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If your child is deciding between two schools based on a financial aid package, be sure to weigh the taxes that may accompany the offer.

Families depend on scholarships, assistantships and grants to help them afford higher education.

Indeed, the annual cost of tuition, fees, room and board at a public four-year college hit $19,080 for the 2018-2019 school year, according to the College Board. And it was $46,680 for private schools.

The upside of scholarships and other “free money” opportunities is that you don’t have to pay them back, unlike loans. However, there is a catch: Scholarships and assistantships may be subject to income tax.

In general, scholarships that cover tuition and fees are tax-free, while money that pays for room and board is not.

Telling the difference between the two is harder than it seems.

“The problem you run into is when the school says, ‘We’re giving you $10,000 and calling it a scholarship,’” said Tim Steffen, CPA and director of advanced planning at Robert W. Baird & Co. in Milwaukee. “Just because the school says it’s tax-free, doesn’t mean it is.”

 

Tax-free conditions

Two conditions must apply in order for a scholarship or fellowship to be tax-free, according to the IRS.

1. You’re a degree-candidate at an educational institution that maintains a regular faculty and curriculum. The school must have a regularly enrolled body of students in attendance.

2. The money you receive is used to pay for tuition and fees necessary for enrollment or for books, fees, supplies and equipment needed for courses.

Scholarships that cover incidental expenses, including room, board and travel are taxable.

You are also on the hook for taxes on any money you get as payment for teaching, research and other services as a condition of receiving the cash.

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