It is the end of the school year. For college students who received financial aid, that means it is time to calculate what they could owe Uncle Sam.
The problem? Some students have no idea their scholarships or grants may be taxable in the first place, resulting in an unexpected financial burden for those who have school loans or hail from low-income households.
One group representing colleges and universities is asking Congress for help with these costs while a deadly virus rages across the country. The American Council on Education sent lawmakers a proposal last month asking that students receive a temporary reprieve from scholarship taxes for as long as the coronavirus pandemic lasts. Taxes this year are due July 15 instead of April 15 due to the spread of the new coronavirus.
The new campaign to suspend college aid taxation is part of a larger effort to reduce the cost of higher education for those who need assistance to pay for it. The U.S. government has already suspended payments and interest on federal student loans for nearly six months to provide relief during a time of economic uncertainty.
Hundreds of thousands pay levies on their scholarships each year due to a 34-year-old federal ruling that any aid used for living, travel and other expenses should be treated as taxable income. Maya Mauroof, a sophomore international student from the Maldives, says she ended up owing $785 in income taxes from her first semester at Mount Holyoke College due to the grants she received for health insurance, room and board and student activities. She was working part time at the dining hall making minimum wage and used her paychecks to pay for her textbooks and personal expenses. She couldn’t afford to pay.
“I remember I cried because I didn’t see this coming,” Ms. Mauroof says. A suspension of that tax, she added, would save her $1,600 owed for her fall and spring semesters. “Keeping that money would help me afford to stay in the U.S. since I absolutely can’t go home right now. It would help me make it through the summer.”
Scholarships haven’t always been subject to taxation in the U.S. The Internal Revenue Code didn’t even reference financial aid until 1954, when Congress introduced a section declaring that scholarships, grants and fellowships for degree candidates were tax-free.
That stance changed in the 1980s. Lawmakers decided the tax benefit should be tied more directly to education rather than rent or food, according to Erica York, an economist at the Tax Foundation, a think tank that collects data on U.S. tax policies. The Tax Reform Act of 1986 pushed by President Ronald Reagan officially defined aid used for living and travel as taxable, part of a sweeping overhaul that closed some tax loopholes and streamlined the tax code to broaden the tax base and lower rates. Textbooks, supplies and required equipment for a class would be free from taxation but if a student used a portion of those funds to pay for housing, travel or food, that amount would become taxable as income.
This rule appears to be a source of increasing revenue for the U.S. Roughly 703,000 taxpayers reported scholarships on their returns in 2017, bringing in $2.8 billion in tax revenue, according to the most recent IRS Statistics of Income Report. That is up from roughly 44,000 taxpayers who paid $325 million in 2015. However, the IRS says that the amount of scholarship income may not have actually changed much, as the agency improved its accuracy in identifying scholarship income in electronic returns starting in 2017.
Some who oppose the tax say it is unfairly applied. “Those who can afford to give charitably receive a tax deduction while students who rely on the aid, who need every dollar, have a tax liability,” says Kalwis Lo, director of policy at Scholarship America, a nonprofit that distributes millions of dollars to students each year. “Something doesn’t make sense there.”
The tax also makes the cost of college more unaffordable for low-income students, says Mark Kantrowitz, the publisher of Savingforcollege.com. Mr. Kantrowitz says he has heard from students who have had to borrow more in student loans to pay their tax liability, adding to the burgeoning amount of outstanding student debt.
“Every dollar more in scholarships reduces that debt,” Mr. Kantrowitz says. “So why are we not allowing people to make full use of their scholarships to reduce that debt?”
Some organizations, including Scholarship America and the National Scholarship Providers Association, have been working for years to restore financial aid’s full tax-free status. Since 2017, Mr. Lo says Scholarship America has been meeting with members of the U.S. House Ways and Means Committee and the Senate Finance Committee, both of which have jurisdiction on tax-related matters.
The American Council on Education says it sent a proposal in April to the two committees asking to temporarily stop collecting taxes on scholarship and grant aid during the coronavirus pandemic. A spokesman for the Senate Finance Committee says it received the proposal and is considering it along with other ideas presented to the committee for possible economic relief and recovery efforts in the future. Representatives of the House Ways and Means Committee declined to comment.
One low-income student who had not accounted for the scholarship tax hit was Sol Adams. He started his freshman year at Colorado Mesa University with enough financial aid, including scholarships and a Pell grant, to pay for his tuition, room and board, and other expenses without taking out any student loans.
It wasn’t until he and his mom were doing his taxes in 2019 that he found out he owed about $600 in taxes that year, thanks to his full-ride. Mr. Adams paid his tax debt to the IRS using money from his savings account.
Now when tax season rolls around, he knows what to expect—he just wishes he’d known it sooner. “I was totally blindsided,” Mr. Adams says. “Fortunately, I had enough saved up.”
Confusion about how to calculate the tax on scholarships is a problem for some students. The only tax form involving scholarships that arrives from universities is a 1098-T tuition statement, which shows how much the student paid the school in tuition and fees and how much the student received in total financial aid. What the statement doesn’t say is how much of a student’s financial aid will be taxable because there is no way for the colleges to know for sure.
The IRS discusses the tax status of scholarships in its annual tax guide and its guide to tax benefits for education. The latter includes a worksheet on how to determine the amount of taxable aid. The Wall Street Journal, using that IRS worksheet, has compiled a
tax calculator to help students figure it out on their own.
Being familiar with the higher education system doesn’t necessarily make this understanding any easier, according to Debbie Gale Mitchell, an assistant teaching professor at the University of Denver.
She had no idea she would have to pay taxes on a portion of the $125,000 National Science Foundation graduate research fellowship she received while in grad school at the university in 2010. It wasn’t until after she had graduated from her Ph.D. program that she heard from the IRS.
“I got a notification saying that I owed more than $5,000 in back taxes,” she says. At the time, her husband was in his medical residency, she was an adjunct professor, and they had two children. They didn’t have the money, so she paid with a credit card.
“In retrospect it seems so obvious,” she says.
