Study tax-free scholarship rules

Is your child a high school senior? A gifted student may qualify for a college scholarship based on talent, experience, or achievement.

Strategy: Have your child aim for tax-free scholarships. While not suggesting overlooking taxable awards, prioritizing tax-free scholarships can optimize the value received. It’s a common misconception that all scholarships are tax-free. Some are completely exempt from tax, some are fully taxable, and others are split.

Here’s the whole story: If your child isn’t a degree candidate, the entire amount of the scholarship is taxable. Conversely, if your child is pursuing a degree, any scholarships earmarked for tuition and fees are exempt from federal income tax. Additionally, the IRS says that no tax is due on amounts used to pay for books, school supplies, and equipment that are mandatory. However, if a professor merely suggests that a particular purchase would be helpful for completing a project, the exemption doesn’t apply. The IRS treats a student as a degree candidate if the child: • Attends a primary or secondary school or is pursuing a degree at a college or university, or • Attends an educational institution that (1) provides a program that is acceptable for full credit toward a bachelor’s or higher degree or offers a program of training to prepare students for employment in a recognized occupation, and (2) is authorized under federal or state law to provide such a program and is accredited by a nationally recognized accreditation agency. Suppose that a scholarship is used to pay for room and board instead of tuition—the full amount is subject to tax, regardless of whether the child is a candidate for a degree. The same is true for wages received for teaching or research services that are a condition of receiving a scholarship or fellowship.

Tip: Find more details in IRS Pub. 970, Tax Benefits for Education, at www.irs.gov/ publications/p970.