Federal Student Aid – What Are The Tax Consequences?

August 26, 2014 : Alison Flores

Ed note: There are a lot of benefits to higher education – increased earning potential, expanded knowledge and even tax perks. However, there are also a few tricky situations to keep in mind when you are financing that education. One question you may have: is Federal Student Aid taxable? Let’s dive in…

College is expensive.  Did you know that taxpayers with college expenses might be able to save money at tax time? How you pay for those expenses can affect your potential education tax benefits. Let’s look at the tax consequences of some types of federal student aid – loans, Pell Grants and work-study programs.

Loans

A loan is borrowed money you have to repay.  Loans are not taxable, so you don’t report the loan on your tax return. You may claim an education credit if you use loan proceeds to pay school-related expenses (like tuition and fees) but not living expenses (like room and board).

You or your parents may be able to claim the American Opportunity Credit (which could save up to $2,500 in taxes) or the Lifetime Learning Credit (which could save up to $2,000). If your parent(s) claim you as a dependent, only your parent(s) will claim the credit, even if you are solely responsible for repaying the loan. 

Looking Ahead – Student Loan Interest: As you repay the loan and make interest payments, you may be able to take a student loan interest deduction on your tax return. The value of the deduction depends on your income and your tax bracket. For instance, if you pay $1,000 in interest and you are in the 15% bracket, you would save about $150 on your taxes. The decisions you make now influence your payments later. For suggestions on how to minimize debt, check out these suggestions on juggling school and work.

Pell Grants

A Pell Grant is financial aid that usually doesn’t have to be repaid (unlike a loan). A Pell Grant is tax-free income if it is spent only on qualified education expenses, which are generally tuition and fees, but paying these expenses with a Pell grant may lower your education credit or even cause you to lose credit eligibility.

If you have living expenses (like room and board), you may allocate the Pell Grant to those expenses instead, but then the Pell Grant will be taxable income. Therefore, how you allocate the Pell Grant is an important decision. The U.S. Treasury Department developed a Pell Grant and Tax Credit Factsheet to help you make your decision.

Work-Study Programs

If you participate in a work-study program, you will be working in a part-time job, usually for your college. Your income from the job is taxable and you’ll need to complete a W-4 so the college withholds the right amount of federal income tax. If you use earnings from your work-study program to pay for school-related expenses (tuition and fees), those payments may be qualifying expenses for an education credit.

Prepare for Tax Time

Keep receipts of your payments for school-related expenses. Your college will probably send you Form 1098-T reporting amounts the college received or billed for tuition and scholarships or grants you received.  You (and your parents, if they are claiming you as a dependent) will need those records when it’s tax time.

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Alison Flores

Alison Flores

The Tax Institute, H&R Block

Alison Flores, JD, is a principal tax research analyst at The Tax Institute. Alison specializes in the Patient Protection and Affordable Care Act, same-sex marriage, tax preparer regulation, and individual income tax issues.