Tax Rules for Scholarships, Fellowships, and Education Benefits Explained

You may be able to leave out some education money from your taxable income if it fits the rules for a qualified scholarship, a fellowship, the Education Savings Bond Program, or a Coverdell Education Savings Account (ESA). The rules are strict, and each program uses different definitions for what counts as qualified education expenses. The most important point across all programs: money used for tuition and fees required for enrollment usually fares better than money used for room and board.

According to analysis by VisaVerge.com, families often mix several benefits in the same year. That’s allowed, but you must reduce qualified expenses by other tax-free benefits before you calculate any new exclusion. This avoids double-counting.

Scholarship and Fellowship Exclusions: Who Qualifies and What’s Taxable

If you’re a candidate for a degree, you can exclude amounts you receive as a qualified scholarship or fellowship. A qualified scholarship is money used for:

• Tuition and fees to enroll at or attend an educational institution
• Required fees, books, supplies, and equipment for courses

Key limits and rules:

• Money used for room and board is taxable.
• If any part of the scholarship or fellowship is payment for past, present, or future teaching, research, or other services, that part is taxable. This applies even if all students must perform those services to get the degree.
• A scholarship prize that you can spend on anything (for example, a contest prize not restricted to education) is not a scholarship for tax purposes. Include it in income on Form 1040 even if you spend it on school.
• Scholarships or fellowships are taxable if the recipient is not seeking a degree.

Education Savings Bond Program: Who Qualifies and How It Works

You may exclude all or part of the interest from redeeming qualified U.S. savings bonds if you use that interest in the same year to pay qualified higher education expenses.

Eligibility basics:

• Qualified bonds: Series EE bonds issued after 1989 or any Series I bond.
• Ownership: Bond must be in your name (sole owner) or jointly with your spouse.
• Age: You must be at least 24 before the bond’s issue date.
• Filing status: Married couples must file jointly to claim the exclusion. Married filing separately does not qualify.

Qualified expenses under this program:

• Tuition and fees required for you and your dependents to attend an eligible educational institution
• Contributions to a qualified tuition program (QTP) or Coverdell ESA
• Not allowed: books, room and board, or courses in sports, games, or hobbies that are not part of a degree or certificate program

Eligible educational institutions include most accredited public, private, and nonprofit universities, colleges, and vocational schools that participate in U.S. Department of Education student aid programs.

You must reduce qualified expenses by any tax-free benefits used for the same student in the same year, including:

• The tax-free part of scholarships and fellowships
• Amounts used to figure the tax-free portion of distributions from a Coverdell ESA or a QTP
• Amounts used for the American Opportunity or Lifetime Learning credits
• Tax-free payments for education such as:
  • Veterans’ educational assistance
  • Qualified tuition reductions
  • Employer-provided educational assistance

Amount you can exclude:

• If your total bond proceeds (principal plus interest) are not more than your adjusted qualified expenses, you may exclude all the interest.
• If proceeds exceed expenses, you can exclude only part of the interest. Compute:
  1. Adjusted qualified expenses ÷ total bond proceeds = percentage
  2. Percentage × bond interest = excluded interest
     The remainder of the interest is taxable.

Income limits (phase-out ranges based on MAGI and filing status; 2023):

• Married Filing Jointly: $137,800–$167,800
• Single, Head of Household, Qualifying Surviving Spouse: $91,850–$106,850

The exclusion starts to phase out above the lower amount and ends at the upper amount.

Example from the rules:

• Robert redeems Series EE bonds with $2,000 principal and $400 interest to pay his son’s tuition. He files jointly and his MAGI is within the MFJ phase-out range. The range is $30,000, and his MAGI is $22,000 below the upper limit. His applicable percentage is 0.733 (22,000 ÷ 30,000). He can exclude $293 of the interest ($400 × 0.733). The rest is taxable.

Qualified Education Expenses: How Programs Define Them

For Coverdell ESAs and QTPs:

• Qualified education expenses include tuition, fees, books, supplies, and required equipment for enrollment or attendance at an eligible educational institution.
• Room and board can qualify if the student is at least half-time, but only up to:
  • The school’s allowance for room and board in the cost of attendance, or
  • The actual amount charged by school-owned housing — whichever is higher.

Adjusted qualified education expenses:

• You must reduce expenses by any tax-free amounts used for the same student in the same year (such as the tax-free part of scholarships, ESA/QTP distributions, or education credits).
• If both a QTP and a Coverdell ESA pay expenses in the same year and total distributions exceed adjusted expenses, you must allocate the expenses between them. Ignore any elementary and secondary education expenses for this allocation.

Important difference to note:

• Room and board may be a qualified expense for ESAs and QTPs.
• Room and board is not a qualified expense for the Education Savings Bond Program, education credits, scholarships, or fellowships.

Coverdell Education Savings Account: Eligibility, Limits, and Distribution Rules

A Coverdell ESA is a trust or custodial account set up in the United States to pay the qualified education expenses of the named beneficiary.

Core rules:

• The account must be a designated Coverdell ESA at creation.
• The trustee or custodian must be a bank or an IRS‑approved entity.
• Contributions:
  • Must be in cash
  • Must be made before the beneficiary (unless a special needs beneficiary) turns 18
  • Cannot exceed $2,000 per year per beneficiary (not including rollovers)
• No investments in life insurance contracts.
• The ESA cannot be commingled with other property except within a common trust or common investment fund.
• The account balance must be distributed within 30 days after the earlier of:
  • The beneficiary turning 30 (unless a special needs beneficiary)
  • The beneficiary’s death

Tax treatment:

• No deduction for contributions.
• Earnings grow tax-deferred.
• Distributions are tax-free up to the amount of qualified education expenses for the year, adjusted for other tax-free benefits.

MAGI limits for contributors:

• If your MAGI is between $95,000 and $110,000 (or $190,000 and $220,000 for joint filers), your $2,000 limit is reduced.
• At $110,000 or more (or $220,000 or more joint), you cannot contribute to any Coverdell ESA.

How to figure the reduced contribution:

1. Compute fraction: numerator = your MAGI − $95,000 ($190,000 if joint); denominator = $15,000 ($30,000 if joint).
2. Multiply that fraction by $2,000.
3. Subtract the result from $2,000. The remainder is the maximum you can contribute for each beneficiary.

Required Documentation and Helpful Records

Keep these items to support any exclusion or tax-free treatment:

• School billing statements showing tuition and fees, and separate charges for books, supplies, and required course equipment
• Proof of how scholarship or fellowship money was spent
• Bond redemption statements showing principal and interest
• ESA and QTP distribution records
• Notes showing how you reduced qualified expenses by other tax-free benefits
• Income records supporting MAGI calculations

When you report taxable amounts, use Form 1040. You can find it at the IRS website: https://www.irs.gov/forms-pubs/about-form-1040

How to Claim or Report: Step-by-Step Overview

1. Identify the program(s) you used: scholarship, fellowship, savings bonds, ESA, or QTP.
2. Gather bills and statements to separate tuition and fees and other required course costs from nonqualified expenses like room and board (for programs where room and board isn’t allowed).
3. Reduce your qualified expenses by all tax-free benefits for the same student in the same year.
4. For savings bonds:
   • Check filing status and MAGI against the phase-out range.
   • If proceeds exceed adjusted expenses, use the ratio method to find the excludable interest.
5. For Coverdell ESA distributions:
   • Confirm that distributions do not exceed adjusted qualified expenses to keep them tax-free.
6. If any part of a scholarship or fellowship is payment for services, treat that portion as taxable and include it on Form 1040.
7. Keep all records with your tax files.

For comprehensive federal guidance, see IRS Publication 970 on Tax Benefits for Education: https://www.irs.gov/publications/p970

Practical Tips to Meet the Requirements

• Separate costs early. Ask the school for a term-by-term breakdown so you can show which amounts are strictly for tuition and fees and which are for housing, meals, or optional items.
• Track how you spend scholarship money. If a sponsor pays you directly, make sure you can show what part went to qualified expenses. Only the qualified scholarship portion is excluded.
• Avoid double-counting. If a tax-free benefit already covers an expense, don’t count that expense again when you calculate a bond interest exclusion or ESA tax-free distribution.
• Watch your filing status. If you’re married and want the bond interest exclusion, you must file jointly.
• Mind the MAGI ranges. If your income is near a phase-out range (for bond interest exclusions or the ESA contribution limit), run the numbers before you contribute or redeem bonds.
• Use the given example as a model. For bond redemptions, the ratio method (adjusted qualified expenses ÷ total proceeds) is key, followed by the MAGI phase-out when applicable.
• Keep timelines in sync. Bond interest must be used for qualified expenses in the same year you redeem the bonds.
• Confirm what “required” means. Only books, supplies, and equipment a course requires are qualified for scholarship exclusion or ESA/QTP purposes.

These rules can make a real difference in a family’s yearly tax bill. With clear records and careful math, you can apply the exclusions correctly and report any taxable amounts on Form 1040 without surprises.