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The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients

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If you’re reading this article, you’ve already done the hard part: You know (or suspect) that you’re supposed to pay quarterly estimated tax on your fellowship using Form 1040-ES. Whether you’re a graduate student, a postdoc, or some other kind of fellow or trainee, if you’re not having tax withheld from your income, it’s pretty likely that you have the responsibility of paying quarterly estimated tax. The main obstacle to PhD students and postdocs paying quarterly estimated tax is simply awareness! The process itself is not complicated or difficult, as I’ll show you in this complete guide to quarterly estimated tax for fellows.

complete guide quarterly estimated tax

If you’re still unsure that you owe income tax at all on your fellowship income – or you want to help your peers understand this issue as well – I have plenty of articles on that topic in particular.

Further reading and listening:

This article is for US citizens and resident aliens, and I’ve made the assumption that you are not, in addition to being a fellow, a farmer, fisherman, or business owner/self-employed, that you do not have any household employees, and that your adjusted gross income is less than $150k. (There are additional factors at play for these groups with respect to calculated estimated tax due.)

What Is Estimated Tax

The IRS expects to receive tax payments from you throughout the year, not just in the spring when you file your tax return.

To that end, employers offer automatic tax withholding to their employees. The employee files Form W-4 with the employer. This form helps the employee perform a high-level calculation about the amount of income tax the employee will owe for the year, which tells the employer approximately how much income tax to withhold from each paycheck. (Non-student employees will also have FICA tax withheld.)

Non-employees are almost never extended the courtesy of automatic income tax withholding by their university/institution/funding agency. (Income tax withholding for fellowship/training grant recipients is offered in rare cases – Duke University is one – so it is worth inquiring about, but don’t be surprised if the answer is no.) Instead, the onus is on the individual to manually make tax payments.

By the time a person/household files a tax return in the spring of each year, the IRS expects the tax paid throughout the year to be in excess of or only slightly less than the actual amount owed. Approximately 3 in 4 Americans receive a tax refund (the amount of tax paid throughout the year minus the actual amount owed) after filing their tax returns. The rest, presumably, owe some additional tax when they file their tax returns. If the amount of additional tax due (above the amount paid throughout the year) is too high, the IRS will penalize the taxpayer.

To help taxpayers avoid underpaying tax throughout the year and being penalized, the IRS has set up a method of making manual tax payments four times per year: quarterly estimated tax payments. Anyone whose primary income isn’t subject to automatic withholding (e.g., fellowship recipients, self-employed people) or who has significant income in addition to their employee income (e.g., investment income) should look into making quarterly estimated tax payments.

Who Has to Pay Estimated Tax

In general, you should expect to pay income tax in the year you receive your fellowship unless:

  • Your income is particularly low (e.g., you had an income for only part of the year or your fellowship went toward qualified education expenses instead of your personal living expenses) or
  • Your tax deductions and credits are particularly high.

Your tax due for the year might be large enough that you are required to make quarterly estimated tax payments or small enough that you can skip the quarterly payments and pay all the tax due at once with your annual tax return.

The dividing line is $1,000 of tax due at the end of the year in addition to the tax you had withheld and your refundable credits. If you expect to owe more than $1,000 in additional tax for the year, you should make quarterly tax payments, unless you fall into one of the exception categories discussed in the next section. If you expect to owe less than $1,000 in additional tax, you don’t have to make those quarterly payments and will just pay everything you owe with your annual tax return.

For individuals who receive only fellowship income not subject to tax withholding throughout the calendar year, the calculation is straightforward: How much income tax will you owe for the year, greater or less than $1,000?

For individuals/households with fellowship income not subject to withholding plus employee income subject to withholding (e.g., one person with part-year fellowship income and part-year employee income, one spouse with fellowship income and one spouse with employee income), both the total amount of tax owed across all incomes and the amount withheld must be taken into consideration. If you will owe more than $1,000 in additional tax at the end of the year, you should file quarterly estimated tax.

Who Doesn’t Have to Pay Estimated Tax

Some people who owe more than $1,000 in additional tax at the end of the year are not required to make quarterly estimated tax payments.

  1. If you had zero tax liability in the previous tax year, you are not required to make quarterly estimated tax payments in the current tax year. For example, if last year you were a undergrad or grad student with no income/a low enough income that you didn’t owe any income tax, you’re not required to make quarterly estimated tax payments this year.
  2. If the sum of your tax withholding throughout the year and refundable credits equals or exceeds 90% of the tax you expect to owe this year, you are not required to make quarterly estimated tax payments. For example, if your spouse earns the lion’s share of your household income and has a generous amount of tax withheld automatically, your household’s overall tax withholding might be sufficient to exempt you from making quarterly estimated tax payments on your fellowship.
  3. If the sum of your tax withholding throughout the year and refundable credits equals or exceeds 100% of the tax you owed last year, you are not required to make quarterly estimated tax payments. For example, if last year you finished undergrad and started grad school with a stipend, your tax owed for the year was likely quite small. If you have assistantship pay with tax withholding for part of this year and then switch to a fellowship with no withholding, your tax withholding from your assistantship might cover 100% of your tax owed from last year, and you wouldn’t be required to make quarterly estimated tax payments.

The best way to estimate your tax due this year along with your withholding and refundable credits and determine whether you are required to pay quarterly estimated tax is to fill out Form 1040-ES.

Fill Out the Estimated Tax Worksheet in Form 1040-ES

Form 1040-ES, specifically the Estimated Tax Worksheet (p. 8), guides you through 1) estimating the amount of tax you will owe for the year, 2) determining if you are required to make quarterly estimated tax payments, and 3) calculating the amount of your required estimated tax payment.

I’ll point out a simple approach to filling out the Estimated Tax Worksheet for individual taxpayers/households with only fellowship and employee income. If you additionally have self-employment income or other types of income, your approach will be more nuanced.

If your fellowship income is disbursed frequently throughout the year (e.g., once per month for the entire year), this simple method will work for you. If your fellowship income is disbursed infrequently (e.g., 2-3 times per year) or throughout only part of the year (e.g., only the fall term after switching funding sources), keep reading for an alternative method.

The important numbers a fellowship recipient needs to plug in to Form 1040-ES to fill it out are:

  • Line 1: Your expected Adjusted Gross Income (AGI), which is your total income for the year less your above-the-line deductions (e.g., deductible portion of student loan interest paid, the Tuition and Fees Deduction). Your AGI includes your fellowship income, taxable scholarship income (if applicable), and any wages you (and your spouse) received, e.g., from an assistantship.
  • Line 2: Your deductions. If you plan to itemize your deductions, you should enter the total of those itemized deductions in line 2a; otherwise, enter the amount of your standard deduction (in 2019: single $12,200, married filing jointly $24,400).
  • Line 7: The sum of your credits if you plan to take any. Examples of credits include the Lifetime Learning Credit, the Child Tax Credit, and the Child and Dependent Care Credit.
  • Line 11b: The sum of your refundable credits if you plan to take any, such as the Earned Income Credit or the Additional Child Tax Credit.
  • Line 12b: Your total tax liability for the prior year.
  • Line 13: Income tax you expect to be withheld throughout the year. This can generally be extrapolated from your most recent pay stub.

If you come to the worksheet with this set of numbers, all you need to complete it is to follow the arithmetic steps instructed in the form and to look up your tax due using the Tax Rate Schedule on p. 7.

Once you fill out the worksheet, line 11c will tell you the total amount of tax that it is estimated you will have to pay for the year. The rest of the form helps you determine the minimum amount of quarterly estimated tax you have to pay to avoid a penalty, which might be $0. Both of these numbers are key for your tax planning for the year; don’t just make the minimum payments necessary and forget that you might owe additional tax along with you tax return in the spring.

Method for Irregular Income

If you receive your income unevenly throughout the year, the IRS has a method for calculating a different amount of estimated tax due in each quarter, the Annualized Income Installment Method (see Publication 505).

Essentially, you calculate your tax due for each quarter based on your cumulative income up to that point of the year. Ultimately, you can pay the lesser of the estimated tax calculated through this worksheet or the quarterly estimated tax calculated from the previous method. (This is helpful if your income is higher later in the year than earlier; you don’t have to pay the extra tax until you actually receive the income.)

If you receive your fellowship income irregularly throughout the year – particularly if you are paid more later in the year than earlier – and want to be very exact about the amount of estimated tax you pay each quarter, you should fill out the Annualized Income Installment Method Worksheet after you complete the Estimated Tax Worksheet.

However, the Annualized Income Installment Method is a very complicated and fiddly worksheet, so if you don’t mind just making the regular quarterly payments, perhaps with guesstimate adjustments, that’s going to be faster and easier. For example, if you have tax withholding in place for much of the year through your assistantship but switch to fellowship funding for just the fall semester, your estimated tax payments all need to be made in the last one or two quarters, not the earlier part when you were having tax withheld.

Paying Your Quarterly Estimated Tax

If you are required to pay quarterly estimated tax, you have many options for doing so, such as by mail, over the phone, and through the IRS2Go app. The easiest method is most likely through the website IRS.gov/payments, where you can choose to make a direct transfer from your checking account for free or to pay using a debit or credit card for a fee.

The due dates for your 2019 quarterly estimated tax are:

  • April 15, 2019
  • June 17, 2019
  • Sept 16, 2019
  • Jan 15, 2020

Please note that these dates are not at 3-month intervals.

Penalties for Underpaying Tax throughout the Year

There are penalties for failing to make estimated tax payments when you are required to do so or underpaying your estimated tax. The penalty is calculated separately for each quarter, so you may be penalized for underpaying in an earlier quarter even if you made up for it in a later quarter. The details about the penalties can be found in Publication 505.

State Quarterly Estimated Tax

Your state and/or local government may also require you to make estimated tax payments.

Set Up a System of Self-Withholding

If you are going to owe any income tax for the year and do not have automatic income tax withholding set up, you should intentionally prepare for your tax bill, whether or not that tax is due with your annual tax return or quarterly.

My recommendation is to set up a separate savings account labeled “Income Tax” or similar. With every paycheck you receive, transfer into your savings account the amount of money from it that you expect to pay in income tax. For example, if you receive monthly fellowship paychecks, you should set aside 1/12th of the amount you calculated in Line 11c (rounding up). When you pay tax quarterly or annually, draw the payment from that dedicated savings account.

How to Avoid Paying Estimated Tax Using Your Spouse’s Withholding

If you are married filing jointly with one spouse receiving a fellowship not subject to withholding and one spouse subject to automatic withholding, it is possible to set up the withholding on the employee income so that you don’t have to pay quarterly estimated tax on the fellowship.

The idea is that you will increase the automatic withholding on the employee’s income so that it covers what you owe in tax for the year as a couple. This involves filing a new W-4 with your spouse’s employer.

There are two types of approaches you can take to increase your spouse’s withholding using Form W-4. The first is to recalculate the appropriate number of allowances to take using the Personal Allowances Worksheet, the Deductions, Adjustments, and Additional Income Worksheet, and possibly the Two-Earner/Multiple Jobs Worksheet. The second is to maintain the number of allowances as they had been (assuming they were accurate) and enter an additional amount of money on Form W-4 Line 6 to have withheld from each paycheck (Form 1040-ES Line 11c divided by the number of paychecks your spouse receives per year).

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Weird Tax Situations for Fellowship Recipients

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One of the most puzzling tax scenarios that is common in academia but almost unheard of outside of it is fellowship funding because it neither a wage nor self-employment income. Fellowships frequently pay the stipends and salaries of grad students and postdocs, but also apply to some other kinds of trainees that aren’t considered students or called postdocs. This post explains the weird tax situations for fellowship recipients and how to resolve them. I’ll clarify right up front that you do need to incorporate your fellowship income into the gross income you report on your tax return, and you almost certainly will end up paying tax on it (unless your total income is very low or you have lots of other deductions/credits).

weird tax fellowship

Further reading/viewing:

I have to define my terms up front here because “fellowship” is used variously inside and outside of academic research, and these weird tax situations don’t always apply. What I’m talking about is when your income from your academic/research role is not reported on a W-2 (and you’re not self-employed). Often, though not always, winning a fellowship generates this kind of income. The NSF GRFP and DoD NDSEG are probably the most well-known examples of this type of income at the graduate level for STEM fields. Basically, you’re being paid because you won an award, not because you are directly trading work or time for money. This kind of income can come from training grants and other kinds of grants as well as fellowships, and in those cases you might or might not be labeled a fellow. If your income is reported on a W-2, whether it’s called a fellowship or not, this post doesn’t apply to you!

Personally, over my time in/near academia, I received non-compensatory pay on five occasions:

  • I was postbaccalaureate fellow at the NIH for a year between undergrad and grad school, and my income was reported on a 1099-G.
  • I was on a training grant in my first year of grad school, and my income was reported on a 1099-MISC in Box 3.
  • I won an internal fellowship for my second year of grad school, and my income was reported on a 1099-MISC in Box 3.
  • I was paid from my advisor’s discretionary funds in my sixth year of grad school, and my income was reported on a 1099-MISC in Box 3.
  • I was a Christine Mirzayan Science and Technology Policy Fellow at the National Academy of Engineering, and my income was reported on a 1099-MISC in Box 3.

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Receiving Unusual Tax Forms

The way to definitively tell that you’re receiving non-compensatory income is that you don’t receive a W-2 at tax time for your income, which was likely paid similarly to a regular salary or perhaps in a lump sum per term. Instead, you might see your income reported on some other strange tax form:

  • 1098-T
  • 1099-MISC

There are other possible mechanism for this reporting; these are the two most commonly used within universities.

Neither of these forms was designed for reporting fellowship income; neither does it very well, but they do get the job done if you know what you’re looking for.

1098-T

A 1098-T, which is issued to some students depending on your university’s policies, is sort of a clearinghouse form for the sum of your fellowships/scholarships/grants received (in Box 5) and also the sum of the qualified tuition and related expenses that were paid (Box 1) to your student account. Your fellowship income might be lumped in with your scholarships in Box 5, which makes them a little hard to parse, or Box 5 might only include your scholarships (see next section if so).

The good thing about the 1098-T if it includes your fellowship income is that it does put front and center two of the important numbers you’ll need to work with when you prepare your tax return, the sum of your non-compensatory (fellowship, scholarship, and grant) income (Box 5) and a subset of your Qualified Education Expenses (Box 1). You don’t really need to know what your fellowship income was independent of your additional scholarship/grant income See Weird Tax Situations for Fully Funded Grad Students for more details about working with the 1098-T.

1099-MISC

The 1099-MISC is a super confusing form to receive for fellowship income.

First, any non-academic who hears/sees that you have income reported on a 1099-MISC is going to think you’re self-employed. Self-employment/contractor income is the most common usage for the 1099-MISC, but that income is reported in Box 7. Fellowship income usually shows up in Box 3, “Other income,” although occasionally it does show up in Box 7. If you are a grad student or postdoc, you are not self-employed; do not pay self-employment tax!

Further reading: Grad Student Tax Lie #2: You Received a 1099-MISC; You Are Self-Employed

Second, the instructions for the 1099-MISC tell you to (“generally”) report your Box 3 “Other income” in the “Other income” line on your Form 1040 Schedule 1 Line 21. You can do it that way and your tax calculation will turn out correctly in a lot of situations, but it’s more correct to report the income explicitly as fellowship/scholarship income. 1099-MISC Box 7 income that is definitely fellowship income should be reported as fellowship instead of as self-employment. In both of these cases, it’s less confusing for the IRS and will possibly enable you to take more educational tax breaks.

Further reading:

Receiving No Tax Forms

Going along with the theme of not receiving a W-2 at tax time, you might very well not receive any tax form at all! It’s very common for there to be zero communication between the organization that pays the fellowship and the fellowship recipient. Other times, the fellow might receive what I call a “courtesy letter,” which is just a short, informal letter stating the amount of fellowship money paid.

Further reading: What Is a Courtesy Letter?

Fellows who don’t receive tax forms or whose universities/institutions don’t communicate with them at all about their personal taxes may feel completely adrift. They have no idea where to even start with preparing their tax returns. Many pay no taxes at all (if you know someone like that, send them this article!) since it takes a certain level of awareness of your tax responsibility to even wonder if you need to pay income tax. Even those who suspect they need to report and pay tax on their fellowship income might be daunted by the task of figuring out from scratch exactly how to do that.

Further listening: Do I Owe Income Tax on My Fellowship?

But it’s really a simple process to carry out if you know what to do! You should be able to find the amount of fellowship income you were paid for the whole year from your bank records. If you’re not a student, you just straight report that number in Form 1040 Line 1 with “SCH” written next to it. If you are a student, you have to work with your other scholarships and qualified education expenses a bit before reporting a number for your non-compensatory pay; see Weird Tax Situations for Fully Funded Grad Students for more details on that.

Further reading: Where to Report Your Grad Student Income on Your Tax Return (applies for non-student fellows as well)

Quarterly Estimated Tax

In my observation, most fellowship recipients have the responsibility of paying quarterly estimated tax, and many, many, many neglect to do so. If you need one level of awareness to even understand you’re supposed to pay tax on your fellowship income, you need an even higher level of awareness before you follow through on paying quarterly estimated tax. In fact, if the organization providing you the fellowship didn’t mention this, it’s not a water cooler topic around your department, and/or you’ve never been self-employed, you almost certainly wouldn’t know to do it.

The basic principle here is that the IRS expects to receive tax payments throughout the year, not just in April when your tax return is due. If you owe enough additional tax at the end of the year (and don’t qualify for an exception), the IRS is going to demand not only your tax payment but late fees and interest as well.

The main system for sending tax in to the IRS is tax withholding on a normal paycheck. If you don’t do that or your withholding isn’t sufficient, you’re supposed to file quarterly estimated tax. Basically, you send in a payment (no forms need to be filed) to the IRS four times per year to make sure you don’t have too much extra tax due when you file your yearly tax return. You should work through the estimated tax worksheet in Form 1040-ES to figure out if you are required to pay quarterly estimated tax and in what amount; you can also find the instructions for filing it in that form.

Taxable Compensation and Earned Income Tax Breaks

Some of the tax breaks the IRS offers are contingent on the type of income you have, and fellowship income (not reported on a W-2) does not necessarily qualify.

Individual Retirement Arrangement

To contribute to an Individual Retirement Arrangement (IRA), you (or your spouse) must have “taxable compensation.” Unfortunately, while taxable, fellowship income does not qualify as “compensation” (Publication 970 p. 5). So if your only income for a whole calendar year is fellowship/non-compensatory income and you’re not married to someone with taxable compensation, you aren’t eligible to contribute to an IRA in that year.

Further reading:

Earned Income Tax Credit

The Earned Income Tax Credit (EITC) or Earned Income Credit (EIC) is a credit extended to low-income individuals and families. If your household income is quite low and/or you have one or more children, you might be able to receive the credit. As the name implies, you need “earned income” to qualify for the EITC. Unfortunately, fellowship/scholarship income is not considered “earned income” (Publication 596 p. 18). Puzzlingly, having zero earned income disqualifies you from the credit, but having too much non-earned income also disqualifies you from the credit. The definition of earned income also plays into the calculations for the Child Tax Credit and Additional Child Tax Credit.

Further reading: Grad Student Tax Lie #8: You Can Claim the Earned Income Tax Credit

Dependent Status

When you are trying to determine if you should file a tax return as an independent adult vs. a dependent of your parents, it is more difficult to qualify as independent with fellowship income rather than an equal amount of W-2 income. (This only applies to students.) While education expenses count as part of the amount of money that goes toward your “support,” scholarships and fellowships that you won do not count as you providing your own support.

Kiddie Tax

Fellowship income counts as unearned income for the purposes of being subject to the Kiddie Tax. If you are under the age of 24 on December 31 and a student, your “unearned” income exceeding $2,100 may be subject to a higher tax rate than the ordinary rate.

What other weird tax situations have you encountered due to your fellowship income?

Weird Tax Situations for Fully Funded Grad Students

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“Actually, I get paid to go to school.” How many times have you said that to distant relatives and new acquaintances? If you look at it that way, being a funded grad student is a pretty sweet gig. But there are definitely downsides, like the low pay, sub-par benefits, and the weird tax situations that come with getting paid to be a grad student in the US. Receiving a 1098-T that has seemingly no basis in reality and having to incorporate it into your tax return – or worse, not receiving one – can become a real time- and energy-suck. The whole tax return support system seems to have been set up to help people who are in the red with their universities, not people who are in the black. Fortunately, there are solutions to these weird tax situations for fully funded grad students, and I’ve brought them to light for you in this point.

weird tax fully funded grad student

The points covered in this post are strictly to do with being a funded graduate student at a university.

Further reading:

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You Might or Might Not Receive a 1098-T

The 1098-T looks like a super official tax form, rather like a W-2. However, I like to think of it as a communication between the university and the IRS that you, the grad student, have only been cc’d on. It’s not issued to help you properly report your income to the IRS. Its primary purpose is to let the IRS know that a student (or a student’s parents) might try to take an education tax break so that it can check the amount of the tax break claimed.

But fully funded grad students often do not claim net educational tax breaks. And if a tax break isn’t in order, it’s actually optional for the universities to even create a 1098-T. So as a fully funded graduate student, you might receive a 1098-T or you might not; the choice belongs to your university.

Further reading: What Is a 1098-T?

Your 1098-T Might Mislead You

The only thing worse than not receiving a 1098-T is receiving one that is misleading.

Further reading: Form 1098-T: Still Causing Trouble for Funded Graduate Students

When a 1098-T is issued, it is supposed to contain all of the scholarships and grants the grad student received (Box 5) as well as the payments received (Box 1) for qualified tuition and related expenses. If Box 1 is greater than Box 5, an education tax break is likely in order, and if Box 5 is greater than Box 1, you may have some excess income to report.

Box 7

But wait! It’s not always that simple. See Box 7? If that is checked, we’ve run into a calendar year/academic year issue. Sometimes the tuition, etc. for a winter or spring semester/trimester (beginning in January through March) is charged in or before December of the prior year. But are the corresponding scholarships that pay those charges posted at the same time? Nope! They often are posted in that January to March window. So the charges end up on the 1098-T for one calendar year while the corresponding scholarships end up on the 1098-T for the subsequent calendar year.

It’s not a good idea to take a tax break in one year only to have to pay a boatload of extra tax in the next year. The solution is to pair the charge with the scholarship that is earmarked for it. You do this by pulling the charge forward into the calendar year when the scholarship shows up.

So basically, your 1098-T isn’t reliable if Box 7 is checked, and you have to do your own arithmetic with the charges and scholarships that show up in your student account to find the proper numbers to plug into your tax return.

Box 1

In addition, your 1098-T might not list in Box 1 all the qualified education expenses you are eligible to claim… More on that later!

Box 3

Starting in 2018, the IRS eliminated the previously used Box 2 (qualified tuition and related expenses billed) in favor of Box 1. Many if not most universities therefore switched accounting systems between 2017 and 2018, and Box 3 is checked if that was the case. This potentially causes a double-counting issue if Box 7 were checked on your 2017 1098-T: the same charge for qualified tuition or related fees could show up in Box 2 of the 2017 1098-T and Box 1 of the 2018 1098-T if it was billed in late 2017 but paid in early 2018.

If You Have Scholarships and Qualified Education Expenses, You Can Choose between a Deduction and a Credit

When you have qualified education expenses such as tuition, you get to use them for some kind of tax break. That’s good news. The bad or at least complicating news is that you have to make a choice about how to use them. With some limitations, you get to choose being using them for a deduction and using them for a credit.

A quick review on deductions vs. credits: Deductions reduce your taxable income, while credits reduce your tax due.

How much a credit is worth to you is pretty easy to calculate. If it’s a $1,000 credit, you knock $1,000 off your tax due. (Be a bit careful because some credits are non-refundable, meaning that they stop working when your tax due hits $0.) If it’s a 20% credit for up to $1,000, if you take the full credit you’re knocking $200 off your tax.

How much a deduction is worth to you depends on your marginal tax rate. You have to multiply the amount of the deduction by your top marginal tax rate (or two tax rates, if the deduction makes you cross tax brackets). If your top tax bracket is the 10% tax bracket, a $2,000 deduction takes $200 off your federal tax due. You also should factor in your state marginal tax bracket if your state honors the deduction.

Further reading: Marginal Tax Brackets, Deductions, and Credits Explained Graphically

With your qualified education expenses, at the graduate level you will choose between ways to use them to reduce your tax burden, and ultimately you may use both. (I’m leaving out some limitations such as what qualifies as an educational institution, income ceilings, and what the scholarships can be used for, so look those up before you make a final decision.) You can:

  • Make some or all of your scholarship/grant income tax-free (i.e., take a deduction), or
  • Use the Lifetime Learning Credit (20% credit up to $10,000 for tax year 2017).

Please note that you can’t use the same qualified education expenses for more than one tax break.

You can find a complete discussion of how to choose among these three educational tax benefits in How to Prepare Your Grad Student Tax Return.

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You Have to Figure Out Your Own Qualified Education Expenses

Oh, and did I mention yet that the definition of a Qualified Education Expense is slightly different depending on the tax break you’re trying to take? Yeah, that’s another weird tax situation for fully funded grad students.

Even though the same term, such as qualified education expenses, is used to label a basic component of many of the education benefits, the same expenses aren’t necessarily allowed for each benefit. – IRS Publication 970 p. 4

Tuition is considered a qualified education expense for all of the education tax benefits I’ve discussed, but some additional expenses sometimes qualify, such as required fees and course-related expenses, e.g., books and supplies. These types of expenses might or might not appear on your 1098-T in Box 1. You should refer to Publication 970 for the full definitions of qualified education expenses under the three different education benefits.

Further reading: What Are Qualified Education Expenses?

One controversial point is whether your student health insurance premium is a required fee/qualified education expense for the purpose of making the scholarship that pays it tax-free. Insurance and student health fees, along with some other expenses, are explicitly disallowed as qualified education expenses for the Lifetime Learning Credit, but not explicitly for making scholarships tax-free. I recently contracted a tax firm to conduct some research for me, and their determination is that a health insurance premium paid to your university can be considered a qualified education expense for the purpose of making the scholarship that paid it tax-free.

You Have to Report Excess Scholarship Income

Funded graduate students with net scholarship (or fellowship) income have to report it on their tax returns. This is a weird tax situation because it’s uncommon at the undergraduate level, so many people, even professional tax preparers, don’t know that you’re supposed to do it. But now that you know, it’s actually quite easy to do.

You report your net scholarship/fellowship income in the same line on your tax return as you report your wages, e.g., Form 1040 Line 1. You also need to print SCH next to the line so the IRS knows part or all of your income is not reported on your W-2.

Further reading: Where to Report Your Grad Student Income on Your Tax Return

You Might or Might Not Be a Dependent of Your Parents (and It’s Not a Choice)

Because graduate students are students, they might be considered dependents of their parents (or another relative) for tax purposes. You and your parents don’t get to choose whether they should claim you as a dependent or you should be independent based on what’s best for the family’s tax due; rather, you have to follow the IRS’s definition.

The conditions for being considered a dependent (not exhaustive) are:

  • You are age 23 or younger at the end of the calendar year.
  • You were enrolled as a student in at least 5 calendar months (doesn’t have to be consecutive).
  • You lived with your parents for at least half the year (being away for educational reasons can count as living with them).
  • You must meet the “Support Test”: You did not provide more than half of your own support in the calendar year (see Publication 17 Worksheet 3-1).

For any years that the first three points above apply to you, you should fill out the Support Test to determine if you provided enough of your own support to qualify as independent. Keep in mind that education expenses count as support that you needed, but scholarships and fellowships that paid that support don’t count as being provided by you.

You’re (Mostly) Not Paying FICA Tax

FICA (Social Security and Medicare) taxes seem like an unavoidable burden for employees and self-employed people. But even if you’re an employee of your university/graduate school (i.e., you receive a W-2 at tax time), you’re most likely not paying FICA tax because you have a student exemption. This exemption depends on both the primary function of the organization that employs you (i.e., educational) and your primary relationship with the organization (i.e., as a student rather than an employee).

The student exemption is almost universal for graduate students, but I have come across two exceptions that depend heavily on the exact wording of the exemption:

1) Graduate students at research institutions that are not primarily universities might not receive the exemption.

2) Graduate students, even at universities, whose primary relationship with their employer is as an employee rather than a student may pay FICA tax. For example, this might occur during the summer vs. during the academic year, and could happen without the student even perceiving a difference in roles. (This is not common; I’ve seen one example and it was for a senior graduate student at a public university.)

Graduate students receiving fellowships also do not pay FICA tax, but that is because they are not receiving wages rather than due to their student status.

Yes, there are a lot of weird tax situations for fully funded grad students. You have to do a bit of legwork instead of just blindly entering numbers from your 1098-T into tax software or ignoring your excess scholarship income. But if you break the issues down one by one, it’s actually straightforward to determine how to resolve them.

How to Prepare Your Grad Student Tax Return (Tax Year 2018)

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It’s common for funded graduate students to be a bit intimidated by preparing their own tax returns, particularly if they are inexperienced in doing so. The sources of PhD student funding, namely fellowship stipends and the scholarships that pay tuition and fees, are rather unusual, so most people and even most professional tax preparers don’t have any experience with them. The strategies that apply for undergraduate-level taxes are pretty different from those that apply for graduate-level taxes. But learning how to prepare your grad student tax return isn’t actually difficult, nor are the resulting steps complicated. There’s no reason to be intimidated! This post covers the essential points you need to know to prepare your grad student tax return, whether you do it manually, with tax software, or with the help of another person.

grad student tax return 2018

 

This post is for tax year 2018. This post only covers federal tax due for domestic graduate students in the United States; you may have additional state and local tax due. I am detailing only the aspects of preparing your grad student tax return that are specific to higher education; I am not covering more general tax information that applies to the population at large.

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Preliminary Remarks

This post is a step-by-step guide on how to prepare your grad student tax return. I want to clear up some confusion right up front so that you can work your way through the guide without becoming sidetracked.

All of your income is potentially taxable. The purpose of your tax return is to show that you don’t have to pay tax on all of it. What graduate students don’t often realize is that they have income sources aside from the one(s) that hit their bank accounts or are reported on official tax documents, and they need to deal with those incomes on their tax returns.

You have your stipend/salary that serves as your take-home pay, and this is potentially taxable, even if you don’t receive an official tax form about it and you didn’t have any taxes withheld. In fact, I’ll say you’re very likely to end up owing tax on it unless it’s quite low and/or you have a lot of tax deductions/credits.

You also have another kind of income if you are funded: the money that pays your tuition and fees. Your university might refer to this as scholarship, tuition waivers, tuition remissions, etc. Even if this money never passes through your personal bank account, it does pass through your name via your student account, and it also is potentially taxable. There is a very high chance you can use an education tax benefit to reduce your taxable income and/or reduce your tax due, but you have to sit down and do the arithmetic on it, not just assume that you won’t owe any tax on it. (In fact, doing the arithmetic may very well help you pay even less tax than if you ignored it!) This guide shows you exactly how to do that.

Further reading:

Collect All Your Income Sources

The first step to prepare your grad student tax return, and any tax return, is to collect all your income sources. These income sources include wages as well as non-wage income such as interest and investment income and self-employment income, but does not include loan disbursements.

With respect to your grad student status, you have income sources that are unusual and may be officially reported to you or not (so check for all of them):

  1. Your TA/RA pay will be reported to you on a W-2.
  2. Your fellowship stipend or training grant income may be reported to you on a 1098-T in Box 5, on a 1099-MISC in Box 3, on a courtesy letter, or not at all. If your university does not send you any documentation of your fellowship income for 2018, you have to sum all the payments you received to figure out what it was.
  3. Your scholarship/grant income (i.e., the money that paid your tuition and fees), may be reported to you on a 1098-T in Box 5 or not at all. If you did not receive a 1098-T from your university, you should look at the transactions in your student account (e.g., Bursar’s account, Cashier’s account) to see the money posted there on your behalf.

Your university may not use the exact terminology that I did, but the tax forms and documentation (or lack thereof) will help you differentiate among the three types.

Further reading:

At this stage, you may be thinking that the total of all this income is way too high. There’s no way you want to pay tax on all this income! Stick with me: We are going to reduce either your taxable income or your tax due in a subsequent step. But for now, work with all of your incomes.

Categorize Your Income

Your grad student income (assistantship pay, fellowships, and scholarships/grants) falls into two broad categories: compensatory and non-compensatory income. Compensatory income is easy to define, as you will receive a W-2 for it. (This rule is with respect to your three sources of grad student income only; other types of income could be compensatory but not associated with a W-2, such as self-employment income.) Non-compensatory income is best defined as any grad student-related income that is not compensatory (reported somewhere other than a W-2 or not reported). According to the IRS, it is “various types of educational assistance you may receive if you are studying, teaching, or researching in the United States… scholarships, fellowship grants, need-based education grants, qualified tuition reductions” (Publication 970 p. 5), but the way the IRS uses those terms doesn’t completely match how we use the terms in academia.

Decide Which Education Tax Benefit(s) to Use on Your Grad Student Tax Return

For tax year 2018, there are two relevant education tax benefits that you can access to reduce your tax burden: making non-compensatory pay tax-free and the Lifetime Learning Credit. You use your qualified education expenses (QEEs) to take a deduction (by either making your non-compensatory pay tax-free) or take a credit  (by taking the Lifetime Learning Credit). A tax deduction reduces your taxable income, while a tax credit reduces your tax due directly. You can apply either one or both of these benefits, but you have to use different QEE dollars.

Qualified Education Expenses

The definition of a QEE changes slightly for each tax benefit.

Even though the same term, such as qualified education expenses, is used to label a basic component of many of the education benefits, the same expenses aren’t necessarily allowed for each benefit. Publication 970 p. 4

Tuition at an eligible education institution is a QEE for both tax benefits (although to make non-compensatory pay tax-free you have to be a degree candidate). “Required fees” are QEEs for making non-compensatory pay tax-free. The Lifetime Learning Credit uses the wording “the fees and expenses [that] must be paid to the institution for enrollment or attendance” to define a QEE. Other fees and expenses beyond tuition may be QEEs; you should refer to the definition of a QEE with respect to each benefit.

If you received a 1098-T from your university, Box 1 will contain the sum of the QEEs that were processed by the office at your university that prepared the form. You may have additional QEEs not reported on a 1098-T.

Between 2017 and 2018, the IRS updated the 1098-T, and some universities had to change their accounting system. If Box 3 on your 1098-T is checked in 2018, it is possible that some of your QEEs are double-counted in both 2017 and 2018. So instead of running with the value in your 1098-T Box 1, you should figure out if any of the QEEs included were already used in 2017.

Further reading: What Is a 1098-T?

Whether you received a 1098-T or not, you should examine the transactions in your student account to make the final determination about the qualified education expenses that were processed by that office.

You may have additional QEEs not reported on your 1098-T or in your student account, such as required course-related expenses (keep your receipts!).

Make Non-Compensatory Pay Tax-Free

The non-compensatory pay that you receive can directly cancel against your QEEs to become tax-free. For example, if the tuition that you are charged and the scholarship or tuition reduction that pays it are exactly the same amount, they net to zero and you won’t be taxed on that portion of your non-compensatory pay. In fact, you don’t even have to show the IRS this calculation; you only have to report the portion of your non-compensatory pay that exceeds your QEEs.

The definition of a QEE to make non-compensatory pay tax-free is (excerpted from Publication 970 Chapter 1):

Further reading: Grad Student Tax Lie #3: You Can Deduct Tuition, Even If You Didn’t Pay It

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Lifetime Learning Credit

The Lifetime Learning Credit reduces your tax burden and may be beneficial to apply if 1) your QEEs exceed your non-compensatory pay and/or 2) a 20% credit is more valuable to you than a deduction.

The Lifetime Learning Credit is a 20% credit; that means that if you use $1,000 in QEE expenses for the Lifetime Learning Credit, your tax due will be reduced by $200. There is a $10,000 limit on QEEs that can be used for the Lifetime Learning Credit, so the maximum benefit is $2,000 even if you have additional QEEs.

The modified adjust gross income phase-out for this deduction begins at $56,000 for a single person and $112,000 for a married couple filing jointly.

The definition of a QEE for the Lifetime Learning Credit is (excerpted from Publication 970 Chapter 3):

If you take the Lifetime Learning Credit, you must fill out and file Form 8863.

How to Decide Which Tax Benefit to Prioritize on Your Grad Student Tax Return

Do you remember how on multiple choice tests you are instructed to choose the “best” answer, not necessary the (one and only) “correct” answer? There are multiple acceptable ways to prepare your grad student tax return. At the end of the day, you can figure out the “best” answer – the one that results in the lowest tax burden for you – but it may very well take calculating your tax due with each of the different approaches. I do think it’s worth delving into the details of this decision, because may be possible to reduce your tax liability by as much as $800!

This section assumes that you are eligible for both of the education tax benefits (based on your income, the status of your educational institution, your student status, etc.); if you are ineligible for one or the other, that makes the decision all the easier. Please note that if you elect to apply the Lifetime Learning Credit when you could have made a scholarship tax-free using a matched QEE, that scholarship (by its terms) has to be eligible to be applied to a non-QEE. If a scholarship, for example, is earmarked only for paying a QEE such as tuition, then you must use your tuition QEE to make it tax-free; the scholarship cannot be included in taxable income and the QEE used for the Lifetime Learning Credit.

Essentially, you will choose which education tax benefit to apply first, tax-free scholarships and fellowships or the Lifetime Learning Credit. The one you apply first should be whichever minimizes your tax liability.

The following method will give you a first-pass indication of which benefit is better for you:

As tax-free scholarships and fellowships is a tax deduction, it is “worth” the amount of your QEEs or non-compensatory income (whichever is lower) multiplied by the sum of your federal, state, and local marginal income tax brackets.

As the Lifetime Learning Credit is a credit, it is worth its face value, which is 20% of the QEEs you apply to it up to $10,000.

Ask yourself if the sum of your marginal tax brackets is more or less than 20%.

If the sum is greater than 20%, that indicates you should apply your QEEs first to make as much of your non-compensatory pay tax-free as possible. If you have any remaining QEEs, apply them to the Lifetime Learning Credit (up to $10,000 of QEEs).

If the sum is less than 20%, that indicates you should apply your QEEs first to the Lifetime Learning Credit (up to $10,000 of QEEs). If you have any remaining QEEs, use them to make as much of your non-compensatory pay tax-free as possible.

When in doubt, calculate your tax due under both methods (or use software). In some situations, the above rule of thumb will not indicate the correct method to minimize your tax burden. For example, with the Lifetime Learning Credit-first method, you report a higher income than you would have if you used the tax-free scholarships and fellowships method, which might make you ineligible for certain tax benefits on other parts of your return, e.g., the Earned Income Credit. It’s imperative to calculate not just your total federal tax due under each method but your state and local tax due as well. Not all states treat scholarships and fellowships as ordinary income, for example.

The Numbers You Need for Your Tax Return

Once you have decided how you would like to use your QEEs, you should bring a few numbers with you to enter into your federal tax return:

  • your total amount of compensatory pay (W-2 pay with respect to your grad student income)
  • your net non-compensatory pay (after applying your QEEs to reduce it), and
  • the amount of your Lifetime Learning Credit (maximum $2,000) from Form 8863.

Fill Out Your Grad Student Tax Return

With respect to your (net) grad student income, Lifetime Learning Credit, and tax already paid, how to report them on your tax return is very straightforward. Of course, you will fill out the rest of your tax return by following the form instructions; this section only relates to the grad student aspects of your return.

Report Your Income

Your compensatory pay and net non-compensatory pay will be summed and reported as a single figure in the wages line of your tax return. (Add to this figure any other wages as well according to the form instructions.)

On Form 1040, you will write your income in Line 1. If your grad student income includes any non-compensatory income, write “SCH” in the line next to the number. You may also include the amount of the net non-compensatory pay. The purpose of this note is to alert the IRS that there is no W-2 associated with all or part of the income reported on that line.

Further reading: Where to Report Your Grad Student Income on Your Tax Return

Report Your Lifetime Learning Credit

Report your Lifetime Learning Credit on Line 50 of Form 1040 Schedule 3; you will also file Form 8863. The amount of this credit will directly reduce your tax due.

Report Your Tax Already Paid

If you received a W-2 and/or 1099-MISC for part or all of your grad student income, you will enter the amount of federal tax that was withheld from your income in Line 16 of Form 1040.

Further reading: Grad Student Tax Lie #5: If Nothing Was Withheld, You Don’t Owe Any Tax

If you paid quarterly estimated tax on your fellowship income, report the total of the estimated tax payments you made in Line 66 of Form 1040 Schedule 5.

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Notes on Other Education Tax Benefits

I have omitted from detailed discussion one education tax benefit that you may be familiar with from past experience preparing your tax return.

American Opportunity Credit

The American Opportunity Credit is typically used during the undergraduate years only. It can be claimed in only 4 tax years and not in any tax year after the one in which you finish your first four years of postsecondary education. Therefore, if you graduated from college in 2018 (in four years) and you (or your parents) claimed the American Opportunity Credit in no more than 3 previous tax years (e.g., freshman spring/sophomore fall, sophomore spring/junior fall, and junior spring/senior fall but not freshman fall), you may be eligible to claim it in 2018. If you claim the American Opportunity Credit, you cannot use the Lifetime Learning Credit. If you are considered a dependent on your parents’ tax return in 2018, you cannot claim the credit.

Conclusion

The most challenging aspect of this process is simply knowing the various aspects that you have to consider. The most complicated aspect is deciding how to use your QEEs, but you can always take the default option of prioritizing making your non-compensatory pay tax-free if you don’t want to do the extra calculations. (Your tax software or professional tax preparer should make the determination for you, but you have to give it/him/her good information to work with to do so properly.)

Further reading: How to Work with a Tax Preparer When You Have Fellowship and/or Scholarship Income

Best of luck to you as you prepare your grad student tax return this year! If you need additional support, download my tax “cheat sheet” and/or register for my workshop (includes live Q&As!). And please consider sharing this post with your peers through social media or a list-serv!

We at Personal Finance for PhDs are not professional tax preparers; this post is for informational purposes only and does not constitute tax advice.

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What Method Should You Use to Prepare Your Tax Return?

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I hope that this is news to no one in the US: Grad student stipends are taxable and so is postdoc income, even if you don’t have taxes withheld or receive an official tax form! You may feel that it’s adding insult to injury to have to pay tax on a lower income, and it is possible that you will not owe any tax if your income is low enough and/or you have enough credits and deductions, but you should still prepare a tax return every year. You need to start from the assumption that all of your income is taxable and use your tax return to reduce your tax burden as much as you can. (This post focuses on US federal taxes for citizens/residents, though international students and postdocs paid in the US will benefit as well.)

A version of this post first appeared on GradHacker.

tax return method

Further reading:

Early-career PhDs can turn to one of four sources to prepare their tax returns: themselves, tax software, a relative or friend, or a professional tax preparer. There are pros and cons to each method, and the ultimate choice of which method(s) to use will depend on the complexity of your tax situation, the resources available to you, and your willingness to learn about this important subject.

Further reading: How Do I Prepare My Taxes during Filing Season?

Free Tax Webinar for Grad Students and Postdocs

Free tax webinar 2017 pfforphds recording

Emily Roberts presented a tax webinar for funded grad students and postdocs (US domestic) on March 9, 2018.

Register for the webinar to receive a replay!

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One very important point to know about your tax return is that you are ultimately responsible for its accuracy. That means that whatever method you use, you must check your tax return through to make sure everything is correct. If you have no knowledge of taxes or have been misled by common tax lies told to graduate students, that will be very difficult; identifying all your income sources properly will be challenging and incompetence on the part of your tax preparer may slip by you.

Further reading: Grad Students, Don’t Believe these Tax Lies!

Your tax return is also only as good as the data you provide to it (GIGO!). If you overlook a part of your income, for instance because you received no official tax form for it, it doesn’t matter what method you use – your tax return will be inaccurate. This is particularly a problem for grad students. Take the time before you even choose your method to assess what sources of income you had and what forms you have or have not received for them. You can learn all about how to handle your various sources of grad student and postdoc income in my free tax webinar this week, which will be helpful no matter which method you ultimately use to prepare your tax return.

Further reading: How to Prepare Your Grad Student Tax Return

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Prepare Your Tax Return Manually

Believe it or not, often the quickest and easiest way to prepare your tax return is to just do it yourself, manually. This is particularly true if you have a simple tax situation, as many young people do. It will probably take an investment of several hours to understand the tax code at a high level and how your income and expenses fit into it the first time you prepare your own tax return. However, subsequent simple or slightly more complicated tax returns should be very quick! (Tip: Instead of using paper and ink, prepare your tax return with the IRS’s Free Fillable Forms.)

Pros:

  • If you learn about the tax code well enough to prepare a simple return (and really, all it takes is the ability to follow instructions and do arithmetic), you will go through your life with far more knowledge about income taxes than the average citizen. Taxes do not have to be mystifying.
  • Only costs your time.

Cons:

  • You don’t know what you don’t know. Without a knowledgeable source keeping an eye on your return, you may miss details such as a credit or deduction that you are eligible for.
  • You may make a mistake, either because of your lack of knowledge and experience or simply a math error.

Prepare Your Tax Return Using Tax Software

I’d bet that the majority of early-career PhDs use tax software (e.g., TurboTax, TaxACT, H&R Block) to prepare their returns. It’s a low-cost way of generating a meticulously prepared return. (Tip: The IRS provides free tax software to individuals who earned less than $66,000 in 2017.)

This is the trickiest method to use if you don’t understand your various sources of income well because without tax forms associated with some of the you may accidentally omit or misrepresent them. Software also tends to misinterpret some forms grad students commonly receive, such as categorizing grad students who receive 1099-MISCs as self-employed. Graduate students and postdocs will probably struggle the most with understanding how to enter their non-compensatory pay (fellowships and scholarships), depending on the documentation they receive.

Further reading: Grad Student Tax Lie #2: You Received a 1099-MISC; You Are Self-Employed

Pros:

  • Often free, and if not still relatively low-cost.
  • Generally thorough and trustworthy if you enter your data correctly.

Cons:

  • Can be more time-consuming to answer the software’s thorough questioning than just skipping to the relevant data entry points if you have a simple situation.
  • The software is not designed with grad student income in mind, so it can be difficult or confusing to enter non-compensatory pay, depending on the forms or lack of forms your university sends you.
  • Perhaps not sufficient for complicated tax situations.

Get a Relative or Friend to Prepare Your Tax Return

It’s fairly common for parents or relatives to (help) prepare children’s tax returns while they are dependents, and it may be tempting to continue that trend into grad school (or beyond!). However, this method suffers from the combined downsides of all the other methods while removing your direct oversight of the situation.

Pros:

  • Likely free and a low time investment.
  • He/she is probably more generally knowledgeable about the tax code than you are.

Cons:

  • While your parents may be competent in preparing their own tax returns as employees or business owners and yours as a college student, they have likely never been exposed to the unusual income reporting strategies employed by universities with respect to their grad students and postdocs.
  • You still have to know enough about the tax code to check their work.

Outsource Your Tax Return to a Professional Tax Preparer

I have to admit a bit of bias against using a professional tax preparer as a grad student, unless your life is so complicated that you need one and you have been assured that they know how to handle grad student income. For postdocs and early-career PhDs who receive compensatory pay, professional tax preparers should be quite competent, and probably more needed as your financial life gains complexity. As a person who speaks and writes about personal finance professionally, I have heard many, many horror stories of professional tax preparers bungling grad student income tax returns, causing the grad student to radically over- or underpay their taxes and forcing them to file amended returns once they catch the mistake – and those are just from the grad students who did catch the mistake (or who described the situation well enough for me to catch it)! I’m sure there are also many cases where everything went perfectly with the return, but I don’t tend to hear about those. The point is that grad students are not a common client type for professional tax preparers, so they are not necessarily knowledgeable about the special situation and may not notice the nuances or take the time to learn about them. Again, the responsibility is still on your shoulders to ensure the correctness of the return.

Further reading: How to Work with a Tax Preparer when You Have Fellowship and/or Scholarship Income

Pros:

  • Thorough, and possibly the best option for complicated tax situations.
  • Low time investment.

Cons:

  • Most expensive option unless you use some sort of free clinic.
  • As they are usually unfamiliar with grad student taxes (unless you screened for this), you still have to know enough about the tax code to check their work.

Free Tax Webinar for Grad Students and Postdocs

Free tax webinar 2017 pfforphds recording

Emily Roberts presented a tax webinar for funded grad students and postdocs (US domestic) on March 9, 2018.

Register for the webinar to receive a replay!

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Conclusion

Everyone should know what information should be included in their tax returns, roughly how to calculate their taxable income, and where their income should be reported on a 1040 (or equivalent). This is the basic amount of information needed to generate and check a tax return with respect to your income. I’ll add on here that to be an informed citizen you should also know the difference between a deduction and credit and how marginal tax brackets work.

Further reading: Marginal Tax Brackets, Deductions, and Credits Explained Graphically

If you have a simple life (e.g., not itemizing deductions, not self-employed), it may be worthwhile to invest the time necessary to prepare your return manually this year, because learning that much will be a real time-saver in years to come. Alternatively, you can use tax software in an early year to help you learn about the tax code, and once you’ve grasped the concepts, use them in future years to prepare your return manually.

If you have a complicated life (e.g., itemizing deductions, marriage and children, home ownership, self-employment, investment income, traditional retirement accounts), it’s probably not worth your time to prepare your return yourself with confidence that you haven’t missed anything (unless you enjoy doing it yourself), so paying for tax software or a tax preparer is likely the better choice.

Whatever you do, don’t wait until April 16 to start preparing your taxes using any of these methods!

Further reading: How to Prepare Your Grad Student Tax Return

My Choice

My method of choice during grad school and since has been to prepare my tax return manually and using tax software each year. First, I draft my return myself, which necessitates learning a little something new about the tax code. Second, I use tax software to prepare my return, which alerts me to anything I overlooked that I could incorporate into my manual return. Third, I submit the manual return I prepared – I have more confidence in the correctness of that version!

How to Work with a Tax Preparer when You Have Fellowship and/or Scholarship Income

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When preparing your tax returns each year, you have three basic options: do it yourself (manually), use tax software, and employ a tax preparer (e.g., certified public accountant (CPA), enrolled agent, human worker at H&R Block). The least common approach for a grad student or postdoc is to hire a human professional tax preparer, but it is warranted in certain circumstances. If you do work with a tax preparer, it’s vital to make sure they properly account for the peculiarities of grad student (and sometimes postdoc) income, namely fellowship and scholarship income.

Please note that this article is relevant for the 2017 tax year only. With the tax overhaul starting in 2018, fellowship/scholarship income may be calculated slightly differently. I will update this article for tax year 2018 later in the 2018 calendar year.

Should I Use a Professional Tax Preparer?

My anecdotal observation is that grad students and postdocs most commonly use tax software to prepare their returns. I am actually a proponent of trainees with simple financial lives preparing their tax returns manually as I think there is less room for error and less effort required.

It is a good idea for you to consider using a professional tax preparer if you have a complicated financial life, need tax planning advice, and/or don’t want to spend time preparing your return manually or with software. Of course, a professional tax preparer comes with the highest price tag of all of the options, so the cost has to be worthwhile to you.

Indications that you have a complicated financial life that perhaps warrants using a professional tax preparer are:

  • You plan to itemize your deductions
  • You or your spouse owns a business
  • You have significant non-wage income (aside from fellowships), e.g., taxable investment income
  • You had a major life event this year, e.g., getting married, having a child, buying a home, receiving an inheritance

I do not think that a person whose only tax complexity is fellowship or scholarship income needs to use a tax preparer. This person would be better off preparing her return manually or with software. Fellowship and scholarship income at the graduate and postdoc level can appear confusing to tax software or professionals who are unfamiliar with it or only understand it with respect to college students. But in reality, incorporating into your tax return is very straightforward and a professional tax preparer is not necessary. As the recipient of the fellowship or scholarship income, you should know how to calculate and report your taxable fellowship/scholarship income whether you prepare your return manually or not. It is your responsibility to make sure your tax return is correct, and checking the work of the tax software or preparer that you engage goes a long way to ensuring that it is.

Interview Questions Your Potential Tax Preparer

If you decide to use a professional tax preparer, you should interview the people you are considering hiring. I would not walk into a tax preparation agency and have my tax return prepared by the first available worker. Naturally, you will vet the tax preparer regarding all the financial complexities that caused you to seek her out.

Further reading: 11 Questions to Ask When Hiring a Tax Preparer

In addition, incorporate a form of this set of questions regarding fellowship/scholarship income (as they apply to your situation):

  1. Have you ever prepared or do you regularly prepare tax returns for graduate students with scholarship income / graduate students or postdocs receiving fellowships?
  2. Are you familiar with how to calculate and report scholarship and fellowship income in excess of qualified education expenses?
  3. (If 2 is yes) Will you please briefly explain how you do that?
  4. (If 2 is no) Are you willing to learn about this issue prior to working on my return?

Yes, I am suggesting that you quiz your tax preparer, especially if he claims he regularly prepares these types of returns. I think the answer to question 3 should sound something like this:

I add up all the amounts of fellowship and scholarship income. Often these are found on a 1098-T or courtesy letter, but I will also ask you to tell me about income not found there. Then, I determine if it is most advantageous to use your qualified education expenses [grad students only] from your 1098-T to make your scholarship/fellowship income tax-free or if it is better to use the Lifetime Learning Credit or Tuition and Fees Deduction. Your net taxable scholarship and fellowship income goes on the 1040 in the Wages line/Line 7, and if I used the Lifetime Learning Credit or Tuition and Fees Deduction I’ll prepare the appropriate forms.

I don’t think you need to eliminate from consideration a tax preparer who is not currently versed in how to handle scholarship/fellowship income, but in that case you need to believe that she is sincere in her promise to learn about it before diving into your return. I do think it’s dealbreaker if she gives a wildly incorrect answer (e.g., “scholarship/fellowship income isn’t taxable”) and expresses no uncertainty or willingness to devote time to understanding the issue when corrected.

A special note for those whose fellowship income is reported on a 1099-MISC: While rare, a few universities report fellowship stipends on Form 1099-MISC in Box 3. This can be confusing for tax preparers and software because Form 1099-MISC is more typically used for self-employment income (in Box 7). However, the use of the 1099-MISC does not mean that you as a grad student or postdoc are self-employed. Once you point this out to your tax preparer, he should confirm that he will treat it as scholarship/fellowship income as above.

Reference on Scholarship/Fellowship Income

If your tax preparer is not already familiar with how to handle excess fellowship/scholarship income, point her to Publication 970 Chapters 1, 3, and 6 (Chapter 1 being the most salient).

Free Workshop: Make Your Quarterly Estimated Tax Payment

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Check Their Work!

You should perform a super simple check when your tax preparer sends you your tax return to make sure the reporting of your fellowship/scholarship income went well. Your net scholarship/fellowship income should be added into the rest of your household wage income in Line 7 of your 1040, and “SCH” should be written next to it (possibly with that net scholarship/fellowship amount).

What I mean by net scholarship/fellowship income is your total scholarship/fellowship income less the qualified education expenses that your preparer used to make your scholarship/fellowship income tax-free. (For postdocs, the gross and net amount should be the same as you were not a student.)

For example: Let’s say you had a $25,000 fellowship and $25,000 of scholarship income that went toward paying $24,000 of qualified education expenses (tuition and required fees). The last $1,000 of scholarship income went to a non-required fee such as your health insurance premium. Your net scholarship/fellowship income would be $26,000. (That is, unless your tax preparer decided to report a higher net scholarship/fellowship income in favor of taking the Lifetime Learning Credit. The addition to your net scholarship/fellowship income should equal the amount claimed for the Lifetime Learning Credit.)

Further reading: Grad Student Tax Lie #6: You Don’t Have to Pay Tax on the Scholarship that Pays Your Health Insurance Premium

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Parting Thoughts

I’m actually quite passionate about the issue of the use of professional tax preparers and scholarship/fellowship income.

In my position as a personal finance blogger-turned-speaker, I’ve heard at least a dozen personal anecdotes from graduate students who used professional tax preparers or services like H&R Block or VITA and caught major errors in how their scholarship and/or fellowship income was calculated and reported.

In many cases, the miscalculated amount of tax due was radically higher (e.g., paying self-employment tax, paying tax on income that should have been made tax-free) or radically lower (e.g., no tax form means no income to report) than the true amount of tax due. These mistakes, frequently caught years later, sometimes cost the student dearly in time and money spent to correct them. I shudder to think of all the mistakes that were not caught by the student, especially regarding overpayment.

I don’t share my observations with you to deter you from using a professional tax preparer, but only to caution you that the interview process and double-checking their work is very important. You can’t afford to be ignorant about how scholarship/fellowship income should be calculated and reported, even if you decide to outsource the tax return preparation process.