Everyone knows about scholarships. They’re no-strings-attached money to help students pay for their higher education. Right?
Usually, but not always. In some cases, there are significant strings attached — including situations in which scholarships are treated as taxable income. While unusual, it’s important for students, their families and scholarship providers to understand all the implications.
The tax status of scholarships first codified in 1954 was simple: for students pursuing a degree, all scholarships, fellowships and grants were tax-free. But later legislation specified portions of a scholarship could be taxed if it is considered “fees for services,” or if it’s used for living, travel or research expenses.
What’s more, scholarships for non-degree-candidates are also taxable. As professional certifications and certificate programs become vital to certain industries, experts say these laws put non-traditional students at risk of a heavy tax burden.
Some experts say taxing scholarships comes at a cost for students and scholarship providers and even the federal government.
“For students, it can harm their ability to pay for their education,” says Robert C. Ballard, president and CEO of Scholarship America, the nation’s largest nonprofit scholarship and education support organization. “For providers wanting to make the biggest charitable impact, it can make providing scholarships less attractive than alternative philanthropic efforts.”
With most federal financial aid calculations based on the pre-tax value of the scholarship, students risk a shortfall in aid. All of this has a disproportionate impact on low-income students. Those from the bottom income quartile spend the largest percentage of family income on higher education; almost half of that money is spent on the non-tuition costs for which scholarship awards are taxable.
“Taxing scholarship funds may increase government revenue in the short term, but it’s short-sighted,” says financial aid expert Mark Kantrowitz. “The federal government benefits financially long-term when students graduate and have the potential to earn more taxable income.”
Should They Be Taxed?
Kantrowitz, along with Scholarship America’s Despina Costopoulos Emerson, say restoring scholarships’ tax-free status will help certificate- and degree-seeking students, and those who must work out of necessity, pursue their education without undue financial burdens.
To learn more about taxing of scholarships visit blog.scholarshipamerica.org.
“Scholarship America and our partners are in ongoing talks with members of Congress, and we hope to see some progress on initiatives that will ensure qualified scholarships are available to students to pay the full cost of education and allow scholarships to be used, tax-fee, to pay for room and board, transportation and other college-related expenses,” says Ballard. “In the meantime, students and their families should research the specifics of all grants, scholarships, fellowships and tuition waivers they are offered in order to understand the true value of their financial aid package after taxes and plan accordingly.”