Are Scholarships Taxable by the IRS? By John D | February 26, 2014 0 Comment Are school scholarships taxable by the IRS? IRS Topic on Scholarships You must include in gross income amounts used for incidental expenses, such as room and board, travel, and optional equipment, and generally, amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. Also, you must include in income any part of the scholarship or fellowship that represents payments for services. What part of a scholarship is taxable? Basically, the portion of the scholarship used for tuition and fees, books, supplies, and equipment are not taxes. The amount over this you are receiving and using for discretionary expenses (Food, Lodging, Transportation, etc) is taxable. You basically got free money that didn’t need to be spent on what the IRS deems “qualified”, so they think you should pay tax on it. Yeah, it sucks. Students tend to get hit hard by that tax because they rarely claim their own exemption.The IRS states that tuition reduction is equal to you receiving a wage from the university, and then turning around and paying it back. This means it is taxable, but you are able to treat it as a tuition expense and claim the lifetime learning credit on the amount of taxable scholarship. See http://www.irs.gov/pub/irs-irbs/irb03-07.pdf American Opportunity Credit (AOTC) and Form 1098-T Info The American Opportunity credit that only allows you to use expenses such as tuition and fees reported by the school (i.e. 1098-T) less scholarships, however it offers the largest credit on its own than the other credits. The other education credits allow you deduct other educational expenses not reportable by the school, like books, supplies, etc. The downside, is the benefit is smaller than the American Opp credit. IRS Form 1098-T You must remember, everything on your 1098-T is reported to the IRS as well. Any mismatched numbers could trigger an audit down the road. With interest and penalties, it would be much higher than it is now (if changes are necessary). Also, the IRS has significantly increased collections over the past year. They are going after anyone and everyone they can find.