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Pell Grants and Other Title IV Need-Based Education Grants These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax free to the extent used for qualified education expenses during the period for which a grant is awarded. Payment to Service Academy Cadets An appointment to a U.S. military academy isn't a scholar- ship or fellowship grant. Payment you receive as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to you in box 1 of Form W-2. Include this pay in your income in the year you receive it. Veterans' Benefits Payments you receive for education, training, or subsis- tence under any law administered by the Department of Veterans Affairs (VA) are tax free. Don't include these payments as income on your federal tax return. If you qualify for one or more of the education tax bene- fits discussed in chapters 2 through 11, you may have to reduce the amount of education expenses qualifying for a specific tax benefit by part or all of your VA payments. This applies only to the part of your VA payments that is required to be used for education expenses. You may want to visit the Veterans Administration web- site at www.gibill.va.gov for specific information about the various VA benefits for education. Example. You have returned to college and are re- ceiving two education benefits under the latest GI Bill: (1) a $1,534 monthly basic housing allowance (BHA) that is directly deposited to your checking account, and (2) $3,840 paid directly to your college for tuition. Neither of these benefits is taxable and you don't report them on your tax return. You also want to claim an American op- portunity credit on your return. Your total tuition charges are $5,000. To figure the amount of credit, you must first subtract the $3,840 from your qualified education expen- ses because this payment under the GI Bill was required to be used for education expenses. You don't subtract any amount of the BHA because it was paid to you and its use wasn't restricted. Qualified Tuition Reduction If you are allowed to study tuition free or for a reduced rate of tuition, you may not have to pay tax on this benefit. This is called a “tuition reduction.” You don't have to include a qualified tuition reduction in your income. A tuition reduction is qualified only if you receive it from, and use it at, an eligible educational institution. You don't have to use the tuition reduction at the eligible educational institution from which you received it. In other words, if you work for an eligible educational institution and the institution arranges for you to take courses at another eli- gible educational institution without paying any tuition, you may not have to include the value of the free courses in your income. The rules for determining if a tuition reduction is quali- fied, and therefore tax free, are different if the education provided is below the graduate level or is graduate educa- tion. You must include in your income any tuition reduction you receive that is payment for your services. Eligible educational institution. An eligible educational institution is one that maintains a regular faculty and cur- riculum and normally has a regularly enrolled body of stu- dents in attendance at the place where it regularly carries on its educational activities. Officers, owners, and highly compensated employ- ees. Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, offi- cers, or highly compensated employees. Payment for services. Generally, you must include in in- come the part of any qualified tuition reduction that repre- sents payment for teaching, research, or other services by the student required as a condition of receiving the quali- fied tuition reduction. 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 include in income 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). Education Below the Graduate Level If you receive a tuition reduction for education below the graduate level (including primary and secondary school), it is a qualified tuition reduction, and therefore tax free, only if your relationship to the educational institution pro- viding the benefit is described below. 1. You are an employee of the eligible educational insti- tution. 2. You were an employee of the eligible educational in- stitution, but you retired or left on disability. Page 8 Chapter 1 Scholarships, Fellowship Grants, Grants, and Tuition Reductions