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Target tax-free scholarships for college

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in Small Business Tax,Small Business Tax Deduction Strategies

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

Strategy: Have your child aim for tax-free scholarships.

Here’s the whole story: If your child is not a degree candidate, the entire amount of the scholarship is taxable. Conversely, if the child is pursuing a degree, any amounts earmarked for tuition or course fees are exempt from federal income tax. Also, 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
  • 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 gainful 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.

What if a scholarship is used only to pay for room and board instead of tuition? In that case, the full amount is subject to tax, whether or not 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 a scholarship or fellowship.

Tip: More details are available in IRS Pub. 970, Tax Benefits for Education.

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