FMS - Taxation of Scholarships and Fellowships - U.S. Residents Only
Generally, a scholarship or fellowship grant is a cash amount paid or allowed to, or for the benefit of, an undergraduate or graduate, to aid such individual in the pursuit of study or research. (IRS Treasury Regulation 1.117-3). A scholarship or fellowship grant may also be a reduction in the amount owed by the recipient to an educational organization for tuition, room and board, or any other fee.
Pell Grants, Supplemental Educational Opportunity Grants, and grants to states for state incentives are scholarships that are tax free to the extent they are used for qualifying tuition and course-related expenses during the grant period.
Qualified Scholarships (Excludable from Income):
A “qualified scholarship” is the amount of a scholarship or fellowship grant that can be excluded from the recipient’s income and is limited to the amount used for tuition and fees, books, supplies, and equipment required for courses. These items must be required of all students in your course of instruction to be tax free. (IRS Treasury Regulation 1.117-6(c)(2)). The amounts representing “qualified scholarships” are not subject to employment tax withholding or reporting requirements. However, no amount of a scholarship or fellowship grant received by a non-degree candidate is considered “qualified”, and thus is not excludable from wage income.
Non-Qualified Scholarships (Includable in Income):
Any amounts received for incidental expenses or by a non-degree candidate are taxable scholarships/fellowships. Incidental expenses include room and board, travel, and expenses for equipment and other items that are not required for either enrollment or attendance, or in a course of instruction. Pursuant to IRS Notice 87-31, the payor of a taxable scholarship/fellowship is not required to withhold income tax and is not required to report the payment either to the student or the IRS.
Compensation for Services (Includable in Income):
A recipient of a scholarship must include in gross income any amount which “...represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship...” (except in the case of the NHSCS or Armed Forces programs). Whether or not the services are required of all degree candidates is no longer a determinative factor. The disallowance from exclusion for amounts representing payment for services is true not only for cash payments, but also for amounts by which the tuition of the person performing services is reduced. Thus, tuition remission payments that represent compensation for services are not excludable.