Paying Taxes on Scholarships

  They say no good deed goes unpunished and students who do very well and earn lots of scholarships might have to take this adage to heart. That’s because the scholarships those students earn could be taxed by the IRS as income.

            There are some caveats to this though and it’s important to note that not all of the scholarships a student receives will be taxed. The IRS does not tax scholarships for degree-seeking students as long as the money is used for tuition and/or required fees, books, supplies, and equipment. Further, it’s worth pointing out that this definition is different and a little bit more restrictive than what we consider “qualified educational expenses” when we are discussing 529 plans. 529 funds can be used for things like housing, meals, and transportation. Those would all fall outside of the scope of tax-free expenses when it comes to scholarships and taxes.

            So, really, you could argue that paying taxes on scholarships is a good problem to have. It is only going to happen if a student earns more scholarship money than their tuition and other required expenses. So, let’s imagine a student is attending a school and is facing a $8,000 tuition bill for the semester. Let’s also imagine they received a total of $10,000 in scholarships. The first $8,000 of those scholarships will be tax free as they wipe out the tuition. The remaining $2000 will count as income for the student and will be taxed. However, what is leftover after the taxes can be used by the student for housing expenses, or perhaps anything they want. The difference in the $2000 and taxes paid on it is going to be more money than the student would have had if they hadn’t earned all those scholarships in the first place. As a friend once told me, “anytime you pay income taxes, you made money.”

            Most scholarship money is going to flow through a student’s college or university. If they earn a state scholarship, maybe one from the school, and perhaps others from somewhere else, all of that will end up going through the financial aid office. The people there should do all the math for you, pay your tuition, and calculate any excess scholarships you’ll need to pay taxes on. When a student earns more money than they owe a college, the college will typically issue the student a check for the difference and 1098-T that is used to report the excess scholarships to the IRS. In instances where the student earns a scholarship that doesn’t flow through a university, as is the case with many “local scholarships” that might originate from an area civic club, foundation, group, etc., the money won’t be reflected in the 1098-T they receive from the school. In those cases, students would likely be responsible for self-reporting those scholarships to the IRS.

How Many Is Too Many Times to Take the SAT

  I was discussing the SAT recently with one of my students and she told me that she didn’t want to take the SAT too many times because she believed that would “look bad” to colleges. This is a rumor I hear from time to time, and I always work to set the record straight as I did with this student.

I’ve heard several versions of this. If you take the test too many times, colleges will average your score. Taking too many tests makes you look desperate. Colleges will penalize you if you take it over X amount of times. I’ve heard them all, but I’ve never had any indication from any college that they care at all how many times a student takes the SAT or ACT. I believe those rumors simply aren’t true. Admission test frequency doesn’t matter, but there are some points to consider that just make sense when deciding how many times to test.

When colleges receive multiple test scores they do one of two things. They either find the highest overall score, even it wasn’t the most recent, and make their decision based on that. Or they combine a student’s best sub-scores from multiple tests to produce what we call a “super score”. Not every school super scores and whether or not they do is a matter of institutional policy that varies from one school to the next.

In both cases, there is an advantage to taking a test more than once. You can’t super score a single test, and a college can’t choose your best score to evaluate you with if there is only one test. What’s more, students who sit for multiple tests almost always improve their scores eventually from their initial attempt. There is pretty clear data that indicates taking the test more than once is beneficial.

However, that data only reflects that benefit to a point. Students do plateau and seem to hit a ceiling at some point. Also, the tests require a fee ($68 for the SAT and as much as $88 for the ACT). They usually begin at 8 am on a Saturday, and it’s just not really what most would call a fun experience. So, there is just kind of a number that’s probably too many, though that can be different from one person to the next. 

I generally recommend that a student take their first college admissions test in the fall of their junior year. Follow that with another in the winter or spring, and another in the summer at the end of the 11th grade. A student might be able to roll with what they have at that point, but if there is a specific target they are trying to reach like a cutoff for a scholarship, or into a middle range of accepted scores at a given school, they can test one or two more times early in the fall of senior year. They might employ this strategy for the SAT and ACT or use those early tests to figure out which one they like more and focus on that test as they try to increase their score. So, that might be as many five attempts at one test, and not including a couple of attempts at the other. Anything more than that, and you’re probably at a point that kind of seems excessive to me. But who cares? Not the colleges, for sure.