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Pub. 970, Tax Benefits for Education 2006 Tax Year

1.   Scholarships, Fellowships, Grants, and Tuition Reductions

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Table of Contents

Reminder

Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. Under this rule, a taxable scholarship or fellowship is compensation only if it is shown in box 1 of Form W-2, Wage and Tax Statement. For more information about IRAs, see Publication 590.

Introduction

This chapter discusses the tax treatment of various types of educational assistance you may receive if you are studying, teaching, or researching in the United States. The educational assistance can be for a primary or secondary school, a college or university, or a vocational school. Included are discussions of:

  • Scholarships,

  • Fellowships,

  • Need-based education grants, such as a Pell Grant, and

  • Qualified tuition reductions.

Many types of educational assistance are tax free if they meet the requirements discussed here.

Special rules apply to U.S. citizens and resident aliens who have received scholarships or fellowships for studying, teaching, or researching abroad. For information about these rules, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Scholarships and Fellowships

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.

A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.

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 Payments 1
  Do not rely on this table alone. Refer to the text for complete details.
  AND you are... THEN your payment is...
IF you use the payment for... A degree
candidate 		Not a
degree
candidate 		Tax free 2 Taxable
Tuition X   X  
    X   X
Fees X   X 3  
    X   X
Books X   X 3  
    X   X
Supplies X   X 3  
    X   X
Equipment X   X 3  
    X   X
Room X     X
    X   X
Board X     X
    X   X
Travel X     X
    X   X
1 Does not include payments received for past, present, or future services.
2 Payments used for any expenses indicated in this column are tax free only if the
terms of the scholarship or fellowship do not prohibit the expense.
3 If required of all students in the course.

Tax-Free Scholarships and Fellowships

A scholarship or fellowship is tax free only if:

  • You are a candidate for a degree at an eligible educational institution, and

  • You use the scholarship or fellowship to pay qualified education expenses.

Candidate for a degree.   You are a candidate for a degree if you:

  1. Attend a primary or secondary school or are pursuing a degree at a college or university, or

  2. Attend an accredited educational institution that is authorized to provide:

    1. A program that is acceptable for full credit toward a bachelor's or higher degree, or

    2. A program of training to prepare students for gainful employment in a recognized occupation.

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:

  • Tuition and fees required to enroll at or attend an eligible educational institution, and

  • Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.

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:

  • Room and board,

  • Travel,

  • Research,

  • Clerical help, or

  • Equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution.

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.

Worksheet 1.1.   You can use Worksheet 1-1 to figure the tax-free and taxable parts of your scholarship or fellowship.

  
Worksheet 1-1.Taxable Scholarship and Fellowship Income
1. Enter your scholarship or fellowship income for 2006 1.    
 

  • If you are a degree candidate at an eligible educational institution, go to line 2.

  • If you are not a degree candidate at an eligible educational institution, stop here. The entire amount is taxable. For information on how to report this amount on your tax return, see Reporting Scholarships and Fellowships.

     
2. Enter the amount from line 1 that was for teaching, research, or any other services. (Do not include amounts received for these items under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.) 2.    
3. Subtract line 2 from line 1 3.    
4. Enter the amount from line 3 that your scholarship or fellowship required you to use for other than qualified education expenses 4.    
5. Subtract line 4 from line 3 5.    
6. Enter the amount from line 5 that was used for qualified education expenses required for study at an eligible educational institution. This amount is the tax-free part of your scholarship or fellowship income* 6.    
7. Subtract line 6 from line 5 7.    
8. Taxable part. Add lines 2, 4, and 7. See Reporting Scholarships and Fellowships for how to report this amount on your tax return 8.    
* If you qualify for other education benefits (see chapters 2 through 12), you may have to reduce the amount of education expenses qualifying for a specific
benefit by the tax-free amount on this line.

Athletic Scholarships

An athletic scholarship is tax free if it meets the requirements discussed above.

Taxable Scholarships and Fellowships

If your scholarship or fellowship does not meet the requirements described earlier, it is taxable. The following amounts received may be taxable.

  • Amounts used to pay expenses that do not qualify.

  • Payments for services.

  • Scholarship prizes.

Each type is discussed below.

Amounts used to pay expenses that do not qualify.   A scholarship amount you use to pay any expense that does not qualify is taxable, even if the expense is a fee that you must pay to the institution as a condition of enrollment or attendance.

Payment for services.   Generally, you must include in income the part of any scholarship, fellowship, or tuition reduction that represents payment for past, present, or future teaching, research, or other services. This applies even if all candidates for a degree must perform the services to receive the degree.

Exceptions.   You do not have to include in income the part of any scholarship or fellowship that represents payment for teaching, research, or other services if you receive the amount under:

  • The National Health Service Corps Scholarship Program, or

  • The Armed Forces Health Professions Scholarship and Financial Assistance Program,

and you:

  • Are a candidate for a degree at an eligible educational institution, and

  • Use that part of the scholarship or fellowship to pay qualified education expenses.

Example 1.

You received a scholarship of $2,500. The scholarship was not received under either of the exceptions mentioned above. As a condition for receiving the scholarship, you must serve as a part-time teaching assistant. Of the $2,500 scholarship, $1,000 represents payment for teaching. The provider of your scholarship gives you a Form W-2 showing $1,000 as income. You used all the money for qualified education expenses. Assuming that all other conditions are met, $1,500 of your scholarship is tax free. The $1,000 you received for teaching is taxable.

Example 2.

You are a candidate for a degree at a medical school. You receive a scholarship (not under either of the exceptions mentioned above) for your medical education and training. The terms of your scholarship require you to perform future services. A substantial penalty applies if you do not comply. The entire amount of your grant is taxable as payment for services in the year it is received.

Scholarship prizes.   If you win a scholarship as a prize in a contest, the scholarship is fully taxable unless you meet the requirements discussed earlier under Tax-Free Scholarships and Fellowships.

Reporting Scholarships and Fellowships

Whether you must report your scholarship or fellowship depends on whether you must file a return and whether any part of your scholarship or fellowship is taxable.

If your only income is a completely tax-free scholarship or fellowship, you do not have to file a tax return and no reporting is necessary. If all or part of your scholarship or fellowship 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 or not you received a Form W-2. If you receive an incorrect Form W-2, ask the payer for a corrected one.

For information on whether you must file a return, see Publication 501, Exemptions, Standard Deduction, and Filing Information, or your income tax form instructions.

How To Report

How you report any taxable scholarship or fellowship income depends on which return you file.

Form 1040EZ.   If you file Form 1040EZ, report the taxable amount on line 1. If the taxable amount was not reported on Form W-2, enter “SCH” and the taxable amount in the space to the left of line 1.

Form 1040A.   If you file Form 1040A, report the taxable amount on line 7. If the taxable amount was not reported on Form W-2, enter “SCH” and the taxable amount in the space to the left of line 7.

Form 1040.   If you file Form 1040, report the taxable amount on line 7. If the taxable amount was not reported on Form W-2, enter “SCH” and the taxable amount on the dotted line next to line 7.

Schedule SE (Form 1040).   Include amounts you receive under a scholarship as pay for your services as an independent contractor in determining your net earnings from self-employment. If your net earnings are $400 or more, you will have to pay self-employment tax. Use Schedule SE, Self-Employment Tax, to figure this tax.

   For more information in determining whether you are an independent contractor or an employee, get Publication 15-A, Employer's Supplemental Tax Guide.

Form 1040NR.   If you file Form 1040NR, report the taxable amount on line 12. You must generally report the amount shown in Form(s) 1042-S, box 2. See the instructions for Form 1040NR for more information on reporting fellowship and scholarship income on Form 1040NR.

Form 1040NR-EZ.   If you file Form 1040NR-EZ, report the taxable amount on line 5. You must generally report the amount shown in Form(s) 1042-S, box 2. See the instructions for Form 1040NR-EZ for more information on reporting fellowship and scholarship income on Form 1040NR-EZ.

Other Types of Educational Assistance

The following discussions deal with common types of educational assistance other than scholarships and fellowships.

Fulbright Grants

A Fulbright grant is generally treated as a scholarship or fellowship in figuring how much of the grant is tax free. You have to report only the taxable amount. See Reporting Scholarships and Fellowships earlier in this chapter.

Pell Grants and Other Title IV Need-Based Education Grants

These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax free to the extent used for qualified education expenses during the period for which a grant is awarded. You have to report only the taxable amount. See Reporting Scholarships and Fellowships earlier in this chapter.

Payment to Service Academy Cadets

An appointment to a United States military academy is not a scholarship or fellowship. Payment you receive as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to you in box 1 of Form W-2. Include this pay in your income in the year you receive it unless one of the exceptions, discussed earlier under Payment for services, applies.

Veterans' Benefits

Payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. Do not include these payments as income on your federal tax return.

If you qualify for one or more of the education benefits discussed in chapters 2 through 12, you may have to reduce the amount of education expenses qualifying for a specific benefit by part or all of your VA payments. This applies only to the part of your VA payments that is required to be used for education expenses.

Qualified Tuition Reduction

If you are allowed to study tuition free or for a reduced rate of tuition, you may not have to pay tax on this benefit. This is called a “tuition reduction.” You do not have to include a qualified tuition reduction in your income.

A tuition reduction is qualified only if you receive it from an eligible educational institution and use it at an eligible educational institution. You do not have to use the tuition reduction at the eligible educational institution from which you received it. In other words, if you work for an educational institution and the institution arranges for you to take courses at another educational institution without paying any tuition, you may not have to include the value of the free courses in your income.

The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education.

You must include in your income any tuition reduction you receive that is payment for your services.

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.

Officers, owners, and highly compensated employees.   Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, officers, or highly compensated employees.

Education Below the Graduate Level

If you receive a tuition reduction for education below the graduate level (including primary, secondary, proprietary, or high school), it is a qualified tuition reduction, and therefore tax free, only if your relationship to the educational institution providing the benefit is described below.

  1. You are an employee of the eligible educational institution.

  2. You were an employee of the eligible educational institution, but you retired or left on disability.

  3. You are a widow or widower of an individual who died while an employee of the eligible educational institution or who retired or left on disability.

  4. You are the dependent child or spouse of an individual described in (1) through (3), above.

Child of deceased parents.   For purposes of the qualified tuition reduction, a child is a dependent child if the child is under age 25 and both parents have died.

Child of divorced parents.   For purposes of the qualified tuition reduction, a dependent child of divorced parents is treated as the dependent of both parents.

Graduate Education

A tuition reduction you receive for graduate education is qualified, and therefore tax free, if both of the following requirements are met.

  • It is provided by an eligible educational institution.

  • You are a graduate student who performs teaching or research activities for the educational institution.

You must include in income any other tuition reductions for graduate education that you receive.

How To Report

Any tuition reduction that is taxable should be included as wages in box 1 of your Form W-2. Report the amount in box 1 on line 7 (Form 1040 or Form 1040A) or line 1 (Form 1040EZ).

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