Financial Aid and Taxes: What Parents and Students Need to Know
- Steve Julal
- Aug 6
- 2 min read
Updated: Aug 20
College costs can add up quickly. For the 2024–2025 academic year, the College Board listed the average tuition and fees as follows:
Private colleges: $43,350
Public colleges (out-of-state students): $30,780
Public colleges (in-state students): $11,610
And that’s before factoring in housing, meals, books, transportation, and other expenses.
Fortunately, a high percentage of students receive some form of financial aid. But before celebrating a scholarship or grant, it’s important to understand the tax rules that may apply.
Understanding Gift Aid
"Gift aid" refers to financial assistance that does not require student employment, such as scholarships, fellowships, grants, tuition discounts, or tuition reductions. Generally, these funds are considered tax-free if:
The recipient is enrolled in a degree program (including graduate programs)
Funds are used for qualified expenses: tuition, fees, books, and required supplies
The student’s qualified expenses equal or exceed the gift aid received during the award period.
"Gift aid" used for nonqualified expenses such as room, board, or travel is taxable income for the student.
Tuition Discounts and Reductions
When a university provides a direct tuition discount or reduction, it’s generally treated the same way as other scholarships or grants. As long as it meets the qualified expense rules above, it remains tax-free.
Are Work-Study and Service-Based Aid Taxable?
Some aid programs require the student to perform services like teaching, research, campus jobs in exchange for funds. Regardless of the label (scholarship, fellowship, etc.), these payments are considered taxable compensation:
Reported on Form W-2 if the student is treated as an employee.
Reported on Form 1099-MISC if treated as an independent contractor.
Why “Taxable” Doesn’t Always Mean “Tax Due”
Even if some financial aid is taxable, most students owe little or nothing because of the standard deduction.
For non-dependent students, the standard deduction for 2025 is $15,000
For dependent students, the threshold is the greater of $1,350 or their earned income plus $450, up to a maximum of $15,000
Excess taxable income is typically taxed at only 10% or 12%. Additionally, if the student isn’t claimed as your dependent, they may qualify for valuable education credits:
American Opportunity Tax Credit: Up to $2,500 per year for the first four years of undergraduate study.
Lifetime Learning Credit: Up to $2,000 per year for eligible expenses beyond the AOTC.
Avoid Surprises
Most financial aid is tax-free, but some cases may lead to taxable income. Keep records, track spending, and consult a tax professional to reduce your tax risk.
If your child is starting or continuing college, we can help you structure their aid usage to maximize tax benefits and avoid April surprises.
