Each financial award you receive from the federal government will have separate and unique tax consequences for your federal tax return.
Student financial aid
If you're like most students, chances are you need some financial help to finance your college education. The federal government provides various types of financial assistance to students if they file a Free Application for Federal Student Aid (FAFSA). Each type of financial award you receive has separate and unique tax consequences that are treated differently on your federal tax return.
Step 1: Exclude your Pell grant from taxable income
If you are awarded a Pell grant, you won’t include the grant amount in your federal taxable income unless you use the funds for unapproved purposes.
Generally, for the Pell grant to retain its tax-free status, you must be a degree candidate at the college and only use the funds to pay for tuition, fees, books, supplies and equipment. However, if you use the funds to pay your room and board or even school-related travel expenses, then you must include the portion of the grant you use to pay these expenses in taxable income.
Step 2: Include your earnings from a work-study award on your tax return
Many students are provided part-time jobs working at their college as part of their FAFSA award. Although this money you earn is intended to ease the financial burden of attending college, the income is fully taxable on your tax return just like any other employment earnings.
When you prepare your tax return, you must include these amounts on the appropriate line for wages and salary.
Step 3: Exclude from taxable income any government student loans
When you take out a student loan, such as a Stafford loan, you have to pay the full amount back with interest. Therefore, even though your FAFSA lists these loans as part of your “award,” it is never treated as taxable income. However, when you begin repaying these loans, you may qualify for a student loan interest deduction if your income is not too high and you use the funds only for school-related expenses while in college.
Step 4: Evaluate any state financial awards you receive
Many states offer additional financial assistance to students who submit a FAFSA. Any award you receive from the state is subject to the same federal income tax treatment as awards from the federal government. For example, if you receive a grant from your state that you don’t repay, you treat it just like a Pell grant, which requires you to use the funds a certain way. All state-sponsored student loans are excluded from your taxable income as well.
Tips
The tax treatment of your FAFSA awards is the same even if you withdraw from the college at a later date, provided you initially use the funds to pay college expenses.
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Step 1: Pell Grant Tax Consequences The Pell grant is a vital source of financial aid for many students. Now, here's the deal: it's generally tax-free as long as you're a degree candidate and use the funds for specific purposes like tuition, fees, books, supplies, and equipment. But tread carefully! If those funds stray into unapproved territories like room and board or travel expenses, you're looking at taxable income.
Step 2: Work-Study Earnings Part-time gigs through the FAFSA award can be a lifesaver, but come tax time, those earnings are fair game. Treat them like any other employment income—they go on the wages and salary line of your tax return. A necessary step to keep the financial gears turning during your college journey.
Step 3: Student Loans and Tax Deductions Now, student loans, particularly Stafford loans, don't count as taxable income initially. But remember, they're not a free pass; you'll be repaying them with interest. However, here's a bright spot: when you start repaying, you might qualify for a student loan interest deduction if your income is within the right range and the funds are strictly for school-related expenses.
Step 4: State Financial Awards States can be generous too, offering additional financial help to FAFSA applicants. The key takeaway: state awards follow the same federal tax treatment rules. Treat state grants like Pell grants—stick to the approved expenses. State-sponsored student loans? They're also exempt from federal taxable income.
Important Tips:
- Tax treatment remains consistent even if you decide to part ways with your college later on, as long as the funds were initially used for approved college expenses.
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