Scholarships/Grants and Fellowships

What is a scholarship/grant and Fellowship?

According to the IRS…

A scholarship/grant is generally an amount of money 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 student.

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

Are Scholarships/Grants and Fellowships Tax-Free?

Many individuals feel scholarships/grants and fellowships are always tax-free.  But this is not true, according to the IRS and Congress.

Here is what is IRS says a tax-free scholarship/grant or fellowship is:

According to the IRS…

A scholarship/grant or fellowship is tax free only if:

You are a candidate for a degree at an eligible education institution, and you use the scholarship or fellowship to pay qualified educational expenses.

Now this sounds pretty straightforward.  Reading the definition, it is clear that most students will be attending college or other forms of post-secondary educational institution in order to get a degree and whatever the institutions bills you is a qualified expense.

Most individuals reading this explanation would come to the conclusion that the above statement is true. 

However, the statement is not totally true.  You have to look into the IRS’s definition a little further to find the correct answer.

For example:

What Is A Qualified Educational Institution:

According to the IRS…

An eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regular enrolled body of students in attendance at the place where it carries on its educational activities.

 This definition covers almost all institutions that provide a course of study above high school.  But what the definition is not telling you is the institution that is giving the education must also be qualified institution.

A qualified institution is a place of learning that participates in the federal financial aid system.  So if you attend a place of learning that does not provide or make available  financial aid from the federal government it is NOT a qualified institution.

Many schools fall in this category.  Most are specialized schools such as computer training, car repair, hair dressers, real estate programs, insurance/security training etc.

Now What Is Meant By Qualified Educational Expenses:

According to the IRS…

For the purposes of tax-free scholarships/grants 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 course at the eligible educational institution. These items must be required of all students in the course of instruction.

If the scholarship/grant or fellowship is used for the items we just went over, the scholarship/grant or fellowship is TAX-FREE.  Tax-Free scholarships/grants and fellowships are normally call QUALIFIED scholarships/grants and fellowships.

However, if the scholarship/grant or fellowship dictates the funds cannot be used for tuition/fees and course related expenses the scholarship/grant or fellowship is now reclassified as a NON-QUALIFIED scholarship/grant or fellowship.

What Are Non-Qualified Expenses:

According to the IRS…

Expenses that are not qualified are as follows:

• Room and Board
• Travel
• Research
• Clerical Help, or
• Equipment and other expenses that are not required for enrollment in or attendance at an eligible education institution.

This is true even if the college or university requires you to pay for these items as a condition for enrollment or attendance and you pay the institution directly.

Now the IRS says the above items are not qualified expenses for the tax-free treatment of scholarships/grants or fellowships, but how is the student able to get a degree WITHOUT living somewhere, traveling to the institution, and purchasing needed equipment (computer, calculators, etc.)?

Well, the IRS and Congress has come to the conclusion, that the student can live with a relative or parents and not on campus.  They also believe the travel to the institution is a personnel expense.  They also have come to the conclusion that computers, calculators, etc. are not necessary equipment that needs to be bought, even if the professor tells the student they need the computer or calculator to take the class. 

The IRS and Congress think the student can get access to these items at the library or borrow them from a classmate.

Now here is where it really get ridiculous.  If the college or institution REQUIRES ALL students that are taking a course of study MUST purchase special equipment (computers, calculators, etc.), then the purchase of these items now have been reclassified as Qualified Educational Expenses and scholarships/grants or fellowships can be used to purchase these items and will be Tax-Free to the student.