Receiving a Pell grant award as part of your federal student aid package can really reduce, or even eliminate, the hefty financial burden of making tuition payments to your college or university. Though uncommon, in some cases, the IRS may require that you report the Pell grant award on your tax return. However, by following a few simple rules, you can easily avoid this situation and receive the Pell grant tax free.
Pell Grant Taxation
Unlike student loans, a Pell grant is free money from the government – but you can only use it to finance certain school expenses at one of 5,400 higher education institutions. When it comes to your taxes, however, the IRS treats your Pell grant as a scholarship, which means it’s possible that you’ll have to report the grant money on your tax return and maybe even pay income tax on it.
Tax-Free Pell Grants
In order to avoid having to report your Pell grant on a tax return, you must satisfy two IRS requirements that actually apply to all types of scholarships – not just Pell grants. First, you must be enrolled in as a degree candidate or be pursuing a training program that prepares you for a specific profession upon completion. And second, you must only use the Pell grant funds to pay “qualified education expenses.”
Qualified Education Expenses Definition
Spending your entire Pell grant on qualified education expenses is the only way to avoid reporting the funds on your return. These expenses include tuition and fees books, supplies and equipment you’re required to purchase for your courses. For example, if your history professor requires all students in your class to purchase a specific book, you treat book’s cost as a qualified education expense. But if the professor merely recommends the book, it’s not a qualified expense if you purchase it. Moreover, you cannot use your Pell grant to pay room and board charges or for traveling to your permanent home on weekends or holidays.
Paying Tax on Pell Grants
In the event you do use all or part of your Pell grant for nonqualified expenses, you then need to figure out how much of it should be reported on your tax return. Colleges and universities commonly combine all student charges on one account, which may include qualified and nonqualified expenses. For example, suppose your total expense for the semester totals $5,000, which includes $3,000 of tuition, $1,500 for room and board and $500 to purchase required books and supplies. If you received a $2,000 Pell grant, you won’t have to report any of it on your tax return. But if you receive a $4,000 grant — $500 of it will be taxable since you only incur $3,500 of qualified expenses. Regardless of which tax return form you use, you’ll need to report the $500 on the “wages and salary” line and make the notation “SCH” to the left of it. But remember, just because you reported the Pell grant doesn’t mean you will automatically owe income tax on it. It will depend on other factors like the amount of other income reported, what your filing status is and the tax deductions and credits you can take to reduce your tax bill.
IRS Publication 970