Large scholarships can be life-changing. But they can also create problems that families do not see coming. Here is what almost no one tells you: in the U.S., scholarship money is not automatically tax-free. 

Colleges celebrate scholarships. Foundations celebrate winners. But they rarely explain what happens at tax time. Students often learn these rules only after receiving a tax bill. Most students first encounter this problem when they are already in trouble. It is not that families are trying to avoid the rules. It is that no one told them the rules existed.

Under IRS rules, scholarship amounts are tax-free only when used for qualified education expenses: tuition, required fees, and required course materials. Everything else counts as taxable income. Room and board? Taxable. Travel? Taxable. Personal expenses? Taxable.

Most students never hear this. They get a scholarship and assume the whole thing is tax-free. After all, we usually think of scholarships as “free money.” When aid covers tuition and living costs, students spend it without realizing they will owe taxes later.

Filing Thresholds for 2025:

Students must file a federal tax return if their gross income (including taxable scholarships) exceeds $15,750. That is the standard deduction for single filers. A student with no job can still owe taxes if scholarship money used for living expenses goes over that amount. Scholarships don’t have taxes withheld. If you expect to owe $1,000 or more in taxes, you should make quarterly estimated tax payments using IRS Form 1040-ES. If you don’t, you may face underpayment penalties and interest when you file your return. 

This is the basic process the tax system uses to track scholarships. Your school reports what it knows. You fill in the rest. Your final tax return is where everything comes together: school aid, outside scholarships, and how the money was actually used.

What you have to do
Your school sends Form 1098-T (usually by January 31) showing the scholarships they gave you (“institutional aid”) and the qualified tuition and fees you were billed. You can also download this from your student portal. Form 1098-T is your starting point for tax filing.

When you file your tax return (Form 1040), you need to:  

✅ Report ALL scholarship income, including outside scholarships not on your 1098-T.

✅ Figure out how much went to qualified expenses (tuition, required fees, required books) versus everything else (room, board, personal costs).

✅ Report the non-qualified portion as taxable income.

Outside Scholarships
Outside scholarships are the biggest risk factor. They come from community foundations, employers, churches, or private donors. They are often paid directly to students, sometimes in multiple checks, and the documentation is thin. Maybe an email. Maybe just a memo line on a check. Form 1098-T only shows what the school knows about. Outside scholarships paid directly to you won’t appear on it. For scholarships paid directly to your college, the form only shows the amounts they received. You are responsible for tracking what gets covered by the various scholarships. 

For example, a student gets $5,000 from a local foundation and uses it for rent. It does not show up on the 1098-T. The student thinks “no form means I don’t report it” and files taxes without mentioning it. Three years later, the IRS sends a notice. The student now owes back taxes, plus interest and penalties. Tax obligations exist whether or not you got a form. If scholarship money is taxable under IRS rules, you have to report it.

Federal tax applies to everyone
All U.S. students follow IRS rules for scholarship taxation, no matter which state they live in. If your taxable scholarship income is over the standard deduction, you file a federal return and pay federal taxes.

State taxes are different
Most states follow federal scholarship rules, but many have lower standard deductions. You might owe state tax even when the federal tax is small. Some states (Texas, Florida, Washington, Nevada) don’t have income tax at all. California follows federal rules but has its own tax brackets (1% to 12.3%) and a much lower standard deduction ($5,706 vs. $15,750 federal). Check your state’s tax rules or talk to a tax professional.

Subsidized housing
If your family receives rental assistance, scholarship amounts over actual educational costs may be counted as household income at recertification. That can increase your rent or reduce your subsidy. Recent rules exclude federal aid like Pell Grants, but other scholarships are treated differently. Contact your housing authority before recertification to understand how they will treat student aid in your program.

If you are studying in the U.S. on a student visa (F-1, J-1, or M-1), your situation comes with extra complications and higher risks. Most international students are classified as a "nonresident alien" for tax purposes. That does not mean you get a free pass on taxes. If you have U.S. income, including scholarship money, you need to file a tax return.

Different Forms, Different Rules
International students file different forms than U.S. citizens. Most nonresident students file Form 1040-NR, not the regular Form 1040. Even if you do not owe any taxes, you must still file Form 8843 every year to report your visa status and time in the U.S. Some tax treaties between the U.S. and other countries reduce or eliminate tax on certain scholarships, but treaty benefits are not automatic. You have to claim them correctly on your return.

Why the Risk Is Higher
Most international students do not expect to file at all. A student might receive a scholarship that covers housing and food, assume it is "free," and never file. Years later, the IRS can still assess back taxes, interest, and penalties. The stakes are higher for international students because tax compliance issues can affect visa extensions and changing immigration status. If you later apply for a visa extension, Optional Practical Training (OPT), or a change of status, immigration officials may request proof of tax compliance.

Scholarships open doors. They change lives. They just should not come with hidden rules.

The system needs to do better. Award letters should explain tax implications. Financial aid offices should teach students what reporting actually looks like. Until that happens, students have to protect themselves: track every scholarship, know which parts are taxable, set money aside for taxes, and keep records even when no form shows up.

Now you know what most students are never told. That means you can plan ahead, avoid surprises, and make sure your scholarship helps you the way it is meant to.

DISCLAIMER
This guide provides general information only and is not tax, legal, or financial advice. Tax rules are complex, and individual circumstances vary significantly. Always consult with a qualified tax professional, legal advisor, or housing counselor; your specific situation may be different.