The taxability of scholarships and fellowships generally depends on the type of expenses that are paid with the benefits, and whether the person receiving the benefits is a candidate for a degree. If you are a candidate for a degree, and your scholarship or fellowship is used to pay qualified education expenses such as tuition and fees, books, supplies, and equipment, your benefits would generally be tax-free. But any part of a scholarship or fellowship that is payment for past, present, or future services could be subject to tax.
For tax purposes, scholarships are amounts that benefit an undergraduate or graduate student attending an educational institution in pursuit of a degree. Fellowships are amounts paid for the benefit of an individual in the pursuit of study or research. In both cases, benefits that qualify for tax exclusion are those that are used to pay for qualified expenses of a degree candidate. So, whether the benefits are denominated as scholarships or as fellowships, their taxability depends on whether the beneficiary is a candidate for a degree, and how the benefits are spent.
Tax-Free Scholarships and Fellowships
The general conditions that must be met in order for your scholarships or fellowships to be tax-free are that:
You must be a candidate for a degree at an eligible educational institution, and
You must use the benefits of the scholarship or fellowship to pay for what are considered qualified education expenses.
Candidate for a Degree
You are considered a candidate for a degree, for tax purposes, if you are:
Attending primary or secondary school (leading to a high school diploma),
Pursuing a degree at a college or university (bachelor’s degree, master’s degree, doctor’s degree)
Attending an accredited educational institution in a program that is acceptable for full credit toward a bachelor’s or higher degree (two-year colleges or community colleges leading to an associate’ degree), or
Attending an accredited education institution in a program of training that prepares students for gainful employment in a recognized occupation (trade, vocational, and technical schools).
Eligible Educational Institution
An eligible educational institution, for tax purposes, is an institution that maintains a regular faculty and curriculum, and a regularly enrolled body of students at a place where educational activities are carried out.
Qualified Education Expenses
In order to be able to exclude scholarship and fellowship benefits from your taxable income, they must be used to pay qualified education expenses, including:
Tuitions and fees required to enroll and attend an eligible educational institution
Course-related expenses, such as books, supplies, and equipment used in the course, and any special fees. These expenses must be required of all the students in the course.
To order to qualify as tax-free, the scholarship or fellowship cannot require that it be used to pay for other expenses such as room and board.
Expenses that Do Not Qualify
Expenses that do not qualify include:
Room and board,
Travel,
Research,
Clerical help,
Equipment and other expenses that are not required for attendance.
Accordingly. if a scholarship or fellowship is used to pay for both qualified and unqualified expenses, part of the benefits are tax-free and part are taxable.