses in excess of $2,000.
Lifetime Learning Credit: Whether you’re pursuing a college degree, higher education coursework independent of a degree or other educational activities to develop your career, another tax credit to consider is the Lifetime Learning Credit. Like the American Opportunity Credit, this credit also reduces your tax bill on a dollar-for-dollar basis for a portion of the tuition, fees and other qualifying expenses you pay for yourself, your spouse or a dependent to enroll in qualifying coursework.
Student Loan Interest Deduction: Another useful tax deduction you may be able to claim comes from the student loan interest deduction. For 2025, you can deduct the student loan interest paid if your modified adjusted gross income (MAGI) is below $100,000 when filing as Single or $200,000 if you file as Married Filing Jointly.

One tax optimization strategy works by considering some of your scholarship money as taxable income by using it for living expenses rather than applying it toward your tuition expenses. This can allow for some of your tuition expenses to be eligible for an education credit that otherwise would have been paid by the tax-free scholarship money.

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Another distinction is that you can’t double dip with these two educational credits. That means you can’t claim both the Lifetime Learning Credit and the American Opportunity Credit in the same year for the same student.

Navigating Tax Software

When using tax software to prepare your tax return, be sure to classify the income as taxable scholarship income. Other terminology that software providers may use to describe this income includes nonqualified scholarships, taxable fellowships, nonqualified fellowships, taxable grant income, and other similar phrases. This type of income is often difficult to find in the software because it is uncommon.

Do not instruct the software that your stipend is substitute W-2 or substitute 1099 income.

Seeking Professional Assistance

If you're not sure if your award is taxable, ask the organization that sponsored the award. They may have information from the IRS regarding your award's tax status. If you have questions, ask as soon as possible to get your answers before the end of tax season, when they are likely swamped with questions. You can also seek information directly from the Internal Revenue Service.

When engaging a professional tax preparer to prepare your return, be sure s/he is aware that this is taxable scholarship income.

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Key Takeaways

Scholarships and grants used for qualified education expenses (tuition, fees, required books and equipment) are generally tax-free.
Scholarship funds used for non-qualified expenses (room and board, travel) are typically taxable.
Report taxable scholarship income on Form 1040, 1040-SR, or 1040-NR, as appropriate.
Consider tax planning strategies to maximize education credits and deductions.
Consult with a tax professional or the IRS if you have questions about your specific situation.

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