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While scholarships won't get you any tax benefits, their status as a form of free money financial aid makes them tax exempt, which makes it easy for students to apply their funding. It is important to look at the fine print when accepting tax-free scholarships, though, because, in certain circumstances, they can be taxable.
Depending on what college or university you attend, your scholarship money may be considered taxable income. You must attend one of the schools that the IRS considers an eligible educational institution.
To see if your school is an eligible institution, you can go on the U.S. Department of Education’s Database of Accredited Post Secondary Institutions and Programs (DAPIP) or the Federal Student Loan Program list. If your school or lender is not on one of these lists, you can always ask your school if they are an eligible educational institution.
Additionally, scholarship money can only be applied to qualified education expenses. These qualified expenses include the price of tuition and other degree-related costs or other expenses related to education. Room and board and other living expenses aren't considered qualified education expenses, so a portion of your scholarship will be taxable if you use it for these purposes. Scholarships considered taxable income occur when all the money is not used towards eligible costs, such as tuition, course fees, and book expenses, meaning they will no longer be a tax-free scholarship.
If you receive the funds in exchange for providing services such as teaching, research, helping out in the admissions office, or even other college related costs that aren't qualified, the money becomes taxable, or at least the portion related to payment for your services is considered income.