College is a significant financial investment. According to the College Board, average tuition and fees for the 2024-2025 academic year are $43,350 at private institutions.
Out-of-state students at public colleges can expect to pay an average of $30,780, while in-state students pay approximately $11,610.
In addition to tuition and fees, students should also consider expenses such as housing, food, books, supplies, transportation and personal incidentals which can substantially increase the overall cost of attendance.
The good news is that a significant number of students at many colleges receive some form of financial aid, so your child’s prospects maybe more promising than expected. If your child qualifies for financial aid, it is important to understand the potential tax implications. Here is what families need to know.
The basics
The economic characteristics of what is described as financial aid determine how it’s treated for federal income tax purposes.
Gift aid, which is money the student does not have to work for, is often tax-free. Gift aid may be called a scholarship, fellowship, grant, tuition discount or tuition reduction.
Most gift aid is tax-free
Free-money scholarships, fellowships and grants are generally awarded based on either financial need or academic merit. Such gift aid is nontaxable as long as:
- The recipient is a degree candidate, including a graduate degree candidate.
- The funds are designated for tuition and related expenses (including books and supplies) or they’re unrestricted and aren’t specifically designated for some other purpose — like room and board.
- The recipient can show that tuition and related expenses equaled or exceeded the payments. To pass this test, the student must incur enough of those expenses within the time frame for which the aid is awarded.
If gift aid exceeds tuition and related expenses, the excess is taxable income to the student.
Tuition discounts are also tax-free
Gift aid that comes directly from the university is often called a tuition discount, tuition reduction or university grant. These free-money awards fall under the same tax rules that apply to other free-money scholarships, fellowships and grants.
Payments for work-study programs generally are taxable
Arrangements that require the student to work in exchange for money are sometimes called scholarships or fellowships, but those are misnomers. Whatever payments for work are called, they are considered compensation from employment and must be reported as income on the student’s federal tax return. As explained below, however, this does not necessarily mean the student will actually owe any tax.
Under such arrangements, the student is required to teach, do research, work in the cafeteria or perform other jobs. The college or financial aid payer should determine the taxable payments and report them to the student on Form W-2 (if the student is treated as an employee) or Form 1099-MISC (if the student is treated as an independent contractor).
Taxable income does not necessarily trigger taxes
Receiving taxable financial aid does not necessarily mean owing much or anything to the federal government. Here is why: A student who is not a dependent can offset taxable income with the standard deduction, which is $15,000 for 2025 for an unmarried individual. If the student is a dependent, the standard deduction is the greater of 1) $1,350 or 2) earned income + $450, not to exceed $15,000. The student may have earned income from work at school or work during summer vacation and school breaks. Taxable financial aid in excess of what can be offset by the student’s standard deduction will probably be taxed at a federal rate of only 10% or 12%.
Finally, if you cannot claim your child as a dependent on your federal income tax return, he or she can probably reduce or eliminate any federal income tax bill by claiming the American Opportunity Tax Credit (worth up to $2,500 per year for the first four years of undergraduate study) or the Lifetime Learning Credit (worth up to $2,000 per year for years when the American Opportunity credit is unavailable).
Avoid surprises at tax time
As illustrated above, most financial aid is not subject to tax; however, there are circumstances in which it may be considered taxable. To avoid surprises, please consult with your Rudler PSC advisor to learn what is taxable and what is not. Contact us at 859-331-1717.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Brandon Hughes, Staff Accountant and Evan Kandra, CPA.
If you would like to discuss your particular situation, contact Brandon or Evan at 859-331-1717.
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