We recently received an interesting question from a client that I know many of you may have as well:
“My son-in-law is doing a PhD and has an NSF Fellowship from the government. Interestingly, the government does not take out taxes nor provide a W2 or 1099 form. I presume that the income is taxable but the government site says “it may be taxable income”. Are there any situations when this income would not be taxable?”
It’s our understanding that this income is subject to federal and state income taxes, but is not subject to Social Security or Medicare taxes. A lot of people receiving these grants don’t think the income is taxable since no tax form is provided. Grants and scholarships are taxable to the extent that the money received exceeds tuition paid.
Here are the rules from the IRS:
Scholarships and Fellowships
A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student may be either an undergraduate or a graduate. A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. Generally, whether the amount is tax free or taxable depends on the expense paid with the amount and whether you are a degree candidate.
A scholarship or fellowship is tax free only if you meet the following conditions:
- You are a candidate for a degree at an eligible educational institution.
- You use the scholarship or fellowship to pay qualified education expenses.
Qualified Education Expenses
For purposes of tax-free scholarships and fellowships, these are expenses for:
- Tuition and fees required to enroll at or attend an eligible educational institution.
- Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.
However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.
Expenses that Don’t Qualify
Qualified education expenses do not include the cost of:
- Room and board.
- Clerical help
- Equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution.
This is true even if the fee must be paid to the institution as a condition of enrollment or attendance. Scholarship or fellowship amounts used to pay these costs are taxable.