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Funds And Taxes For The College Student
By Jerald R. Gober
Funds college students receive from certain sources
can have unusual tax liability results under federal tax laws. While it
is widely assumed that scholarship funds are not income for tax liability
purposes, situations can arise where taxable income is created. The type
of employment, institution, or enrollment or degree candidacy status may
each have an effect on income being included in the social security tax
base.
Types Of Income
A common source of income for students is the scholarship or grant. Most
scholarships have no restrictions as to how the funds are spent. These
funds are not part of income for taxation or subject to social security
when spent on tuition or fees, books, supplies, or equipment required
for courses.1 A tax liability situation may arise from scholarship funds
that are used to pay for room and board, or exceed the amount spent for
tuition, fees, etc. These excess amounts are taxable for federal income
tax, but not for social security as the student is not considered to be
self-employed. Receiving multiple scholarships or a "full" scholarship
(including funds for room and board) can result in a student receiving
funds in excess of the tax law limitation on spending for tuition, fees,
etc.
Institutions are inconsistent in reporting the income to the student for
tax purposes. While most taxable income is reported on a W-2 Form or a
Form 1099, there are no requirements that scholarship funds be reported.
However, nonreceipt of a reporting form does not make income nontaxable.
Compliance by colleges for the withholding of 14% of the taxable amount
of scholarships, which is received by foreign students, is also sporadic.
A fellowship is generally funds received while doing graduate work beyond
the undergraduate degree. These funds, like scholarship funds, are not
taxable if used for tuition, fees, etc. The funds become taxable if they
are received for services performed that are not a degree requirement.
these services may include teaching, research, etc.
The receipt of funds for tax purposes is not necessarily restricted to
the calendar year in which received. Receipt of scholarship funds for
an academic school year, which are in excess of the amount required for
tuition, etc., for the fall semester, can be used in the spring or summer
of the next year and any excess would be taxable income in the second
year. This allows some carry-over between years and discretion in spending.
In the event the scholarship or fellowship is received by an individual
who is not a candidate for a degree, other limitations apply.2 These limitations
are in the form of amount received and the time period in which the funds
are received. Fund sources can also determine the taxable status of the
funds.
The "work-study" program that many students participate in is
another source of funds. The program is normally administered through
the university's financial aid office. A student in this program is required
to work part-time for the institution. All income received is taxable
for federal income tax purposes, because the student is performing services
that are in the nature of part-time employment.3 An exception applies
when the work is required as part of the degree program. The "work-study"
income may be exempt from social security tax, if the student is "working
for a private school, college, or university, is enrolled, and is regularly
attending classes."4 The "work-study" designation can be
extended to work performed on campus for entities like bookstores, etc.
Tuition reduction programs, where the tuition is reduced for eligible
persons, exist at most institutions. While normally for education at the
undergraduate level, the tax-free treatment can also apply to a graduate
student who performs teaching or research activities for the institution.
Individuals who qualify are generally limited to employees (current, retired,
or disabled) and spouse or dependents of employees. The amount of the
tuition reduction is not taxable income nor subject to social security
taxation. The program is more of a fringe benefit for the institution's
employees and treated as nontaxable if the plan is available on a nondiscriminatory
basis.
Various loan programs are another source of funds. these are not income
for taxation purposes. Any funds obtained are expected to be repaid after
the individual ceases to be a full-time student. There are instances where
the debt may be canceled due to employment of a specific nature. An example
is teaching at a specified level or location. The cancellation does not
create income as is normally the case for forgiveness of a debt.5
Funds received from a "summer job" are taxable income and identical
to wages for any individual working at a part-time or full-time position.
The wages are earned income for both federal income tax and social security
and may result in the student having to file a tax return. A potential
problem is the increasing usage of the "independent contractor"
status for workers by employers. No deductions are made from the earnings,
but the worker is responsible for self-employment taxes (Social Security
and Medicare). The earnings in many cases are below the minimum for an
income tax liability to occur, but no minimum applies for the self-employment
taxes.
Interest received from a checking or savings account is unearned income
for the student. The situation that arises with this type of income is
that a tax return is required when the combination of unearned income
($1 or more) and earned income is over $600. The standard exemption amount
for a student, who is being claimed as a dependent by another person,
is the earned income up to a maximum of $3,800. This results in unearned
income being taxable, if earned income is over $600 due to the way the
standard deduction is computed.6
Effect On Student
One possible result of having an income is that a tax return may be required.
If the student is being claimed as a dependent on the parent's tax return,
then either earned income of over $3,800 or a combination of unearned
income ($1 or more) with earned income for a total of more than $600 determines
that a tax return must be filed. Claiming the student as a dependent by
the parent is beneficial in most cases as the parent normally has a higher
tax rate than the student. One limitation for claiming the student as
a dependent is the child must be a full-time student.7 Also, funds received
as scholarships are not taken into account when determination of support
is made.8
A common reason for a student to file a tax return is to simply obtain
a refund of any amount withheld for federal income taxes, where the level
of taxable income does not produce a federal tax liability. If the student
is reasonably sure the total income will be under $3,800 for the calendar
year, he/she can indicate on the W-4 Form that no tax liability is anticipated.
Consequently, no federal income tax will be withheld, but social security
tax is still paid.
When a dependent marries, the dependency exemption is normally lost. However,
if parents continue to provide the support for the couple, an extra exemption
may be gained. Primarily, both may be claimed as dependents by whomever
provided the support if three conditions are met.9
These are:
1. neither individual is required to file a return,
2. neither individual would have a tax liability if they filed a separate
return, and
3. they only file a joint return to obtain a refund of tax withheld.
Again, the benefit of the parents claiming the exemption is that the tax
rate is normally higher for the parents.
Remember
Income may be taxable and still not result in a tax liability. Also, the
W-2 Form received may indicate taxable income and not have any amounts
withheld for federal income tax or for social security, and still be correct.
Filing of a tax return is necessary in many cases, but is basically an
information only return
.
Endnotes
1. IRC Section 117(b)(2)(A) and (B).
2. Income Tax Regulation SS 1.117-2(b).
3. Income Tax Regulation SS 1.117-2(a)(1).
4. IRC Sec.3121(b)(10). See Circular E, Employer's Tax Guide for further
distinctions.
5. IRC Sec 108(f).
6. See instructions for applicable 1040 form for worksheet.
7. IRC Sec 151(c).
8. IRC Sec 152(d).
9. IRC Sec 152(a).Jerald R. Gober is an assistant professor in accounting
at Barry University.
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Scholarship Not taxable (limited Not taxable to tuition, fees, etc.)
Fellowship Not taxable (if part Not taxable of degree program)
Work-Study Taxable Not taxable
Tuition Not taxable Not income
Reduction
Loans Not income Not income
Interest, etc. Taxable Not taxable
Summer Job Taxable Taxable
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