The College Funding Coach team hopes that you were still able to celebrate St. Patrick’s Day in these uncertain times, even if it meant staying at home with family or close friends and embracing the classic St. Patrick’s Day “Spirit(s).”
St. Paddy’s Day, Awkward Moments, and Taxes
March 17th brings about a pure sense of glee and happiness that doesn’t come too often, but if you’ve ever read the words “Congratulations! You have been awarded (insert scholarship or grant name here)” in a letter from a university your child plans to attend, then you’ve undoubtedly experienced that joy once again.
On the other hand, many of us have also become familiar with the “feelings” on March 18th, also known as National Awkward Moments Day. For many, the merriment of St. Patrick’s Day is directly linked to the ensuing sensations of Awkward Moments Day and, in a way, that scholarship and/or grant award letter may carry with it a similar sensation. Just as March 18th may have an awkward moment waiting for you at your 5th cup of coffee, the day after an award letter is received may spark the worrisome question “Is this award really free? Or will unforeseen tax liabilities spoil the fun?”
Maybe the comparison of St. Patrick’s Day to an award letter is a bit of a stretch, but being preemptively aware of the potential tax liabilities of grants and scholarships is equally if not more valuable than having that Pedialyte and/or Aspirin on your bedside table to wake up to.
To help prepare for that feeling, this post will first compare grants and scholarships, then explain any potential tax consequences that may be associated with each.
Grants vs Scholarships
Both grants and scholarships are types of financial aid that are free money (“gift aid”) in the sense that they do not have to be repaid.
Grants are typically disbursed by the government and aim to support undergraduate students’ families that have demonstrated financial need eligibility in paying for their tuition.
Most federal grants have only one requirement: you must fill out the Free Application for Federal Student Aid, more commonly known as the FAFSA. In order to be eligible for these grants, a family must fill out the FAFSA each year. Many families miss out on these grants because they do not continue to apply once their child has started attending his/her university!
Scholarships, on the other hand, are typically merit-based and offered to students by non-governmental agencies that are funded by university endowments, businesses, religious groups, community organizations, etc. These scholarships are awarded dependent on any number of factors like academic achievements and/or extra-curricular merit. Requirements for scholarships vary greatly and can include components such as an application, an essay, or organizational involvement (e.g. Boy Scouts of America Scholarships).
For all intents and purposes, grants and scholarships are similar in that they are both free money for tuition and are not expected to be repaid. However, they differ greatly in eligibility, requirements, and most importantly, how they are funded.
Since grants are typically provided by the government, stipulations are in place to ensure that they are used only for qualified educational expenses meaning you will not have to report them to taxes.
In contrast, scholarships are much broader in their stipulations and use. This flexibility can be advantageous but is also the feature that can make a scholarship taxable as income.
So, What Will Get Taxed?
When determining if financial aid is taxable, you can follow this general guideline: if a grant and/or scholarship is used to pay for qualified educational expenses (i.e. tuition, fees, and books/supplies/equipment required for coursework), then they are tax-free. But if any amount is used for non-qualified expenses (i.e. room, board, travel, research, books/supplies/equipment not required for coursework), then the amount used would be reported as taxable income.
This guideline applies to both grants and scholarships equally. However, scholarships hold an extra wrinkle that is rarely, if ever, present in grants. Scholarships have accompanying documents that spell out the terms and conditions of the awards. These stipulations may include selection criteria, continuation of funds requirements, and most relevantly how the funds are intended to be used. To illustrate why the latter consideration is so important, let’s use an example.
Let’s assume that your son or daughter has been awarded the “St. Patrick’s Place to Sleep” scholarship and the documents that accompany it stipulate that the funds are earmarked to pay for room and board.
Next, let’s assume that your son or daughter has been selected as a resident advisor on campus. Upon accepting, you’re informed that his/her room and board is now free in exchange for fulfilling the duties of the role. Now that room and board are free, you decide that the funds from the “St. Patrick’s Place to Sleep” scholarship would be better served paying for tuition and required textbooks. This is where that awkward moment sets in.
Although tuition and required books are typically considered qualified educational expenses, the scholarship funds that you used were specifically earmarked for room and board. Because of that stipulation in the documents, any amount used would have to reported as taxable income.
It’s Vital to Understand the Stipulations Behind This “Free Money”
So, are grants and scholarships taxable? If so, how do you know? Just like the answer to the question “how will I feel come March 18th?” it’s all about being prepared.
Financial aid in the form of grants and scholarships is meant to do just as the name implies: aid your family in handling the costs of higher education.
The determining factor on how helpful it truly is, and how it will be treated from a tax standpoint, is dependent on how you use it. Understanding the terms and conditions of your financial aid, and knowing the accompanying stipulations, will be key in adding them to your college funding plan. They are just one more puzzle piece that contributes to the greater picture of a successful plan, and to know how to use them most effectively is admittedly a tall task.
National Awkward Moments Day may blindside you, but don’t let college funding blindside you as well. The College Funding Coach team is ready and excited to help you put the puzzle together and demystify the awkward process of successfully paying for college while simultaneously accomplishing your goals!
CFC Virginia – Richmond Team