Tax incentives for college students: Part 2

October 1, 2020

By Alyssa M. Reed, CPA, The Tax Insider

College is very expensive, yet for many people it is essential for future success. This two-part article discusses the tax incentives to help parents and children pay for this important passage in life. Part 1 of this article examined the options to save for college and the tax credits and deductions available to B and his parents as he began college. But what if he receives scholarships? What is taxable? This part applies knowledge from Part 1 to explain the taxability of scholarships and who gets the deduction for repaying the student loans.

Taxability of scholarships

While there are tax incentives to assist in the cost of education, some students may also qualify for scholarships. The conundrum occurs when parents or students must determine what portion of the scholarship might be taxable. Sec. 117 excludes any amount of a qualified scholarship that is used for qualified expenses: tuition and fees required for enrollment or attendance at an eligible school, and required course-related expenses including fees, books supplies, and equipment, but not room and board.

If B is, for example, an all-star basketball player who is given a full scholarship, the amount of the scholarship designated as covering room and board is taxable. Many schools provide students with a Form W-2, Wage and Tax Statement, for this amount, but, even if the university does not provide a W-2, it is still the student's obligation to claim the room and board portion as taxable income. The student would put the amount of room and board scholarship on line 1 of Form 1040, U.S. Individual Income Tax Return, with "SCH" beside it to designate it as scholarship income.

If B is a graduate student receiving a scholarship, the rules become a bit more complex. If the student works for the scholarship, it is taxable unless the hours worked are for a teaching or researching institution. Many schools have broad definitions of teaching and researching, such as assisting professors with proctoring exams, grading papers, or supporting an instructor's research. If the student meets the definition of teaching and researching, the scholarship is not taxable.

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