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Tax-Free Scholarships and Fellowship Grants A scholarship or fellowship grant is tax free (excludable from gross income) only if you are a candidate for a de- gree at an eligible educational institution. You may be able to increase the combined value of an education credit and certain educational as- sistance if the student includes some or all of the educational assistance in income in the year it is received. See the examples underCoordination with Pell grants and other scholarships in chapter 2 and chapter 3. A scholarship or fellowship grant is tax free only to the extent: • It doesn't exceed your qualified education expenses; • It isn't designated or earmarked for other purposes (such as room and board), and doesn't require (by its terms) that it can't be used for qualified education ex- penses; and • It doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship. For exceptions, see Payment for serv- ices, later. Use Worksheet 1-1 to figure the amount of a scholar- ship or fellowship grant you can exclude from gross in- come. Candidate for a degree. You are a candidate for a de- gree if you: 1. Attend a primary or secondary school or are pursuing a degree at a college or university; or 2. Attend an educational institution that: a. Provides a program that is acceptable for full credit toward a bachelor's or higher degree, or of- fers a program of training to prepare students for gainful employment in a recognized occupation; and b. Is authorized under federal or state law to provide such a program and is accredited by a nationally recognized accreditation agency. Eligible educational institution. An eligible educational institution is one whose primary function is the presenta- tion of formal instruction and that normally maintains a regular faculty and curriculum and normally has a regu- larly enrolled body of students in attendance at the place where it regularly carries on its educational activities. Qualified education expenses. For purposes of tax-free scholarships and fellowship grants, these are ex- penses for: • Tuition and fees required to enroll at or attend an eligi- ble educational institution; and • Course-related expenses, such as fees, books, sup- plies, and equipment that are required for the courses at the eligible educational institution. These items TIP must be required of all students in your course of in- struction. Expenses that don't qualify. Qualified education ex- penses don't include the cost of: • Room and board, • Travel, • Research, • Clerical help, or • Equipment and other expenses that aren't required for enrollment in or attendance at an eligible educational institution. Payment for services. Generally, you can't exclude from your gross income the part of any scholarship or fel- lowship grant that represents payment for teaching, re- search, or other services required as a condition for re- ceiving the scholarship. This applies even if all candidates for a degree must perform the services to receive the de- gree. However, see Exceptions next. Exceptions. You don't have to treat as payment for services the part of any scholarship or fellowship grant that represents payment for teaching, research, or other services if you receive the amount under: • The National Health Service Corps Scholarship Pro- gram, • The Armed Forces Health Professions Scholarship and Financial Assistance Program, or • A comprehensive student work-learning-service pro- gram (as defined in section 448(e) of the Higher Edu- cation Act of 1965) operated by a work college (as de- fined in that section). Example 1. You received a scholarship of $2,500. The scholarship wasn't received under any of the exceptions mentioned above. As a condition for receiving the scholar- ship, you must serve as a part-time teaching assistant. Of the $2,500 scholarship, $1,000 represents payment for teaching. The provider of your scholarship gives you a Form W-2 showing $1,000 as income. Your qualified edu- cation expenses were at least $1,500. Assuming that all other conditions are met, the most you can exclude from your gross income is $1,500. The $1,000 you received for teaching must be included in your gross income. Example 2. You are a candidate for a degree at a medical school. You receive a scholarship (not under any of the exceptions mentioned above) for your medical edu- cation and training. The terms of your scholarship require you to perform future services. A substantial penalty ap- plies if you don't comply. The entire amount of your grant is taxable as payment for services in the year it is re- ceived. Athletic Scholarships An athletic scholarship is tax free only if and to the extent it meets the requirements discussed earlier. Page 6 Chapter 1 Scholarships, Fellowship Grants, Grants, and Tuition Reductions