Understanding the Tax Consequences of College Scholarships and Financial Assistance

A federal employee has a child entering college this fall. The child is fortunate to have received a scholarship to help reduce their high cost of higher education. The question then becomes whether the scholarship is considered taxable income to the child and/or parent. With the 2026-2027 academic year fall semester starting soon, this is an important question. This column discusses the tax consequences of scholarships and other financial assistance.

The question of whether scholarships are taxable or nontaxable is an important question for families to consider, especially for higher income families. This is because a full-time college student who is from an upper income family could owe federal income tax (and probably state income tax) on the amount of the scholarship, with the amount of federal income tax determined  at the child’s  parents’ federal marginal tax bracket  rather than at the child’s lower marginal tax bracket. This is a result of the “Kiddie Tax” which is discussed in a recent FEDZONE column entitled “Parents and Grandparents Should Beware of the Kidde Tax When Helping Their Children and Grandchildren”.

Knowing  Which Type of Financial Assistance Is Tax-Free and Which Is Taxable

Scholarships and fellowships received by a degree candidate and which are used to pay tuition, enrollment fees, books, supplies and equipment that are required for courses given at the educational institution, are excluded from income.

The key here is required for the course given at the educational institution. If a student uses  a portion of scholarship money to buy a computer that is not required for a course of study, then that portion of the scholarship money is considered taxable income. Financial assistance received by a student who is not a candidate for a degree is also taxable. A degree candidate includes the following: (1) A primary or secondary school student; (2) A college undergraduate or graduate student; or (3) A full-time or part-time student at an accredited educational institution that provides a program that is acceptable to full credit toward a bachelor’s or higher degree. Also included are programs of training to prepare students for gainful employment in a recognized occupation.

The following table presents a tax summary with respect  the use of funds emanating from scholarships and fellowships:

Tax Summary – Scholarships and Fellowships

¹ Amounts used for these expenses are nontaxable only if the terms of the scholarship or fellowship do not prohibit the expense.

² If required of all students in the course.

Understanding IRS Form 1098-T

Each year, colleges and universities must issue both to students and to the IRS Form 1098-T  showing tuition paid and scholarships awarded. A sample Form 1098-T for the year 2026 is shown:

Understanding the Tax Consequences of College Scholarships and Financial Assistance

Note the following boxes on Form 1098-T: (1) Box 1 shows qualified tuition and related expenses paid by or on behalf of the student; (2) Box 5 shows the amounts of scholarships or grants from the institution to the student.

There are some questions associated with Form 1098-T. For example,  Form 1098-T does not break down whether any portion of the scholarship or grant money is taxable income. If, for example, a student uses scholarship money to pay room and board expenses, it is up to the student and parents to keep records and report the amount of taxable income on their federal income tax return . Both IRS Publication 970 (Tax Benefits for Education), and IRS Tax Topic 421 (Scholarships, Fellowship Grants and Other Grants) provide information on how to report taxable amount of scholarships and grants on the student’s or parent’s federal income tax return.

Coordinating Financial Assistance Via Scholarships and 529 Withdrawals to Minimize Federal Income Tax Exposure

Many parents who save for their children’s college expenses use tax-favored 529 college savings accounts. Withdrawals from 529 college savings accounts are tax-free when used to pay eligible education expenses. The tax rules for making tax-free withdrawals using 529 accounts tend to be more generous than the tax rules for using scholarships and fellowship money.

For the purpose of minimizing income tax exposure, planning is important when it comes to using 529 college savings account. For example, if a student is enrolled at least half-time, 529 college savings accounts withdrawals are tax-free to pay room and board expenses. This is unlike scholarship dollars that are taxable when used to pay room and board expenses (see table above). Another example, those students living and eating off campus can make tax-free 529 college savings plan withdrawals in order to pay rent and grocery bills. These withdrawals are limited to the college or university’s room and board charges.

The are other considerations for those students who have a mixture of scholarship money and 529 plan college savings accounts. Up to $10,000 of 529 account funds can be withdrawn tax-free each year in order to pay down student loans. 529 plan college savings plan tax-free withdrawals can also be used for graduate education, professional school (medical school, dental school, law school) education as well as undergraduate education .

IRS Enforcement on College Scholarship and Financial Assistance

According to Mark Kantrowitz, a nationally recognized expert on student financial aid, scholarships, student loans, college savings plans and education tax benefits, there is almost no IRS enforcement of the tax rules regarding use of college scholarship and fellowship aid when paying higher education expenses. As a result, students and parents who make every effort to keep good records of payments of their educational expenses and make reasonable efforts to comply with IRS rules have little to fear in case of an IRS audit.

Ed Zurndorfer, EA, ATA, CFP®, CLU®, ChFC®, CEBS®, ChFEBC℠: Federal Employee Benefits Expert

A former career Federal employee, Ed has published a staggering 1,200+ separate articles on Federal Benefits and Retirement! Just “Google” his name, and you are likely to find a plethora of sites that contain his writings. Drawn to its mission to reach, teach and serve Feds, Serving Those Who Serve is the only financial planning practice with which Ed has chosen to affiliate in over 20 years teaching. In addition to conducting Federal Benefits seminars for Serving Those Who Serve, you can find Ed’s writings here on our blog in the FedZone, and on Fed-Soup, MyFederalRetirement, FederalNews Radio and NITP.

He is a member of the Maryland Society of Accountants, the National Association of Enrolled Agents, the International Society of Certified Employee Benefits Specialists, the Financial Planning Association, the National Association of Health Underwriters, and the Society of Financial Service Professionals. Since 1999, Ed has taught many thousands of Federal employees about their benefits, in person and at Federal agencies all over the country. Ed is a true national treasure.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street – Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.