Is your child starting college this fall? If so, you may be knee-deep in the many financial considerations that attend higher education. You’re probably grateful if your child received scholarships, grants and other financial aid to help defray the cost — but not so grateful about potential tax exposure. When exactly is financial aid taxable and when is it not? Let’s take a look.
When aid is tax-free
Scholarships and grants, including Pell Grants and Fulbright Grants, are generally treated the same from a tax perspective. If scholarship or grant funds are used by a degree-seeking student to pay for qualified education expenses at eligible education institutions, they aren’t considered taxable income.
A degree-seeking student pursues studies for an associate, bachelor’s or higher degree at an eligible education institution. Eligible institutions provide programs with full course credits toward college degrees, or they offer training programs for students seeking gainful employment in recognized occupations. These institutions also must have received a nationally recognized accreditation status.
Qualified education expenses include tuition and fees, as well as course-related expenses (such as books, supplies and equipment) required in a student’s course of instruction. They don’t include room and board, however. To qualify, expenses must be required of all students taking the particular course. Optional expenses aren’t considered qualified.
When proceeds are subject to tax
If scholarship or grant proceeds are used for any external purposes, the money is considered unearned income and is subject to taxation. This includes funds left over after all qualified education expenses have been paid. Of course, students can use this money for other purposes, such as to pay for room and board, utilities, groceries or meals eaten out. But they’ll have to pay tax on it when they file income tax returns.
It's important to note that qualifying payments received through the Department of Veterans Affairs (including the GI Bill) generally aren’t taxable if used to pay for education or training. But if a student receives payment for teaching, research or other services that are required as a condition of receiving the scholarship or grant, this money is generally considered taxable income. Exceptions are made for services required by the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship and certain other programs.
When the “kiddie” tax comes into play
Another potential issue is the “kiddie” tax. This tax originally applied to children under 14 years old with unearned income, but its scope has progressively increased over the years. Now, the kiddie tax applies to some college students — specifically, children who are claimed as dependents and are under 19 years old, or full-time college students between 19 and 23 years old who have at least one living parent and aren’t married and filing joint tax returns with their spouses.
College students who meet one of these definitions and have unearned income worth more than twice the standard deduction amount for a dependent must complete IRS Form 8615 to determine how much tax is owed. The 2024 standard deduction for a dependent is $1,300 or the sum of $450 plus the individual’s earned income, not to exceed the regular standard deduction.
Don’t let it fall through the cracks
Right now you might feel a little overwhelmed by the financial details of sending a child to college. But don’t let tax issues fall through the cracks. Consult an experienced financial advisor.
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