Scholarship money is tax-free income to the recipient if used to pay tuition and fees, or when used to pay for books, supplies, and equipment required by the curriculum. Anything received tax-free is a good thing . . . OR IS IT? What most people don’t know is that students are sometimes better off claiming their scholarship as taxable income, if permitted to do so. Why would one be better off reporting a scholarship as taxable income when it can be reported as tax-free income? If you work closely with your tax professional and use him for tax planning services rather than merely tax preparation services, you would better understand the many nuances of the tax laws.
The parents of a full-time student receiving a post-secondary education are generally aware that they are entitled to claim tuition tax credits. If the parents’ income is too great for them to claim the credit because of the income phase-outs in the tax law, they then instruct their child to claim the credit on the child’s tax return. However, a student receiving a tax-free scholarship must reduce tax-credit expenses by the scholarship amount. In some situations, this will actually increase the overall tax liability. This is where tax planning comes into play. If the scholarship allows the student to spend the money on room and board, transportation, or other non-qualifying expenses, by spending an appropriate amount on these expenditures allows the student to convert tax-free scholarship income to taxable income and allows the student to claim a greater tuition tax credit. Special considerations come into play for families with 529 plans.
Taxes are complicated, and many of the complications of this particular strategy, including eligibility rules and tax dependency issues, must be thoroughly analyzed before implementing this strategy. The taxpayer needs to analyze the different scenarios available to see which scenario results in the lowest tax liability.
If you want to learn more about planning strategies to pay for a college education, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA officeto discuss your situation. You can also schedule a consultation at Click Here.