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Set your sights on tax-free college scholarships

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in Small Business Tax

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

Strategy: Aim for tax-free scholarships. That doesn’t mean your family should turn down awards that are taxable. But a tax-free scholarship provides more bang for the buck.

“I thought all college scholarships were tax-free,” you might say. That’s a common misconception. In reality, some scholarships are completely exempt from tax, some are fully taxable and others are split.

Here’s the drill: If your child is not a degree candidate, the entire amount of the scholarship is taxable. Conversely, if your child is pursuing a degree, any amounts earmarked for tuition or course fees are exempt from federal income tax. Also, 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 student attends a primary or secondary school or is pursuing a degree at a college or university.
  • The student attends an accredited educational institution authorized to provide either (1) a program that is acceptable for full credit toward a bachelor’s or higher degree or (2) a program of training to prepare students for gainful employment in a recognized occupation.

What if a scholarship is used to pay for room and board instead of tuition? In this case, the full amount is subject to tax, whether or not your child is a candidate for a degree. The same thing is true for wages received for teaching or research services that are a condition of a scholarship or fellowship.

Tip: For more details, see IRS Pub. 970, Tax Benefits for Education.

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