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Grab a passing grade with tax-free scholarships

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in Small Business Tax

If your child will start college or return to high school for his or her senior year this fall, he or she may qualify for a scholarship award based on talent, experience or achievement.

Strategy: Have your child focus on tax-free scholarships or fellowships.

That’s not to say you should turn down taxable awards. After all, every little bit helps. But all things being equal, concentrate efforts on securing the greatest after-tax benefit.

“I thought all college scholarships were tax-free,” you might say. That’s a common misconception.

The crux of the matter: If your child is not a degree candidate, the entire scholarship amount is taxable. Conversely, if your child is pursuing a degree, any amounts earmarked for tuition or course fees are exempt from federal income tax.

The IRS treats a student as a degree candidate only if:

-He or she attends a primary or secondary school or is pursuing a degree at a college or university; or

-He or she attends an accredited education institution that is authorized to provide either (1) a program that’s 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.

In addition, Uncle Sam claims no tax on amounts used to pay for mandatory books, school supplies and equipment. (If a professor merely suggests that a particular purchase would help complete a project, for example, the exemption doesn’t apply.)

What if your child uses the scholarship to pay for room and board instead of tuition or some other IRS-approved expense? The full amount is subject to tax: in this case, whether or not your child is a candidate for a degree.

The same applies to wages received for teaching or research services that are a condition of the scholarship or fellowship.

Tip: For more details, consult IRS Pub. 970 (Tax Benefits for Education). It’s available at

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