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How to Financially Manage a Once-Per-Term Fellowship Paycheck

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In some PhD programs, graduate students on fellowship are paid only once per semester or trimester, between 2 and 4 times per year. This pay frequency engenders unique challenges and opportunities for those PhD students. The less frequent your pay, the more dire the consequences can be if you don’t manage it satisfactorily. This article will walk you through all the areas of financial management that you need to consider when you only receive one fellowship paycheck every three to six months.

financially manage once per semester trimester fellowship

The Good News

Fellowship (and training grant) income is different from most income. I call it “awarded income” as it is technically not given in exchange for work. On the other hand, “employee income” is what you receive for work, such as research (a research assistantship) or teaching (a teaching assistantship).

Some universities use these terms differently, but at the end of the day the way to differentiate them is by what tax form you do or do not receive at tax time. Employee income is reported on a Form W-2, and awarded income is not.

In a typical employer-employee relationship, the employee works and then receives their pay after the pay period has ended, whether that is weekly, biweekly, semimonthly, or monthly.

Because fellowship income is awarded and does not have to follow a period of work, it can be awarded at any time.

Since your fellowship income is awarded once per term, the good news is that you’re receiving that income up front, in a sense. You receive the income near the start of the multi-month period that it is intended to fund, which I’ll call the budgeting period in this post.

That’s the good news: You receive your income at the start of your budgeting period in a sense, instead of at the end of a pay period. That makes the transition onto fellowship income much easier since you do receive a lump sum up front. However, the corollary is that coming off of this type of income can be very difficult—more on that later.

When Exactly Will Your Paychecks Arrive?

As soon as you find out that you are switching to a once-per-term pay frequency, you should inquire about the date on or by which you can expect to receive your paycheck and whether you have to do anything to trigger its payout.

Often, the answer will be vague, for instance a range of a couple weeks or even a month. If it is specific, ask if fellowship pay has ever been doled out late—this is a good question to ask the administration as well as your fellow PhD students.

Then, no matter the information you are given, build into your plans that the pay might come at the end of the stated range or some time after the stated date.

I have heard horror stories from graduate students whose once-per-term fellowship income arrived weeks later than the date they were told, and sometimes that the student had to request a “refund” from the Bursar’s office before it was paid (of which they were not informed in advance).

It’s quite unlikely that an employer would issue their employee’s paychecks late. But again, this is awarded income, so the same rules are necessarily in place.

When it comes to your paycheck dates, play “offense” by being proactive about finding out the above information and taking any steps you are supposed to, but also play “defense” by reserving within your own finances the ability to pay for your expenses for an extra few weeks or month in case your next paycheck does arrive after you expected it to.

In What Amount(s) Will the Paychecks Be?

When you found out that you won your fellowship, you were certainly told its value, i.e., how much money you would be paid over the course of a year.

However, your fellowship award might not be distributed to you evenly throughout the year. If nothing else, it’s common for the summer term to be paid at a lower (even zero!) or higher level than the academic year.

Another consideration is whether you are responsible for paying any fees or similar out of your pocket. In the case of fellowship income, those fees might be automatically deducted from your award before it is distributed to you, which can be jarring if you are not expecting it.

Income Tax

With this type of once-per-term fellowship income chances are good that your university/institute is not withholding income tax on your behalf. (If it is, you can disregard this section!)

If no income tax is withheld from your fellowship paychecks, you have two important money management tasks to accomplish:

  1. Calculate and set aside the right amount of money to pay your eventual income tax bills.
  2. Determine if you are required to pay quarterly estimated tax.

Basically, in step 1, you’re estimating the amount of tax you’ll have to pay, and in step 2, you’re figuring out when you have to pay it (quarterly or yearly).

The best way to accomplish both with respect to your federal tax (you may also be responsible for paying state tax!) is to fill out the Estimated Tax Worksheet on p. 8 of Form 1040-ES. If that seems intimidating to you at all, please check out my resources to assist you and provide workarounds:

Step 1: Estimate Your Tax Bill

Sign up below to receive by email a spreadsheet that helps you with estimating your federal tax due for the year and how much you should save from each of your paychecks. You’ll receive follow-up emails explaining more about how taxes work for fellowships and then be subscribed to my mailing list!

Step 2: Determine If You Must Pay Quarterly Estimated Tax

It’s very common for fellowship recipients, if they are on fellowship for a full calendar year, to be required to pay quarterly estimated tax. Basically, instead of your employer (if you had one) sending the IRS a slice of each of your paychecks automatically, you receive your full pay and have to make manual payments to the IRS.

The Estimated Tax Worksheet on p. 8 of Form 1040-ES will definitively tell you if you are required to pay your estimated tax quarterly or if you can pay your full bill when you file your annual tax return.

If this is daunting to you, I recommend that you sign up for my workshop, which assists fellows in exactly your situation. It walks you through how to fill out every single line of the Estimated Tax Worksheet and covers several special scenarios that are common to PhD students, such as what to do when you switch on or off of fellowship midway through the calendar year. I even outline a shortcut method that allows you to skip filling out most of the form and still avoid being penalized by the IRS!

How to Manage Spending

The most common question I hear regarding once-per-semester or once-per-trimester fellowship income is, “How do I budget with this infrequent income?”

Yes, it is a good thing that this money is paid in a lump sum up front, but it does put a lot more responsibility on the graduate student than they may have bargained for.

Budgeting Regular Expenses

A robust budget is even more vital for a fellow in this situation than it is for a person receiving more frequent paychecks. While Americans living paycheck-to-paycheck might experience a few days of austerity when it turns out there is “more month than money,” in your case overspending could require weeks of austerity, which is rather infeasible.

What I mean by a budget in this case is to predict very well the expenses you will incur over the course of your budgeting period plus an extra few weeks or month.

Those expenses include all your regular and necessary fixed expenses (e.g., rent, fixed-rate utilities, insurance premiums, subscriptions) and variable expenses (e.g., groceries, utilities billed by usage). They also include what you project that your regular discretionary expenses will be (e.g., eating out, entertainment, shopping).

Budgeting Irregular Expenses

Irregular expenses are expenses that you incur once per year or a few times per year.

Examples of irregular expense categories are:

  • University bills, e.g., tuition, fees, health insurance premium, textbooks, parking permits
  • Insurance premiums paid yearly or every six months
  • Car maintenance/repairs
  • Travel
  • Electronics
  • Moving expenses
  • Household furnishings
  • Tax

Irregular expenses end to trip up graduate students for two reasons:

  1. The expenses tend to be large relative to a graduate student’s cash flow.
  2. Graduate students are often relatively new to budgeting and managing money, so they don’t have past experience to rely on to predict these expenses.

If a graduate student identifies this kind of expense as a budgeting issue, I recommend that they create a system of targeted savings accounts to help predict and save up in advance for the irregular expenses in their life.

You can read more about how to create this type of system in this article: Solve Your Irregular Expenses Problem with Targeted Savings Accounts.

Essentially, you create a unique savings account for each category of expenses and save regularly into that account, pulling money from it only when you incur a related expense.

The advantage that you have in receiving your income for several months up front is that you can also fund your targeted savings accounts up front, at least for the several-month period that your paycheck covers.

Account Structure

I really believe in setting up checking and savings accounts to serve your needs, not simply following the crowd—hence the system of targeted savings accounts I just reviewed.

While I imagine some people can keep all of their fellowship income in their checking account and draw it down over the course of the semester or trimester without running out of money or making sub-optimal financial decisions… I wouldn’t risk it!

Many graduate students I speak with who have once-per-term fellowship income use a separate savings account to hold the bulk of their paycheck and pay themselves a salary of sorts with a once-per-month automated transfer.

While this system simulates a monthly paycheck, it doesn’t take advantage of the unique property of receiving the large paycheck up front.

Instead, what I would do is set up several accounts (you might need to use two banks for this!):

  • One checking account for your monthly expenses that are fixed or only vary slightly with usage, e.g., rent, utilities, subscriptions. You should set up auto-drafts to pay these bills directly from this account.
  • One checking account for your variable and discretionary spending, e.g., groceries, eating out, entertainment, shopping. You can spend directly from this account and/or use it to pay your credit cards.
  • One savings account that holds the part of your fellowship paycheck that you will draw down.
  • Your set of targeted savings accounts.

Here is how I propose that you use this set of accounts:

  1. When you receive your fellowship paycheck, deposit it into your ‘monthly bills’ checking account.
  2. Calculate using your budget the amount of money you will spend on those necessary monthly expenses throughout your budgeting period; round up or leave some buffer. This amount will stay in this checking account, and all those monthly bills will be paid from this account.
  3. Transfer the rest of the income to the savings account for holding it over the budgeting period.
  4. Fund your targeted savings accounts according to your calculations for your irregular expenses.
  5. Above a certain buffer amount of money, divide the balance in your holding account by the number of weeks in your budgeting period. Set up an auto-transfer to move this amount of money from savings to your variable and discretionary spending checking account. That is the amount of money you can spend that week on the categories it covers.
  6. Pull money from your targeted savings accounts into your checking account as needed to cover your planned-for irregular expenses.
  7. Repeat every time you receive a fellowship paycheck.

While somewhat complex, the advantage of this system is that it helps you make spending decisions across three time frames: yearly (for the targeted savings), monthly (for the monthly bills), and weekly (for the variable and discretionary spending), which are otherwise difficult to synthesize.

Reaching Long-Term Financial Goals

In the budgeting exercise I outlined above, I did not include any line items for saving or repaying debt. While these steps are out of reach for graduate students who are paid only enough to survive (or not even that much), as a fellowship recipient, you might have more financial wherewithal.

If you are being paid above the local living wage or more than your peers who are not on fellowship, I encourage you to set a monetary financial goal so that you come out of graduate school with more money to your name than you went in with.

If you don’t yet have any emergency savings, make a ‘starter’ emergency fund your #1 goal! Open up yet another savings account and nickname it ‘Emergency Fund.’ Contribute money to it until you reach at least $1,000 and perhaps up to two months of expenses. When you are just getting started with savings, this Emergency Fund can double as your in-case-my-paycheck-is-late fund, but as you create more financial wherewithal, they should add on top of each other.

After that, your goal might be to increase your emergency fund to 3-6 months of expenses, pay off debt, or invest for retirement or other goals.

You can still accomplish these goals with infrequent fellowship income. As you catalog your expenses, write in a savings goal to your budget as well. You can put money from your paycheck toward this goal shortly after you receive it if you’re confident you won’t overspend the money you keep in cash. Alternatively, you can put the money toward your goal near the end of your budgeting period once you’re sure you won’t run out of funds! A combination of the two might be even better: contribute a minimum amount first and set aside another amount as a stretch goal that you can contribute once you near the end of the budgeting period.

Switching Off of Fellowship Income

Just as you looked into the dates of your expected paychecks when you switched onto infrequent fellowship income, you need to ask about the frequency and pay dates of the assistantship or other type of income that you are switching onto when your fellowship ends.

Again, you can expect to be paid at the end of or after the pay period rather than at the beginning. That means you will have to pay for your living expenses for an extra couple of weeks or a month off of your fellowship income before your assistantship income arrives.

For example, if your fellowship was for an academic year and summer, September through August, and you switched onto assistantship pay at the start of the following September, it would be typical for your first assistantship paycheck to come at the end of September or beginning of October. That’s 13 months of living expenses that your fellowship needs to fund, not 12.

How to Qualify for a Mortgage as a Graduate Student or PhD, Even with Non-W-2 Fellowship Income

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In this episode, Emily interviews her brother, Sam Hogan, a mortgage originator with Prime Lending who specializes in PhDs and PhD students, particularly those receiving fellowship income. Sam relays what it takes to qualify for a mortgage in terms of credit score, income, and debt load, including the special way deferred student loans play into the calculation. He details the unusual strategies he has learned over the past year of working with PhD clients to help them get approved for mortgages, even with non-W-2 fellowship income. At the end of the interview, Sam shares why he loves working with PhD home buyers. Over the past year, Personal Finance for PhDs has referred so much business to Sam that he has become an advertiser on the podcast.

Links Mentioned

grad student PhD mortgage

Teaser

00:00 Sam: It’s always best for a PhD student to be as proactive as possible. I’ve seen letters with three years of continuance, but they’ve reached out to me after one semester has passed. Now they only have two and a half years of continuance, where someone, if they had reached out a year earlier about their future, and how they’re planning to purchase home when they were in a new area, that is the perfect slam dunk way to do it.

Introduction

0:33 Emily: Welcome to the Personal Finance for PhDs podcast, a higher education in personal finance. I’m your host, Dr. Emily Roberts. This is Season 5, Episode 17. And today, my guest is Sam Hogan, a mortgage originator with prime lending who specializes in PhDs and PhD students, particularly those receiving fellowship income. Sam relays what it takes to qualify for a mortgage in terms of credit score, and debt load, including the special way deferred student loans play into the calculation. Sam details the unusual strategies he has learned over the past year of working with PhD clients to help them get approved for mortgages, even with non-W-2 fellowship income. At the end of the interview, Sam shares why he loves working with PhD home-buyers. Over the past year, Personal Finance for PhDs has referred so much business to Sam that he has become an advertiser on the podcast. Without further ado, here’s my interview with my brother Sam Hogan.

Will You Please Introduce Yourself Further?

01:34 Emily: I’m welcoming back to the podcast today. My brother Sam Hogan, who is mortgage originator. He sells mortgages. And Sam was actually on the podcast before in Season Two, Episode Five. It was while we’re recording this on April 12, 2020 and he was last on about a year ago. At that time, we were talking about how someone with fellowship income can actually get a mortgage — non-W-2 fellowship income because tis is a tricky thing that we talked about in that episode. So now, as I said, it’s been a year since that time, Sam’s handled a lot more mortgages of this type and so he knows a lot more about this process now. So I thought we’d have him back on for an update, basically, and a little more background on getting a mortgage as a graduate student or postdoc or PhD. So, Sam, welcome back to the podcast. Thank you so much for coming back on. Will you please just tell the listeners a couple words about yourself?

02:28 Sam: Thank you for having me, Emily, and Happy Easter from the east coast. Yeah, I’ve been working with PhD students now pretty heavily over the last 12 months. The company I work for, Prime Lending, is licensed in all 50 states. I’ve had the opportunity to read, review, approve, sometimes deny, these special candidates while they’re looking for their options for home-ownership.

[Sam’s Nationwide Mortgage Licensing System and Registry number: 1491786]

Basics for First Time Home-Buyers

02:52 Emily: Thinking about someone who is probably probably a first time home-buyer doesn’t necessarily know a whole lot about the process of getting a mortgage, and of course is concerned maybe about their their income, and are they really going to qualify and all these factors — what are the factors that go into a mortgage application? And what are the the ranges, that would be acceptable for those different factors?

03:16 Sam: Okay, so generally speaking, we’re looking at a risk profile and the ability to repay. For the borrower, having a over 700 credit scores for conventional, now about over 640 or 660 for FHA loans.

Different Types of Home Loans

03:32 Emily: Okay, you just dropped the terms conventional and FHA — what’s the difference between those two?

03:37 Sam: Yeah, so FHA is your original first time homebuyer program. It’s backed by the government and it’s designed for everyone to qualify for it, if you have decent credit and decent income. Conventional is preferred because it’s going to have a lower monthly payment, and the private mortgage insurance will drop off automatically. You should have over 680 or higher credit scores to go conventional and the income ratios are a little tighter. So it’s the better loan to qualify for and it has better terms throughout the whole 30 years, or whatever your loan term is.

04:16 Emily: Okay, so FHA is a little bit easier to qualify for, because it’s sort of designed for first time home-buyers, but it’s a less preferable loan in the long term. And so if I remember correctly, a lot of people who have FHA loans for a while they then end up refinancing to a conventional type of loan a little bit later on, to get rid of that private mortgage insurance.

04:38 Sam: That is correct.

04:39 Emily: Okay, great. Okay, so going back to the the lending standards you just mentioned, like credit scores, what else goes into an application package?

04:49 Sam: Yeah, I want to just touch on our current world situation and the lending standards are changing right now. And they’re changing because everyone is in the same boat regarding a possible change or disruption in income, slowing income for a certain amount of time, so be sure to talk with an expert and their specific requirements because this will change from bank to mortgage company to a larger credit union or financial institution. These are uncertain times, so you’re going to have some fluctuation and differences from lender to lender, but you want to work just as we said before, you want to work with someone who’s keeping you in mind and your goals in mind.

How Credit Scores and Debt Impact Home Loans

05:32 Emily: Yeah, okay, great. I totally agree and we should re-emphasize that like we’re recording this in mid April, things could be different by the time we publish it, things could be different a couple months down the line, so definitely just talk with someone right away. You mentioned credit scores, but I know also, your income, of course, plays into how much of a mortgage you can qualify for. Can you talk about that a little bit?

05:53 Sam: The common rule of thumb is people will qualify for four to five times their annual income. Now that will depend also on how much debt they’re carrying, and how much they’re putting from their savings into downpayment. But that’s a pretty safe estimate. Some people who are completely debt free will qualify six times their annual income, up to. Something else lenders experience a lot is, um, people doing their own due diligence and crunching the numbers, but we have systems and practices that do this quickly, more accurately, and can give you better results, so I would say talk with someone early and have them do the work. And then after you get their feedback, run your numbers to double check and maybe have some questions for them. We want to be able to work for you, and there’s no obligation to just have a few conversations and have someone explore your options.

06:48 Emily: Yeah, that sounds good. How does that play into that because I know a lot of PhD students do have significant debt loads from maybe undergrad or a master’s degree or something like that. How does debt affect the package?

07:03 Sam: Debt is not bad. It’s good to have things on your credit that have positive history, whether that’s a student loan you’ve paid off or currently paying off, revolving credit cards. You will run into issues, if you have absolutely no debt or debt history. I strongly recommend everyone, even against their pride, get a credit card. Don’t exploit it but use it regularly, pay off regularly. You want to have established credit, especially for a young homebuyer, because they might not have the 10 or 15 years of other types or forms of debt that someone who’s in their 30s or 40s might have.

07:49 Emily: Yeah, I definitely agree with establishing a credit score and having a strong credit history. But I’m just wondering, you mentioned earlier about the size of the mortgage and how debt can affect that. Solet’s say there’s someone who’s holding a good amount of debt. Does that affect like the ratio of the amount of mortgage they can take out?

08:06 Sam: Absolutely. Let me put it in some simpler numbers. If you’re bringing in $3,000 a month, all your credit cards, new house payment, maybe your car payment or gym membership, all that cannot add up to more than $1500 dollars of your income, We take your gross income and if you’re over 50% of that debt ratio, that’s a “Hey, better luck next time.” Even better situation is to be under 43%. Under 43% of your monthly income to debt ratio, is what Freddie Mac and Fannie Mae require, currently. Now this could be used to change, sometimes annually, sometimes quicker than that, but under 43% and better is a very good place to be in.

08:55 Emily: That makes sense. Yeah, so the total amount of debt payments you can have per month is limited and the mortgage has to fit in. To be approved for a mortgage, it has to kind of fit in around those other debt obligations that you already have.

09:09 Sam: Correct.

09:09 Emily: Okay, yeah, that definitely gives us something to kind of get our hands around when someone’s deciding, like, is it even worthwhile for me to approach Sam or another lender about possibly applying for a mortgage? I know you said earlier, just ask, that’s the best thing to do, because you guys can run the numbers better than than we can outside of the industry. I had one more question about student loans, because while student loans are in deferment, how does that play into that 43% that you just said. Because if they don’t make payments, does that just like not count at all? Or how does that work?

09:43 Sam: This a very specific guideline detail that changes, just letting you know Emily, and for conventional loans, and FHA loans, it’s both different. A rule of thumb: if your student loans are in deferment, you have to take the remaining balances and calculate 1% of that, and we factor that into your debt to income ratio. So if you have $100,000 in student debt, and we’re about to calculate a potential thousand dollar payment, even though you’re not making payments on them, that could stop your deal. Okay, so brings me back to letting an expert look at it.

10:19 Sam: Also, sometimes when the lender pulls credit, the way the credit populates, it looks like they’re making payments on their student loans. But really, they’re in deferment, so all those payments have to be switched. This is why when people run the numbers themselves, they might think, “Oh, no, I can’t do it.” But lenders know what it takes to get it approved. And I did want to touch back on the debt to income, it’s best for people to know first that you want to be under 43%. If that’s 42.98%, that’s still two thumbs up. But as soon as you’re over the 43%, some of the loan terms can change and make it stricter for you to buy.

10:56 Emily: Gotcha. And I also want to emphasize that just because you qualify for a mortgage of a certain size, or just because your debt-to-income ratio fits onto that 42% or whatever, that doesn’t mean you have to buy a house that that’s expensive. So these standards are for the lending industry, they’re not necessarily the advisable thing on the personal finance side. So just keep that in mind. We’re talking about basically how to qualify, not whether this is a good idea for your finances overall to have that high of a, an amount of debt per month. I just want to add that in there from the personal finance side.

What If You Don’t Have a Typical Situation?

11:33 Emily: Okay, Sam, so thanks for running down those broad strokes criteria. If someone doesn’t meet one of these, is there any recourse? Is there anything else that can be done if they still want to go through with a purchase?

11:47 Sam: Don’t give up lenders in general, we’re in the process of approving loans. We’re not in the business of denying people we would be out of business. So try and try again, I would say, because I have had PhDs students who have finalized their transactions with me been denied by two other lenders. The tip I can give to some of these people exploring their options is be willing to over document things for any uncertainty the lender might have. If there’s some variables in your income, explain to them that “Hey, this is all under the same advisor. I’m working in different areas, different years, but it’s under the direct supervision of x and he can provide you a letter saying that I’m here for five years under his supervision and it’s common for students in my place to continue to receive their funding. Please let me know if you need any other confirmation from my supervisor.” But yeah, recourse I would just validate how good of a borrower you are: I have great credit. I have the downpayment. I have guaranteed funding.

12:52 Sam: And you always can strengthen a file with obviously a cosigner. You can have a non occupant co bar family member, even a friend, who also is hopefully in good credit standing and has income to cosign on the loan for you. That’s not a forever thing, you can refinance them off the loan. But what I’ve found out in my years in this business is, there’s always a way to make it work if you keep working at it. Some people run out of options, and while they’re in school, it’s a funky time in their life, but that doesn’t mean that you’re not going to be a homeowner in a year or two years.

13:33 Emily: Yeah, gotcha. I actually was thinking specifically about co-borrowers because that was another example that we had on the podcast. My interview with Matt Hotze, he bought a home in Durham, North Carolina when he was at Duke and he bought his first year there and he had his parents, or maybe one of his parents, as his co signers and that enabled him, because his income was, low — one graduate student stipend. He was able to get into a larger house than he would have qualified for on his own. He actually had a three bedroom house. And then he rented out two of the bedrooms. So he was able to house hack, had no problem paying the mortgage because he had reliable renters. And yeah, it all worked out really well for him. So he just needed that little bit of help at the beginning. His parents, very fortunately, were able to provide that to him, and it was kind of a rosy story after that point, but that’s what he had to do to qualify for the mortgage.

14:27 Sam: A cosigner, sometimes can solve everything, except for poor credit. But strength in numbers. You can have up to four people on conventional loan application. Have I done that ever? No. But is it possible? Yes. So yeah, I mean, if you’re having some difficulty, your loan officer, if you’re brainstorming with them, one of their first solutions is have a cosigner. A cosigner is a very simple fix. If you have to pivot your approval because you have gone through the process, you didn’t get approved on your own and your adding a cosigner on your contract, I would say give your lender about 10 days and you should be in good shape.

15:08 Emily: Gotcha. I’ll add in one more time. This is the “how to qualify for a mortgage” talk, not “is it a good idea to be a cosigner or to have a cosigner”. Totally separate conversation.

15:19 Sam: A client of mine that’s closing this month who listened to your podcast…I don’t want to reveal too much about his purchase, but we’ve been given the approval and at the start, we ran the numbers a few different ways. He was like “With a cosigner, what’s my payment? Without a cosigner how much is my cash to close?” And we were on the fence for a little bit but we were still in the process. So while he was under contract, I was still able to give him scenarios and options. We eventually decided with his deposits and everything that was already being credited, his cash to close was low enough that he wouldn’t need to have a cosigner. So it’s not set in stone at the start. Yes, it’s always better to have your ducks in a row. But the lender is flexible. We always can pivot for the buyers needs. And I also say that in the buyers defense. If something’s going wrong with the house, the lender can help you get out of the loan on your finance contingency, maybe if your home inspection is past. So there’s different ways we’re always here willing to help.

16:25 Emily: Yeah, that sounds really good.

Commercial

16:30 Emily: Hey, social distancers, Emily here. I hope you’re doing okay. It took a few weeks, but I think I have my bearings about me in my new normal. There is a lot of uncertainty and fear right now about our public and personal health and our economy. I would like to help you feel more secure in your personal finances and plan and prepare for whatever financial future may come. You can schedule a free 15 minute call with me at PFforPhDs.com/coaching to determine if financial coaching with me is right for you at this time, I hope you will reach out, if only to speak with someone new for a few minutes. Take care. Now back to our interview.

Tips for Home Loans with Non-W-2 Income

17:15 Emily: Okay, so let’s narrow down to the the scenario that we talked about the last time we did an interview, which is about a graduate student or postdoc with fellowship income, with non-W-2 income, and that a lot of lenders don’t understand how to deal with that. You’ve been working with these types of clients quite a bit over the last year. And so you have really figured out some things that how to make these loans work in some cases and what will not work in other cases and maybe in those cases, a co-borrower or something like that would be needed. Can you just tell me a little bit about, you know, this particular weirdness of non-W-2 fellowship income and how you make it work?

17:54 Sam: It’s definitely a tricky income. How I help make it work is I support all the variables within the fellowship income. I show that it’s the same field of study or field of work that they previously in. Especially in the offer letters, they usually always contain a phrase if the student remains in good standing, and the underwriter can say, well, that’s too much of a variable, we can’t accept this income because there’s too many variables. Well, I say well look at her transcripts, look at his transcripts. They’ve always been in good standing, literally forever. That’s why they were one of five students selected out of 400 applicants to get into this program. Yeah, it takes a little bit of storytelling, and the presentation is important, so it’s okay if someone who doesn’t have W-2 income, we treat other incomes just as fairly, but you have to know how to present it, how to over-document it, and if it’s too uncertain at the start, most lenders have a scenario desk you can reach out to who will give you some early feedback without going completely through the application process, completely through the loan process, and still having a little bit of a question mark about if you’re really approved. I’ve had our scenario desk, give me pushback on certain files, and I just asked, How can I support that variation or the uncertainty that you’re seeing in this letter because I can provide what you’re looking for most likely, I just need to know what that is.

19:38 Emily: Yeah. So I think if I can kind of zoom out from that a little bit. First of all, one of the things that you talked about in the last interview was that non-W-2 fellowship income is not going to qualify for an FHA loan. It’s just completely off the table. It’s only going to be a conventional loan. And what you’re talking about now is saying, okay, you know, PhD student or postdoc, you’re showing me your offer letter and you are looking for certain things that offer letter, like the income and also the number of years of guarantee, sometimes that’s in there as well. And then you’re saying, Okay, well for all the things in the offer letter that are maybe a question mark to the underwriter, you have now learned how to recognize some of those things, and you can start providing additional supportive documentation, that is asking the student or postdoc, okay, well send me your transcripts. Okay, well send me whatever it is, your work history. I don’t know what those things are. Can you talk a little bit about that guarantee? Because I know the guarantee is a very important factor when we’re talking about non-W-2 income.

Loan Types for Non-W-2 Income

20:41 Sam: Yes. So I want to answer your questions in the right order. One of the main critical points for this type of income is that it’s not recognized by the VA, Veterans Administration, FHA. It’s not recognized by USDA, and it’s not recognized by Fannie Mae. Your most successful application and loan approval is going to come from a Freddie Mac conventional loan, okay. Now you can do as little as 3% down for that conventional loan. But this is the key point that only Freddie Mac recognizes this income, per the lenders approval. Why these PhD students are not going to approved their first attempt with their lender is because it’s per the lenders approval, the lender can’t document it and approve it with their underwriter, then Freddie Mac will not take the loan.

21:40 Emily: So what you’re just saying there is that you now know having worked this type of income, this mortgage type is off the table. This mortgage type is off the table. This is the one that is potentially successful. And what you have to do is get your underwriters that you work with to approve that loan and then Freddie Mac will take it on, will approved it. What you have figured out is these little tricks and document support and so forth that need to happen for the underwriters that you work with, which presumably would be the same elsewhere, except they’re not necessarily as knowledgeable about this particular type of income.

The Importance of Offer Letters for Non-W-2 Income

22:15 Emily: Let’s talk more about that. I know that you’ve mentioned to me before, I think you mentioned in the last interview, that for this non-W-2 income, normally underwriters, lenders for W-2 income, they presume it’s going to continue for at least a while, even though we all know you can lose a job at any point. But for the fellowship income, they for some reason, don’t presume that it’s going to continue and they want to see a certain length of guaranteed fellowship time.

22:41 Sam: Yes. For conventional loans, we’re looking for three years of continuance of income. Now, I know it’s not fair because my job doesn’t guarantee me three years of employment in the future. That’s not the typical contract for all employment, its employment will usually. For conventional loans we want to see three years. I actually have a example that I’ve written up. It’s a mix of a few different approval letters that worked, that I had some success with clients in the past year. And I will say briefly that if your approval letter is more than three pages, there might be too many variables in your offer to get an approval.

23:36 Emily: You’re saying an offer letter, like the offer letter you get when you start grad school or start a postdoc position. This is going to be your stipend this along goes on for. This is a typical document, like instead of having a Form W-2, this is what a fellowship recipient would send to you. They would send you their offer letter and so what are you looking at in that offer letter that is like yeah, this is going to go forward or no, this might be a problem.

24:00 Sam: Yes, so what we’re looking for is the continuance of income, we want to have three years. We want it to state that you’re being provided health insurance, because that’s a really good sign shown you’re actually an employee, you’re not just a student. It’s okay for it to have a few variables in it, like remaining in good standing or making satisfactory progress towards their doctoral degree. That’s a good phrase in there, that’s fine. But when you have layers and layers of variables, like you know, making satisfactory progress towards our doctorate, you must take these courses or get this exact GPA or higher in these courses, must have approval from their supervisor for a continuance into a fifth year. Those are things I’ve had to get more information on because the more variables, the more uncertainty it makes the underwriter feel. And so that’s where it comes back to the presentation of the loan.

An Example of An Offer Letter

24:58 Sam: “I’m pleased to inform that you been awarded a fellowship in the first academic year beginning September 2019. In subsequent years, you’ll be supported by research and teaching assistantship. This Fellowship Award gives you deserved recognition for your accomplishments to date, as well as added independence to stipend and exploring your research interests for the first year. For the academic year 19-20, the stipend will be $3,345 for nine months. For Summer 2020, the stipend will be $3,475 for three months. This means you receive an annual stipend of $40,530. In addition, the award pays your tuition health insurance and health services fee. We are committed to continue this financial support for for up to five years, as long as you remain a PhD student in good academic standing.

25:51 Emily: Yeah, so what I’m hearing and I think what the listeners will hear is, that’s first year fellowship followed by W-2 income for the remainder, four years guaranteed.

26:02 Sam: Right.

26:03 Emily: That’s great. So that means in your world, that person would qualify for a mortgage during that first year, even though it’s fellowship, because their letter says, Yeah, it’s one year of fellowship, but you’re going to have after that this W-2 type income,

26:17 Sam: Correct. The most success I’ve seen with the PhD community are the simple letters that are less than two pages with little variable, that will show more than three years of continuance. And that’s a very simple approval for us.

26:35 Emily: And that’s whether that is fellowship income, or W-2 or a combination. If that’s what the offer letter says three years or more. That’s straightforward for you.

26:46 Sam: Correct. And that is where I’ve seen the most success with these doctoral candidates.

26:53 Emily: But still going back to your earlier point of if that’s not what a particular individuals letter looks like, still reach out to you, or another lender, because maybe with enough supplementary documentation, it could still go through, but it’s just going to be a little bit more of a process.

27:09 Sam: Correct. And, I mean, when I get connected with some of these department supervisors, I let them know, “Hey, this is what we’re looking for. Can you simplify this offer ladder for me, because we’re looking for something a little less complicated?” And I do like to tell my PhD applicants that, “Hey, I would love a shortened version of your personal statement. I want to be able to know a little bit more about where you’ve been, where you’re going.” And it always helps to tell a little bit of a story.

27:40 Emily: That is really interesting. That adds a little more detail to what you said earlier about the story and the presentation being what matters. That’s really interesting to me that you that you might include something like a version of a personal statement in this package that goes to the underwriter, that’s really interesting.

27:59 Sam: At the end of the day, I know I said this in the last episode, the last time I chirped in, but it does come down to one person’s decision. If the underwriter is comfortable, they’re going to approve you. If they’re not comfortable, they’re gonna want more documentation, or a cosigner, or something else to make it, you know, aboveboard.

28:20 Emily: Yeah, that clarifies. Thank you.

Final Words of Advice

28:23 Emily: Sam, is there anything else that you’ve learned about this fellowship type income that would be helpful to the listeners, with respect to getting approved for a mortgage?

28:32 Sam: I’ve learned that working with the PhD community are some of the best clients I’ve ever had.

28:38 Emily: Yeah, you’ve told me that before, and I really love to hear it!

28:42 Sam: Yeah. It’s really nice to work with people who are planning. It’s always best for a PhD student to be as proactive as possible. I’ve seen letters with three years of continuance, but they’ve reached out to me after one semester has passed, so now they only have two and a half years of continuanc, and that is a big problem. Whereas someone, if they have reached out a year earlier about their future, and how they’re planning to purchase a home when they were in a new area, that is the perfect slam dunk way to do it. Unfortunately, I’ve had to let some PhD students know that it’s not going to work out because their continuance, they’re under three years. And that’s going to be one of the major roadblocks. So talk to someone early, tell them you’re interested in a Freddie Mac, conventional loan. If they can find the right way to document their income and approve them. It’s happened more often in the last two months, I would say, with clients reaching out at this time of the year, when, if I had been talking to them six months ago, I could have had them approved.

29:52 Emily: Yeah, so actually at this time of the year, April 15 is decision day. Everyone has to decide what grad school they’re going to, or they’re supposed to decide. So if a PhD student is looking at that fellowship income in their offer letter, it says three years, they need to reach out to you sooner rather than later before that clock starts ticking, if they’re interested in purchasing within that first few months or first year or whatever, of being in graduate school. They need to reach out earlier. Thank you for saying that.

How To Reach Sam Hogan

30:21 Emily: Sam, you have not been particularly self promotional during this interview, and I appreciate that but I do want to say that you have been working with this type of client — people receiving fellowship income, also other types of PhD clients over the past year. I think you’re working really hard for them and that they should go to you, at least among getting a few different voices in their life, they should come to you. So will you please tell them the best way to contact you?

30:46 Sam: The best way to reach me is definitely by cell phone. Text is preferred right now because there’s a lot of volume going through the industry. My cell phone number is (540) 478-5803. And then my work email is a great line of communication, also. It’s samuel.hogan@primelending.com.

31:15 Emily: Yeah. And we’ll have all that contact information in the show notes, as well. Sam just mentioned, I was surprised to learn, but even during this social distancing period, the mortgage industry is hopping, because interest rates are so low. People are really refinancing a lot right now, even if they’re not doing necessarily new purchases at the moment or not going into that process at the moment. But, you know, maybe in a few months or a year, whatever things will return to a more normal time and you’ll be able to move forward with lots more purchases.

31:47 Emily: Sam, thank you so much for coming on the podcast. And thank you so much for working with this population and being willing to, as a personal favor to me, to investigate this and take this on. I think it’s really fruitful and it’s been really great for my audience, so I really appreciate you

32:00 Sam: Thank you for having me on Emily. Always a pleasure to work with you and the PhD community. I’m just here to help, so if you need help text me, call me bother me on the weekend. It’s all good. I just want to make sure you all are seeing some success here while you’re getting your doctorates.

32:16 Emily: Excellent. Thank you, Sam.

Outtro

32:18 Emily: Listeners, thank you for joining me for this episode. PFforPhDs.com/podcast is the hub for the personal finance for PhDs podcast. There you can find links to all the episode show notes, and a form to volunteer to be interviewed. I’d love for you to check it out and get more involved. If you’ve been enjoying the podcast, please consider joining my mailing list for my behind the scenes commentary about each episode. Register at PFforPhDs.com/subscribe. See you in the next episode, and remember, you don’t have to have a PhD to succeed with personal finance, but it helps. The music is stages of awakening by Poddington Bear from the Free Music Archive and is shared under CC by NC podcast editing and show notes creation by Lourdes Bobbio.

How Winning Fellowships Forced This Grad Student to Take Out Student Loans

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In this episode, Emily interviews Dessie Clark, a doctoral candidate in Community Sustainability at Michigan State University. In 2018, Dessie received a few small fellowships for conference travel and a couple months of stipend income. In 2019, the financial aid office told her she had been “over-awarded” and had to pay the travel fellowship money back. Dessie took out student loans to pay that bill and then set up a payment plan with the IRS when she couldn’t pay the additional tax due on the fellowships. Dessie shares the steps she takes now when receiving fellowships so that she does not become over-awarded and how to prepare for tax time as a fellowship recipient.

Links Mentioned in This Episode

over-awarded fellowship grad student

Teaser

00:00 Dessie: Outside of academia, people wouldn’t hesitate to ask questions about their paycheck, right? And so we need to kind of be thinking about it the same way. If something was different on your paycheck, you would ask why or what’s going on and how you need to deal with it. So just not being afraid to try and talk to people about what’s going on with you so you don’t get in a bind.

Introduction

00:22 Emily: Welcome to the Personal Finance for PhDs podcast, higher education in personal finance. I’m your host, Dr. Emily Roberts. This is season five episode one and today my guest is Dessie Clark, a doctoral candidate and community sustainability at Michigan State University. In 2018, Dessie received several thousand dollars in fellowship income for travel awards and a couple months of stipend income. In 2019, she received a bill from the university for the amount of the travel awards. Apparently, she had become overawarded, a term that was totally new to me., Dessie he took out student loans to pay back the university, and to add insult to injury, faced a higher tax bill that season as well. Dessie relays what she had learned on how to avoid becoming over awarded and her advice for all graduate students receiving stipends. Without further ado, here’s my interview with Dessie Clark.

Will You Please Introduce Yourself Further?

01:19 Emily: I have joining me on the podcast today Dessie Clark, who is a graduate student and is going to be telling us about being awarded fellowships as a graduate student and some of the unexpected downsides that can come with being awarded fellowships, which is of course a wonderful thing, but in Dessie’s case they caused a few other complications. Dessie, thank you so much for joining us on the podcast today and will you please tell us a little bit about yourself?

01:45 Dessie: My name is Dessie Clark and I am a doctoral candidate in community sustainability at Michigan State University. I actually got my master’s degree at Vanderbilt University in community development and action. And then I moved to Michigan to finish out my PhD.

02:01 Emily: Great. And how long have you been at Michigan State?

02:04 Dessie: I have been at Michigan State for four years.

02:09 Emily: Okay. So I won’t ask you when you’re finishing, but I’ll just say soon, you’re finishing soon.

02:13 Dessie: Yeah, hopefully this year, maybe next year, maybe, you know, whenever.

Funding During the PhD:

02:16 Emily: Yeah. So can you tell us a bit how your funding has worked since you’ve been doing your PhD?

02:22 Dessie: I’ve mostly been funded as a research assistant, so that provides coverage for tuition and then a stipend to live on. There have been a couple of summers where I’ve taught as an instructor, but for the most part it’s been RAs. And then there have been some brief moments in time where fellowships have also come into play, which is what I wanted to talk about today.

02:43 Emily: Yeah. Please elaborate about that. When did you win fellowships and maybe what amounts were they, those kinds of details?

02:52 Dessie: I think one of the things that’s important is that I didn’t necessarily know that I was getting fellowships. How this came into play for me was I had friends that had gotten fellowships and they had talked about how they were unaware of the tax implications. So I knew when I was going to apply for fellowships or asked for them that there would be tax implications there. But for me, I was actually receiving fellowships in the form of travel awards. So there were multiple times where I applied to go to conferences, and when I was awarded that travel money, I wasn’t aware that they were fellowships. So I’ve won I guess, fellowships of several thousand dollars for travel. Then there was a brief time where, I needed to change labs and so fellowships were used to fund me in my transition.

03:40 Emily: Okay. So definitely for the travel awards, we’re only talking about thousand, few thousand dollars here and there. Seemingly a relatively small amount of money, right? And then when you were switching labs, was it a semester’s worth of funding or how long was that?

03:54 Dessie: It was still relatively small. It was a couple of thousand dollars, but all of these fellowships awards actually happened in the same semester, so by the end it ended up being like $7,000 or $8,000.

04:07 Emily: Oh, okay. When they hit all at once, it really does add up in that case. Okay. So yeah, you didn’t really know that that was what you were receiving. So what happened? You get this money and it’s all good, right?

04:19 Dessie: Right. So I get this money and I’m really excited, I can afford to go to these conferences, I’m able to switch labs. But one of the things that I didn’t know is that they were fellowships, so I was kind of surprised two-fold. The first thing that happened that let me know that something wasn’t going quite right was that — this was in the fall of 2018 — so when I was going to start school in spring 2019, I got a bill from the university that said, “you owe us money, you’ve been over awarded.” I had no idea what that meant, but what I understand now is that every student has a cap on what they’re allowed to receive for education-related expenses. They had decided that this amount of money that I had received for travel had thrown me over that, so I needed to pay back university. That was kind of the first thing I noticed.

Fellowship Cap and Being Over-awarded

05:05 Emily: Let me pause there, because this term over awarded is new to me as well. What are you paying back to the university?

05:16 Dessie: What they were charging me ended up being the sum total of those travel award costs. There’s something that you can do to kind of help with this. Like I said, every student has a cap for how much money they’re allowed to receive, but one of the things that your department can do is they can write a letter saying, “This travel money is necessary for this person’s education. This is advancing their education or contributing in some way and this money is going towards that. It’s nothing extra. It’s not something we can go shopping on. This is money for the students’ education.” I didn’t know that that was something that could be done or needed to be done, so it wasn’t done in my case. I got this bill and it happened to be for the exact amount that I had received for travel awards. I found out through talking to financial aid that basically those things have been passed through as fellowships and because of how they were categorized, I got more money from the university than I was allowed to and so I needed to pay it back.

06:12 Emily: So it sounds like your stipend had been paid by your RA position and this supplemental fellowship, but those were kind of evening out to be what you’re allowed to be paid. And then these travel awards were over and above that and they were like, you’re not allowed to receive this money. This is literally the first time I’ve heard of this. I don’t know if maybe this is unique to your university or your department or maybe in all these cases, other people write these letters, their advisors write these letters that you’re talking about. I’m not sure how that works out, but this is really the first time I’m hearing about this, so it’s definitely raising like some major red flags for me.

06:46 Dessie: Yes. So from my understanding, and this is just what I’ve been told, this kind of cap exists for every student that is at a university, but I don’t know if it’s just how my university chose to handle it, or if this is happening a lot more than people know about, but basically what happened was I was over whatever that cap is. So it became a huge issue because now I’m sitting here before I can start school being told that I was thousands of dollars.

07:15 Emily: Right, exactly. So what did you do?

07:19 Dessie: What I did was what I didn’t want to do, I took out student loans and they subtract it from that.

07:24 Emily: So you took out student loans to pay the university for money that you had won that you used go to conferences. This Is bananas. This situation makes no sense. I’m really glad that you volunteered to come on the podcast to talk about this because the situation I’ve heard in the past for other students is that maybe they have a fellowship coming from the university or maybe they have an RA position or TA, something like that. Then they win a fellowship that’ll pay like their stipend. And a lot of students think, “I am in the money now.” They think getting that fellowship on top of the existing funding for their RA position or whatever it was. That is almost universally not the case. It is possible that you may end up being paid more than you were going to in the first place, but it’s not going to be double what your stipend was to begin with. And so there’s plenty of people who are caught by surprise by “what I just won funding, what do you mean you just take away my other funding?” No, that’s definitely how that works everywhere. There may be some room for negotiation and so forth, but that’s how the standard situation works. But I’m really glad to hear about your situation as well. So you know, now that you have been through the whole thing, what could have been done on your behalf and wasn’t. I don’t know. This is something that I’ve never heard of, of a student having a proactively ask for, so of course you wouldn’t have known, but I guess in the future, anyone listening who receives extra fellowships in some manner, make sure that you’re not going to run into any kind of cap, or whatever exceptions need to be made are going to be made on your behalf. Is that your advice?

Proactive Steps to Avoid Getting Over-awarded

08:54 Dessie: Yes, that is definitely my advice. I think something else too that really ties into this, that I experienced, is I got another fellowship for travel in spring and of course this time I was like, “hi, can you please write this letter and send it to financial aid? “And they were able to do that. But I came upon a situation this summer where there was something the university was going to pay for and they weren’t able to pay for it the way that they want it to. I had gone to my college and I said, I need help figuring out how this thing is going to get paid for, but it can’t be a fellowship because I’m scared I’m going to get over awarded again and I’m going to owe it. My college was really great at hearing that concern and trying to work with me on it, but what ended up happening in the meantime is that the graduate school at my university granted it as a fellowship anyway. One of the things that I think is a kind of a broader issue is that when we’re getting loans or we’re getting grants, we have to accept them and there’s usually some paperwork that we have to go through promising whatever and making sure we fully understand the impacts, but I was awarded a fellowship without my permission basically. I think that the school has figured it out, so that way I won’t be over awarded and this won’t impact me, but I also think that’s why I said at the beginning, it’s really important to know how things are being classified and categorized on your behalf because maybe something is a fix, but then all of a sudden six months down the road you’re being asked to pay it back. I think keeping an eye on that is really important.

10:15 Emily: Yeah. I mean, it sounds like you were taking the proactive steps the second time around that you knew to take, and yet, as you just said, they can just push these things through into your student account and there’s no process around it. It’s totally on their end and they have control over it. But I guess, did it just end up being that they just took it back like, “Oh, we gave it to you, now we’re going to take it back and award you the money in some other way?”

10:40 Dessie: They ended up just doing what I was talking about before and doing the right amount of paperwork to explain why this is an educational expense and all of that. I think it was handled because they knew that there were some extra steps that needed to be taken. But I think another thing too is you asked me how I found out about all this. Like so many other students at tax time, it really became a “you owe this money.” I think too, it’s easy for us to just think like, well this was only, you know, $1,000 here or $1,000 there. But it really adds up. And for most graduate students, we’re not in a super comfortable financial place. So even a surprise tax of a couple of hundred dollars can really set you back.

11:20 Emily: Yeah, and sometimes I think it’s easy to forget the academic year and the calendar year don’t line up, right? So you could be receiving fellowships maybe in two different academic years, but if they fall in the same calendar year, then it’s all going to add up at that year-end tax return.

Commercial

11:40 Emily: Emily here for a brief interlude. Tax season is upon us and while no one loves this time of year, it’s particularly difficult for post-bac fellows, funded grad students, and postdoc fellows. Even professional tax preparers are often thrown for a loop by our unique tax situation. And don’t get me started on tax software. I provide tons of support at this time of year for PhD trainees preparing their tax returns. From free articles and videos, to paid at-your-own-pace workshops, to live seminars and webinars for universities and research institutes. The best place to go to check out all of this material is pfforphds.com/tax that’s P F F O R P H D dot com slash T A X. Don’t struggle through tax season on your own. Visit my website for the exact information you need in the most efficient form available. Now back to the interview.

Tax Consequences of Being Over-awarded

12:44 Emily: Okay, not only did you, you know — Hey, you received award funding. Awesome. Got that. Oh no, you have to pay it back to the school. Ridiculous. You have to take out student loans, do that. So essentially, with some middlemen, you were just taking out student loans to go to conferences, which is probably not a decision, it sounds like, you would have made, had you known that was going to be outcome. On top of that, travel and research is not a qualified education expense for making fellowships tax free. So you end up with this tax bill on top of all the other stuff that’s happening. How did that play out?

13:19 Dessie: I think one of the things that I knew when I was changing labs is that I knew that a portion of that fellowship money, I knew it was untaxed* and I was gonna need it. So I was able to put that aside. What surprised me is when I sat down with my accountant and she put two and two together, that all these other things had been categorized as fellowships, the amount I had set aside to pay taxes on was not nearly the amount of money that I needed. That was obviously a huge strain. I’m lucky enough that I have a partner who works, but we did end up having to go on a payment plan to the IRS because I just couldn’t afford to come out of pocket the amount that I owed.

[* By ‘untaxed,’ Dessie is referring to the fact that income tax was not withheld for her on this portion of her income, not necessarily that it is tax-free.]

13:57 Emily: At the point when you were working with your tax preparer, at what point in tax season was that? Were you getting ready to file and you found out that, “Oh wait, I’m going to owe more than I had set aside?”

14:08 Dessie: It was right at the end. There was no fixing it. I getting ready to file taxes and she’s like, this is not looking good, and it was what it was at that point.

14:18 Emily: Not all the listeners may know, but some people might hear, maybe from their parents or something, about filing extensions. So they get another, I don’t know, six months or something to file your tax return. You do not get an extension on actually the tax that you owe. You only get the extension on the return. So if you’re finding out in March or April that you owe a tax bill and you’re not prepared to pay it, as you said, graduate students typically live without much margin in their lives. If you find that you owe a tax but you’re not prepared to pay it, really probably the best thing to do is what you did, which is to go on a payment plan with the IRS. A lot of people would say, “Oh my gosh, the IRS, I’m so afraid I don’t want to talk to them. I don’t want to deal with them,” but actually that’s the worst step you can take, is not to talk to them. Did the payment plan work out okay? Did it end up being all right that you could pay a little bit over time?

15:06 Dessie: I’m still on it to this day. I owed a chunk and there’s only so much I could put towards it per month. So yeah, it has worked out. I’m making my payments so I haven’t gotten in trouble with the IRS, but it isn’t a new bill now every month that I have to pay. I think too, just thinking about this calendar year and the implications for next tax season, I think now I’m just very closely watching anything financially that comes through the school just to make sure I don’t get into this situation again. I know now there are ways that your department or your college can help you, and making sure that these expenses are processed the way they should be as true education expenses and not as extra in your life. And just keeping an eye on that. I think especially as I get into the fall, I will definitely be following up with my administrators and saying, “Hey, just want to make sure I see this here. Was there something that went with this to make sure that I’m not getting a bill for being over-awarded again, or I’m not having any more tax implications than I already know I will have.”

Saving Money for Taxes When Your Fellowships Do Not Have Tax Withheld

16:08 Emily: Right. At this point, now that you’re so aware and you’re so proactive about everything, are you filing quarterly estimated tax or does your additional tax due not rise to that level of necessity?

16:22 Dessie: It doesn’t rise to that level, but I am always putting stuff aside. Even when there are things that should be categorized in a way that I won’t have to worry about that, I’m still always just taking a certain percentage and putting it aside, because I think in my situation, the worst case scenario is to have what happened this year and be totally surprised and unprepared, because that’s exactly what happened.

16:42 Emily: Can you tell the listeners a little bit about your system for setting money aside? Because maybe they want to know, mechanically, how you do that.

16:48 Dessie: Yeah. I am not an accountant so I don’t have this down to any kind of science. It’s just kind of what I’ve found has worked for me. So anytime that I get any kind of award through the school, whether it be for travel or whatever else, it could be research money, I always take about 30% of that and I put it in a savings account. And that seems to be kind of a pretty safe estimate of you definitely won’t need to pay more than that, and so I think that’s been my system now. Even when I make requests for money, I always keep that in mind, because I think something that I’ve watched other students go through is they ask for exactly what they need, forgetting about that tax buffer. And so you might end up short or paying back necessary money later.

17:33 Emily: Yeah, good idea. I do think 30% is a very good margin, probably more than you’ll need, but better to be on the safe side than on the sorry side, as you definitely found out. Do you have like a separate savings account that you use for that or something?

17:46 Dessie: Yes, I have a savings account that I just don’t touch. I kind of joke with my partner, that it’s like the savings account that you don’t use as a savings account. There is no level of emergency that could make me touch that money. I pretend it’s not there because for all intents and purposes, it’s not mine. It’s the government’s, and I don’t want to end up in a situation. I mean it’s August, right? And I’m still on a payment plan for this past year’s taxes. I don’t want to have to do that again.

18:12 Emily: Yeah, I do the exact same thing. When I was in graduate school, some years…Well, I guess it wasn’t in graduate school, but it was when I did my postbac, taxes weren’t being withheld. I had to pay quarterly estimated tax at that time. I started doing the exact same thing. I set up a separate savings account, I have it nicknamed tax, put money in there as I get money to come in, withdraw from it as I was paying quarterly estimated tax. But I wanted to say that I do the exact same thing as you, which is that I don’t think about that tax savings account as being my money. Right now, when I’m self employed, I also have the responsibility of paying quarterly estimated tax. And so I actually calculate my, or our family’s net worth every month, on the first of the month, and so I calculate two numbers, which is one my technical net worth, which includes the tax money in it, and then what I label as my true net worth, which subtracts that tax savings account balance out. And I say, “Nope, I don’t even think of it as being mine right now because, as you said, I know I just have to hand it over to the IRS in a few months.” I don’t want to think of it as accessible at all, in the meantime. So yeah, thanks for sharing about that.

Final Words of Advice

19:16 Emily: Is there any other final advice around the situation that you would want to tell someone else so they don’t get into the same kind of problems that you did?

19:24 Dessie: Yeah, just kind of recapping what I said. So I think, of course, the conversation that fellowships are untaxed* is just a broader conversation we need to be having in general because I don’t think a lot of people know that. But again, just monitoring how things are being processed for you and if they’re technically being categorized as a fellowship. Then, I think that for the most part students are pretty safe. I don’t want to create mass panic as far as this cap goes. If you’re just talking about you just have an RA or you know, just the little student loans or you just have a TA. I think where you start to get near this cap is when you’re doing a lot of research awards and travel awards and teaching where it’s on top of what you’re already getting. I think for students that might have multiple things going on, like I clearly had, making sure you’re having a conversation and knowing where that line is so that way you don’t cross it because the way that they balance their books is you’re not going to know until you’re far down the road and the money is already spent. It’s going to be the next semester. So just keeping an eye on that and honestly just reaching out and asking your financial aid office and saying “I know that there’s a certain amount of aid that we’re allowed to get. What is my number?” So you can kind of monitor it yourself because I really think that for most people, you’re better off saying, “No, I’m not going to take that award this semester. No, I’m not going to get this or do this now” and waiting, so you don’t cross that line and end up having the money need to be paid back.

[* By ‘untaxed,’ Dessie is referring to the fact that income tax was not withheld for her on this portion of her income, not necessarily that it is tax-free.]

20:44 Emily: Yeah. Or just be aware, as you were saying earlier, that these letters or whatever can be written so that the money goes on top. So it sounds like, at least your university, your department, it wouldn’t be like, oh, your advisor just wants to pay you more or someone wants to just like give you a fellowship. You’re going to run into problems with that. It has to be something that’s justifiable under their system for raising their cap on an exception basis to allow that award to go through.

21:10 Dessie: Right, and I think too, just noting that the people that work in financial aid may not be as familiar with why research money or why conference money is an educational expense. So things that you might see and go through and you think, “Oh yeah, that’s totally an expense for my education. Anyone would see that?” No, you might have to justify it and they might need, you know, justification from your department on why this is important for your education.

21:32 Emily: Yeah. And I will just add that financial aid professionals and so forth, they’re not going to touch this tax issue with you. They’re going tell you to go away if you try to ask them tax questions. But in the area of how much you’re supposed to be awarded and what the education expenses are, they are the experts in that area. So you can definitely go to them with those kinds of questions. Just don’t ask them, “what’s my tax bill going to be?” They’re not going to answer that. But, yeah, among that subject matter, they are the best people to go to, I think. It sounds like you’ve developed a little bit of a working relationship with those people.

22:04 Emily: Dessie, thank you so much for giving this interview and sharing the story. I think it’s really unfortunate how it worked out and also just that you were saying that you didn’t catch all of this until the following calendar year or the following semester, naturally. That’s how these things work. Of course you wouldn’t, but because it happened so late, it sounds like the proper paperwork couldn’t have been pushed through in the past. I just want to ask the concluding question that I ask of all my guests, which is what is your best financial advice for another graduate student or early career PhD?

22:34 Dessie: I think asking questions. I think that early and often you should ask questions about the money that you’re getting, where it’s coming from, how it’s classified, and just always not being afraid to shoot financial aid and message and say “Hey, this has come through. Is there anything I need to do with this?” Because I think everyone, us included, but also the financial aid folks would rather be proactive about dealing with a problem rather than getting the early spring email, which was “what is happening, I can’t pay you a couple of thousand dollars.” I think just always asking questions and not being scared to ask about how these things impact you. Outside of academia, people wouldn’t hesitate to ask questions about their paycheck, right? And so we need to kind of be thinking about the same way. If something was different on your paycheck, you would ask why or what’s going on and how you need to deal with it. So just not being afraid to try and talk to people about what’s going on with you so you don’t get in a bind.

23:28 Emily: Yeah, absolutely. And like you said earlier, you don’t have to accept a fellowship. It can just be pushed through. And likewise for some other people, they might not even really be aware of how they’re being paid. They’re just kind of receiving a paycheck and they don’t really know is it from an assistantship. I mean they would know if they were teaching your class, right? They know if it says teaching assistantship, but is it a fellowship, is it an RA, I don’t know. The roles, like what you actually do for each of those things, are pretty much the same. So you might not even be aware until you get a W2 at tax time or don’t get a W2 at tax time, what happened in the previous year. Then, if any adjustments need to have made, then it’s too late, right? Then the tax year has already ended. So totally want to underline that advice — know why you’re being paid, know what kind of tax forms you’re going to receive.

24:10 Emily: I just want to add in a final note for the listeners, if there’s anyone listening who is receiving a fellowship, even a small award, like what Dessie’s been talking about during this interview, you should look into whether or not you need to file quarterly estimated tax. I’m going to link in the show notes my massive article on quarterly estimated tax. And I also have a workshop on that that’s linked from that article. So I’ll link to both those things in the show notes. Please note that the deadlines for quarterly estimate tax are in mid April, mid June, mid September and mid January of every year, usually the 15th of the month or the business day following. So keep those deadlines in mind. If you are receiving a fellowship, you might not have to pay quarterly, but at least you need to investigate and figure out whether or not it’s your responsibility, or whether like what Dessie’s doing, you can just set the money aside and leave it until the end of the year and pay it all at once with your annual tax return.

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25:01 Emily: Thank you again Dessie for coming on and giving this interview and giving this word of warning to all the other graduate students listening.

25:08 Dessie: Thank you for having me.

Outtro

25:10 Emily: Listeners, thank you for joining me for this episode. PFforPphDs.com/podcast is the hub for the Personal Finance for PhDs podcast. There, you can find links to all the episode show notes and a form to volunteer to be interviewed. I’d love for you to check it out and get more involved. If you’ve been enjoying the podcast, here are four ways you can help it grow. One, subscribe to the podcast and rate and review it on Apple podcast, Stitcher, or whatever platform you use. Two, share an episode you found particularly valuable on social media or with your PhD peers. Three, recommend me as a speaker to your university or association. My seminars covered the personal finance topics PhDs are most interested in, like investing, debt repayment, and taxes. Four, subscribe to my mailing list at PFforPhDs.com/subscribe. Through that list, you’ll keep up with all the new content and special opportunities for Personal Finance for PhDs. See you in the next episode, and remember, you don’t have to have a PhD to succeed with personal finance, but it helps. The music is Stages of Awakening by Podington Bear from the Free Music Archive and is shared under CC by NC. Podcast editing and show notes creation by Lourdes Bobbio.

Fellowship Income Is Now Eligible to Be Contributed to an IRA!

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In this episode, Emily explains the new legislation that allows non-W-2 fellowship income to be contributed to an Individual Retirement Arrangement (IRA). Up until 2019, fellowship or training grant income (reported on a Form 1098-T or Form 1099-MISC or not reported at all) was not eligible to be contributed to an IRA. Certain legislation, the Graduate Student Savings Act (GSSA), which fixes this problem, has been proposed a few times since 2016, but never passed. However, at the end of the 2019 Congressional session, the text of the GSSA was passed and signed into law as part of an omnibus spending bill (H.R. 1865). PhD trainees who are newly eligible to contribute to an IRA should consider their overall financial status and goals to determine whether to contribute and in what amount.

Links Mentioned in this Episode

taxable compensation fellowship IRA

Intro

Welcome to the Personal Finance for PhDs podcast: a higher education in personal finance. I’m your host, Dr. Emily Roberts.

This is Season 4 Bonus Episode 1, and in this episode I will update you on recent legislation that has a major positive impact on the PhD trainee population.

Specifically, starting on January 1st, 2020, the definition of “taxable compensation” for the purpose of contributing to an individual retirement arrangement or IRA was  updated to include taxable fellowship income not reported on a W-2.

That’s the takeaway point for those of you already in the know about this issue: Your taxable non-W-2 fellowship income is now eligible to be contributed to an IRA. You can open a Roth or traditional IRA on January 1 or following and put in the $6,000 maximum contribution if you like, assuming your taxable fellowship income is at least $6,000 in 2020. If that’s all you need to know, feel free to stop this episode now, but please share it with your peers as you go.

In the rest of this episode, I will review the prior definition of taxable compensation and how it negatively impacted the PhD trainee community and then explain the recent legislation that changed the definition for 2020 and forward. At the end of the episode, I’ll point you to a few resources to help you in your investing journey.

1 The Prior Definition of Taxable Compensation

The federal government offers a few different tax incentives to encourage individuals to invest for their retirement.

When you invest money inside a tax-advantaged retirement account, you don’t have to pay tax on the growth in your investments as you would for a regular taxable investment account and you also can take a tax break on either the amount of money you contribute to the account or the amount of money you withdraw from the account in your retirement.

Most of the tax incentives are offered through workplace-based retirement accounts, such as a 401(k) in the private sector or a 403(b) in the nonprofit sector. However, there is one type of account that can be opened outside of your workplace, and that is the Individual Retirement Arrangement or IRA.

You as an individual can go to just about any brokerage firm and open an IRA, and it’s not at all connected to where you work. The contribution limit for an IRA is $6,000 per year if you’re under age 50.

The restriction the federal government places on IRAs is that you have to have what’s called “taxable compensation” in a given calendar year to contribute to an IRA. Your overall income also has to fall under certain limits to contribute.

The old definition of taxable compensation was as follows. Think of a two-column list. The left-hand column is types of income that are considered taxable compensation, and the right-hand column is types of income that are not considered taxable compensation. I’m not giving you the exhaustive lists, but just an idea.

In the left-hand list, taxable compensation, you had:

  • W-2 income, such as you would receive from being an employee,
  • Self-employment income,
  • Alimony,
  • Etc.

In the right-hand list, not taxable compensation, you had:

  • Rental income,
  • Interest and dividend income,
  • Pension or annuity income,
  • Taxable scholarship and fellowship income not reported on a W-2,
  • Etc.

This was specified in the tax code. So if your fellowship or training grant income was reported on any kind of tax form other than a W-2, such as a 1098-T or 1099-MISC, or not reported at all, it was not considered taxable compensation for the purposes of contributing to an IRA.

That means that if you went an entire calendar year with only non-W-2 fellowship income, you would not have been able to contribute to an IRA in that calendar year.

This was really tough news for a lot of people in our PhD community. The irony was that students and postdocs who won outside fellowships often received a higher income than their employee peers, so they perhaps had more money available to invest, but they were barred from using an IRA to do so.

Now, there were a couple workarounds. Keep in mind that the contribution limit to an IRA is $6,000 or the amount of your taxable compensation, whichever is lower.

First, the calendar year and the academic year do not line up. So if your funding source switched between W-2 and non-W-2 between academic years, you would still have at least a degree of IRA eligibility in that calendar year.

Second, if you were married and your spouse had taxable compensation, you could contribute to a spousal IRA, up to their amount of taxable compensation or the overall $12,000 per year limit for two IRAs, whichever was lower.

Third, if you had a side hustle, that self-employment or W-2 income would give you some eligibility.

As a last resort, if you truly didn’t have access to an IRA in a calendar year, you still had the option to invest for retirement in a regular taxable investment account. If you chose a tax-efficient investing strategy, such as passive index investing, you probably would not have much of an additional tax burden due to the favorable tax rates for long-term capital gains and qualified dividends. However, this tax advantage was not widely recognized.

The effect of this law was that many PhD students and postdocs who had the financial means to invest for retirement were prevented from contributing to IRAs, and they likely didn’t try to invest instead in a taxable account. The law sent the message that PhD trainees were not supposed to be investing for retirement and were not worthy of being extended the same tax break that employees were. This had an overall dampening effect on the financial ambition of PhD trainees, which in my opinion was a very serious problem.

2 The Legislation That Changed the Definition

All that has changed now. In essence, the new legislation moved taxable scholarship and fellowship income not reported on a W-2 from the right-hand column to the left, from being explicitly excluded from the definition of taxable compensation to being explicitly included in the definition for graduate students and postdocs.

The origin of this legislation was the bipartisan Graduate Student Savings Act or GSSA, first introduced in 2016 in the Senate by Senators Elizabeth Warren and Mike Lee and in the House by Congressmen Joe Kennedy and Luke Messer; however, it was not passed at that time. The GSSA was re-introduced in 2017 and 2019 and eventually included in the bipartisan SECURE Act in 2019, none of which passed.

You can learn more about the GSSA in Season 4 Episode 9 of this podcast, in which I interview Abby Dove, a graduate student who as a science policy fellow worked on getting a scientific advocacy group to endorse the GSSA.

Ultimately, in the closing days of the 2019 session, the text of the GSSA was included in an omnibus spending bill along with the rest of the SECURE Act, passed by both chambers of Congress, and signed into law by the president.

I’ll read to you exactly the change that was made in House Resolution 1865, and I’ll link it from the show notes.

“SEC. 106. CERTAIN TAXABLE NON-TUITION FELLOWSHIP AND STIPEND PAYMENTS TREATED AS COMPENSATION FOR IRA PURPOSES.

(a) In General.—Paragraph (1) of section 219(f) of the Internal Revenue Code of 1986 is amended by adding at the end the following: “The term ‘compensation’ shall include any amount which is included in the individual’s gross income and paid to the individual to aid the individual in the pursuit of graduate or postdoctoral study.”

(b) Effective Date.—The amendment made by this section shall apply to taxable years beginning after December 31, 2019.”

There you have it! The definition of “taxable compensation” for the purposes of contributing to an IRA now includes taxable fellowship income for graduate students and postdocs. However, by my reading, it seems that taxable post-baccalaureate fellowships have not been included in the definition.

That language of “aid the individual in the pursuit of graduate or postdoctoral study” reflects the definition of a fellowship from IRS Publication 970, which reads quote “A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research” end quote.

3 What to Do Now

This change is really good news for the PhD trainee community overall, but it may or may not materially change anything for you. If you now have access to an IRA in 2020 when you otherwise would not have, what should you do? I imagine that PhD trainees fall into one of three groups.

First, some PhD trainees should not be investing for retirement right now, so having access to an IRA doesn’t really matter. This is the case if you don’t have the available cash flow to invest or have other, higher-priority financial goals, such as paying off high-interest debt or saving up cash.

Second, some PhD trainees are ready and able to invest but don’t have pre-existing savings or investments. Maybe they have recently finished paying off certain types of debt or saving up sufficient cash, and they now have cash flow available for investing. This is the group that can open up an IRA and set up a regular savings rate into it; this is called dollar cost averaging. With a $6,000 per year limit, your regular monthly contribution to the IRA can be up to $500, which would be a great savings rate for a graduate student or postdoc.

Third, some PhD trainees have already been saving or investing outside of an IRA and are eager to contribute a lump sum of money to an IRA. You are permitted to contribute the full $6,000 in one go if that’s your preference. Then, throughout the year, you can direct your ongoing savings rate to a taxable investment account or other financial goals.

One question I’ve already received a few times is whether fellowship recipients will be able to contribute to a 2019 IRA. In general, you are allowed to contribute to your prior year’s IRA up until tax day of the subsequent year, and this is a strategy I recommend to anyone who has not yet maxed out their IRA for the prior year. However, since the text of the bill says the change will go into effect after December 31, 2019, my reading is that the old definition of taxable compensation will apply to 2019 IRAs and the new definition will apply to 2020 IRAs.

If you’re not sure what your unique next steps should be or if what I spoke about today even applies to you, I am available to coach you. I can’t recommend specific funds, but we can work together to determine your next financial goal, increase your savings rate, and figure out which high-level investing strategy is most appropriate for you.

You can set up one-on-one coaching with me by going to PFforPhDs.com/coaching. Another excellent option is to participate in my upcoming program, The Wealthy PhD, through which you will receive course content, individual and group coaching, and community with your peers. You can find more information about The Wealthy PhD at PFforPhDs.com/wealthyPhD.

I would be absolutely delighted to shepherd fellowship recipients who have never before invested through the process.

As for additional resources, I have many, many articles on investing on my website, and I have linked several updated ones from the show notes. You can find the show notes for this episode at PFforPhDs.com/s4be1 for season 4, bonus episode 1.

For international students and postdocs, I would also recommend listening to Season 4 Episode 17 of this podcast, which answers the question of whether it is permissible and advisable for international students, postdocs, and workers to invest while living in the US. Keep in mind that I recorded this episode prior to the definition of taxable compensation changing.

Finally, if you need to take a big step back because you were surprised to hear that your fellowship and potentially scholarship income is taxable, I recommend listening to Season 2 Bonus Episode 1 of this podcast, titled Do I Owe Income Tax on My Fellowship?

Thank you for joining me for this special bonus episode. Please spread the good news about IRA eligibility to your peers also receiving fellowship or training grant income by sharing this episode with them!

Outtro

Listeners, thank you for joining me for this episode.

PFforPhDs.com/podcast is the hub for the Personal Finance for PhDs podcast. There, you can find links to all the episode show notes and a form to volunteer to be interviewed. I’d love for you to check it out and get more involved.

If you’ve been enjoying the podcast, here are four ways you can help it grow:

One, subscribe to the podcast and rate and review it on Apple podcast, Stitcher, or whatever platform you use.

Two, share an episode you found particularly valuable on social media or with your PhD peers.

Three, recommend me as a speaker to your university or association. My seminars covered the personal finance topics PhDs are most interested in, like investing, debt repayment, and taxes.

Four, subscribe to my mailing list at PFforPhDs.com/subscribe. Through that list, you’ll keep up with all the new content and special opportunities for Personal Finance for PhDs.

See you in the next episode, and remember, you don’t have to have a PhD to succeed with personal finance—but it helps.

The music is Stages of Awakening by Podington Bear from the Free Music Archive and is shared under CC by NC.

Weird Tax Situations for Fellowship and Training Grant 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 or training grant funding because it neither a wage nor self-employment income. Fellowships and training grants, which I call “awarded income” 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 Form W-2 (and you’re not self-employed).

Often, though not always, winning an external or internal 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 Form 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 awarded income 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 awarded income is that you don’t receive a Form 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:

  • Form 1098-T
  • Form 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 awarded income; neither does it very well, but they do get the job done if you know what you’re looking for.

Form 1098-T

Form 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 Form 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 awarded (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 Form 1098-T.

Form 1099-MISC

Form 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 Form 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 awarded income; see Weird Tax Situations for Fully Funded Grad Students for more details on that.

Further reading: Where to Report Your PhD Trainee Income on Your Tax Return

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.

Further reading: The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients

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 From 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.”

Through 2019, the definition of “taxable compensation” did not include fellowship and training grant income not reported on Form W-2. However, starting in 2020, the definition of “taxable compensation” changed for graduate students and postdocs to include fellowship and training grant income even if not reported on From W-2.

Therefore, all types of graduate student and postdoc taxable income, whether reported on a Form W-2 or not, is eligible to be contributed to an IRA starting in 2020.

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 under age 24.) 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 $2,200 may be subject to a higher tax rate than the ordinary rate.

Further reading: Fellowship Income Can Trigger the Kiddie Tax

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

Do I Owe Income Tax on My Fellowship?

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Postbac, graduate student, and postdoc fellows frequently ask whether their fellowships are considered taxable income. PhD-type fellowships that are not reported on a W-2 are non-compensatory income. They might be reported on a 1098-T in Box 5, on a 1099-MISC in Box 3, or on a courtesy letter or not reported at all, which accounts for the widespread confusion. Publication 970 answers the question of when a fellowship can be considered tax-free. Fellowships are considered part of the recipient’s taxable income unless they go toward paying qualified education expenses (students only).

Links Mentioned in the Episode

income tax fellowship

Transcript

Welcome to the Personal Finance for PhDs Podcast – a higher education in personal finance. I’m your host, Emily Roberts.

I’m doing something a little bit different in this special bonus episode for Season 2.

I’m using it to answer a frequently asked question that I receive about taxes. The question is: Do I owe income tax on my fellowship?

In this episode, I’m speaking to citizens and residents in the United States. And I’m also talking about PhD-type fellowships whether at the postbac level, the graduate student level, or the postdoc level.

What’s going on with these fellowships that makes the recipient question whether or not they are taxable is that they are not reported on a W-2. They might not be reported at all, or they may be reported on a 1098-T in Box 5, on a 1099-MISC in Box 3, or on a courtesy letter, which is not an official tax form but rather just a letter that states what the amount of the fellowship was in that calendar year.

Fellowship income is considered part of your taxable income. Now, you may not actually end up paying tax on your fellowship income depending on the rest of your return, like the deductions and credits you’re going to be able to take, but it is considered part of that taxable income.

Now, I know you’re not inclined to just believe me right off the bat. I mean, there’s a strong incentive for you to believe that your fellowship income is not taxable, so I’m going to give you a bit of evidence here.

IRS Publication 970 is the definitive publication on the taxability of fellowship and scholarship income. I’ll read you a few excerpts from Chapter 1 of Publication 970.

First, some definitions:

A scholarship is generally an amount paid or allowed to, or for the benefit of, a student (whether an undergraduate or a graduate) at an educational institution to aid in the pursuit of his or her studies.

A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.

So you can see that fellowship grants are much more broad; they can be issued to non-students, whereas scholarships only go to students.

Chapter 1 of Publication 970 approaches fellowships and scholarships from the perspective of trying to make them tax-free.

So let’s see how that can happen:

A scholarship or fellowship grant is tax free (excludable from gross income) only if you are a candidate for a degree at an eligible educational institution.

So right off the bat we know that anybody who is receiving a fellowship who is not a student cannot make their fellowship tax-free, i.e., it is part of their taxable income.

Additionally:

A scholarship or fellowship grant is tax free only to the extent: It doesn’t exceed your qualified education expenses…

So now we’re just dealing with the graduate student population that has the potential to make a scholarship or fellowship grant tax-free.

The way that we use the terms ‘scholarship’ and ‘fellowship’ in academia, a ‘fellowship’ generally refers to the money that you take home for your living expenses, whereas ‘scholarship’ is the money that goes towards paying your tuition and fees, the qualified education expenses.

Very roughly speaking, your qualified education expenses can make your scholarships tax-free if you’re a fully funded graduate student, but there’s no more qualified education expenses to start making your fellowship income tax-free. Therefore, again, roughly, your fellowship income is included in your taxable income.

So to summarize, fellowship and scholarship income that goes towards paying our qualified education expenses like tuition and fees can be made tax-free, but fellowship and scholarship income that goes towards paying other kinds of expenses like your living expenses can’t be made tax-free.

Now, I’m glossing over some very important details on how you actually calculate your taxable income, so if you want more information about that, please see the tax center on my website, pfforphds.com/tax.

But, there you go, roughly speaking, fellowship income does need to be included in your taxable income, whether you are a postbac, a graduate student, or a postdoc.

Thanks for joining me in this short bonus episode!

Please share this episode on social media and with your peers because this is a message that they need to hear. It’s not a message that they want to hear, but it’s a message that they need to hear to stay on the right side of the IRS.

Show notes for this episode can be found at pfforphds.com/s2be1.

Thanks for joining me today, and I’ll see you in the next episode!

Further reading/viewing: