tax lies

The Saver’s credit is an incentive program for low-income people to save for retirement. Basically, if you contribute money to a retirement account and your adjusted gross income is below a certain threshold ($30,500 for single filers $61,000 for married filing jointly filers), you can receive a tax credit. The credit is worth between 10 and 50% of your contribution (the less you make, the higher the percentage) up to $2,000!

If you are a grad student and contributing to an individual retirement arrangement, you are a rock star. You should be able to take advantage of this awesome credit – but you can’t. One of the three exclusion criteria for the Saver’s credit is being a full-time student (p. 47 of Publication 590A).

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

Note: The content in this article is outdated. As of January 1, 2020, there is a new definition of taxable compensation. You can read or listen to the details about the new definition in: Fellowship Income Is Now Eligible to Be Contributed to an IRA!

This tax lie is tied with lie #6 as my least favorite because I fervently wish it were true. It makes intuitive sense that everyone with an income should have access to tax-advantaged retirement accounts. However, only income that is taxable compensation is eligible to be contributed to an individual retirement arrangement (IRA).

You can open and make contributions to a traditional IRA if: You (or, if you file a joint return, your spouse) received taxable compensation during the year, and… (Publication 590A p. 5)

Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and… (Publication 590A p. 40)

Sounds good so far, right? Typically, when grad students ask themselves if their income is “taxable compensation,” they focus on the “taxable” half of the term. Yes, your grad student income is taxable. But is it “compensation?”

Publication 590 has the answer here, as well. Under the section header “What Is Compensation?” it states:

Generally, compensation is what you earn from working… Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2. (Publication 590 p. 6)

Scholarships and fellowships paid to grad students are almost always reported on a 1098-T, a 1099-MISC (box 3), a courtesy letter, or not at all – basically anywhere other than a W-2. So the question of taxable compensation as it relates to grad student income comes down to whether the income was reported on a W-2 (which is typical for assistantships). Grad student pay that is reported on a W-2 is compensatory, while grad student pay reported on a 1098-T, a 1099-MISC (box 3), a courtesy letter, or not at all is non-compensatory.

Further reading: Earned Income: The Bane of the Grad Student’s Roth IRA

If your only source of income in a calendar year is non-compensatory fellowship pay, unfortunately you aren’t supposed to contribute to an IRA for that year. However, if you are married to someone with taxable compensation, you can contribute to a spousal IRA. If you are an unmarried fellowship recipient who really wants to contribute to an IRA, you can consider generating a side income specifically to gain that eligibility. You can contribute 100% of your taxable compensation to an IRA up to $5,500 in 2018.

Further reading: Can a Grad Student Have a Side Income?

Ineligibility to use an IRA, however, is not a reason to give up on your goal of saving for retirement while receiving fellowship income. There are workarounds available so that you can still minimize your tax burden.

Further reading/viewing:

• Fellowship Recipients Can Save for Retirement Outside an IRA
• Webinar: Retirement Investing in a Taxable Investment Account

We at Personal Finance for PhDs are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

Tax credits are amazing, and you should definitely claim as many of them as you can. While a tax deduction reduces your taxable income, a tax credit directly reduces your tax due. A deduction of $2,000, for example, is worth $2,000 x your marginal tax bracket. Many grad students are in the 15% tax bracket (or lower), so a $2,000 deduction is worth only $300 for them. A tax credit of $2,000, on the other hand, is $2,000 directly knocked off your tax bill. Some tax credits can be refunded to you, meaning that instead of paying tax for the year, you are given money!

“The earned income credit (EIC) is a tax credit for certain people who work and have earned income under $53,267. A tax credit usually means more money in your pocket. It reduces the amount of tax you owe. The EIC may also give you a refund.” (Publication 596)

You have to have a pretty low income to qualify for the EIC (adjusted gross income < $14,820 for a single person without children), but plenty of grad students fall into those income brackets, especially if they have a dependent spouse and children.

The catch for grad students, though, is right in the name of the credit. Eligibility for this credit depends on having earned income, which is bad news for grad students who receive fellowship pay (aka non-compensatory pay).

Rule 7 states that you need earned income to claim this credit. If you have an assistantship, you have W-2 pay, which is earned income. If your spouse has a real job or is self-employed, that is earned income. But if your only household income is from a fellowship or scholarship (reported anywhere other than a W-2 or not reported), that is not earned income, and you will not be able to claim this credit.

“A scholarship or fellowship grant that wasn’t reported to you on a Form W-2 isn’t considered earned income for the earned income credit.” (Publication 596 p. 18)

See the tax lies home page for a full list of tax lies that graduate students should not fall for.

We at Personal Finance for PhDs are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

“Oh, you’re moving for grad school? You’re being paid to go to grad school – like a job? You should take a deduction for your moving expenses! I’ve done that whenever I’ve moved for a job.”

The moving expenses deduction is a great one to be aware of, but you’ll probably only be able to apply it after grad school.

To be able to take the deduction, you have to pass three tests, one of which is the “time test.”

The time test states:

“If you are an employee, you must work full-time for at least 39 weeks during the first 12 months immediately following your arrival in the general area of your new job location.”

(If you are working a full-time job or are self-employed full-time in addition to your graduate work, perhaps you will be able to take the moving expenses deduction. The rest of this post assumes is intended for graduate students who are being paid stipends by their universities and who have little to no outside work.)

While you are absolutely working ‘full-time’ and then some on your graduate degree, you are almost certainly not considered a full-time employee. Graduate students with assistantships are student-employees, but the fine details of their contracts/offers reveal that they have only a 50% appointment or less. That means that the hours for an assistantship are capped at 20/week, which does not meet the eligibility requirements for the moving expenses deduction. Graduate students paid by fellowships are not employees at all, nor are they self-employed, so they also fail the time test.

See the tax lies home page for a full list of tax lies that graduate students should not fall for.

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

Update 4/8/2016: This post has been updated and improved based on commenter feedback. Weigh in with your opinion in the comments section!

This is just about my least favorite tax lie. I believed this lie all through grad school and I think everyone at my university did, too. When I first started researching grad student taxes in detail, I became aware of the possibility that the scholarships that pay health insurance premiums may be taxable income, and I tried as hard as I could to find a justification that they weren’t. Ultimately, I was forced to admit defeat. I now believe that at many universities the scholarships that pay grad student health insurance premiums are taxable income. However, I still fervently want to change my position on this, so if you have any evidence that this is not a lie after all, I want to hear it!

It would be logical if the portion of our income that pays our health insurance premiums were not taxed, because that is how that portion of employee pay is treated when the premiums are paid through payroll deductions. However, the grad students that are not full-fledged university employees (I’ve only heard of a few universities where that is the case – virtually all grad students are primarily students and some of them only secondarily employees) are not paying the premiums through payroll tax but rather through their student accounts. (Grad students who are employees and do pay their insurance premiums through payroll deductions might be able to take a tax deduction on the income that pays the premium.)

The great majority of grad students have health insurance premiums posted to their student accounts alongside their tuition and other required fees. Then, scholarships are posted to the account to pay all those fees. Scholarships do not have to be included in our gross taxable income if they are completely balanced out by qualified education expenses, but excess scholarship money is taxable. The key point to understand is that health insurance premiums may not be qualified education expenses.

IRS Publication 970 Chapter 1 (p. 6) states:

Qualified education expenses. For purposes of tax-free scholarships and fellowship grants, these are expenses for:

• Tuition and fees required to enroll at or attend an eligible educational institution; and
• Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.

Expenses that don’t qualify. Qualified education expenses don’t include the cost of:

• Room and board,
• Travel,
• Research,
• Clerical help,
• or Equipment and other expenses that aren’t required for enrollment in or attendance at an eligible educational institution.

You can see that health insurance is not explicitly listed as a qualified education expense or excluded from being a qualified education expense. The key to determining whether it is a qualified education expense or not is likely whether it is classified as a required fee.

At my alma mater, every student was required to have health insurance. While health insurance was offered by the university, it was not required that we buy it through the university. In that situation, I don’t think that our health insurance premium was a qualified education expense. This point is absolutely debatable, and I have debated it with my husband, a CPA and staff member at my university, friends, and online commenters, generally without coming to a conclusion that is fully satisfactory to both sides.

Further Reading: Disagreement over Grad Student Health Insurance Taxes

Think about this extreme case as a test: If a student bought insurance independently that met his university’s requirement, would the premium for that insurance be a qualified education expense for the purpose of making scholarship or fellowship income tax-free?

It may be the case that other universities require their graduate students to buy health insurance from the university as a condition of enrollment. Those health insurance premium would be a required fee and therefore a qualified education expense. The scholarships that pay health insurance premiums at those universities could therefore become tax-free for the students. How universities provide health insurance for their students is currently a rapidly changing landscape due to the Affordable Care Act, so this designation could even change from one year to the next at the same university. If you are receiving a scholarship that pays your health insurance premium, be sure to check each year to see whether it is a required fee.

Whether health insurance premiums at universities are qualified education expenses for the purpose of making a scholarship tax-free is a confusing question, even for the IRS. Kathleen shared in a comment below (from 3/27/2016) that she talked with an IRS helpline agent who confirmed that at her university the health insurance premium was a qualified education expense for the purpose of making a scholarship tax-free. I also called the IRS helpline about this issue on 4/1/2016. At first, the agent I spoke with stated that the health insurance premium was a qualified education expense, then after better understanding the scenario at my own alma mater she reversed her position to say that it wasn’t. After further discussion, we left the conversation with her leaning toward the premium not being a qualified fee, but not completely sure. With this confusing and conflicting feedback from IRS helpline agents (who have no more information available to them than what is public), perhaps it can be called a gray area. (If you have called the helpline about this issue, please leave a comment on what you were told!)

If you decide to make the scholarship that pays your health insurance premium tax-free, be prepared to justify to the IRS (if it asks) that your health insurance premium was a required fee with written documentation of your university’s policies.

A quick note on 1098-Ts: A student’s health insurance premium should not be listed in Box 1 or 2, which is one point of reference for determining the amount of qualified education expenses a student has in the course of a year that the IRS may rely on. (Please add a comment if your university does list the premium in Box 1 or 2.) It is acceptable to include more (or fewer) qualified education expenses in your tax calculations than what is listed on your 1098-T, especially because of the varying definitions of a qualified education expense.

The 1098-T Instructions state (p. 3):

Qualified tuition and related expenses. Qualified tuition and related expenses are tuition, fees, and course materials required for a student to be enrolled at or attend an eligible educational institution.

The following are not qualified tuition and related expenses.

• Amounts paid for any course or other education involving sports, games, or hobbies, unless the course or other education is part of the student’s degree program or is taken to acquire or improve job skills.
• Charges and fees for room, board, insurance, medical expenses (including student health fees), transportation, and similar personal, living, or family expenses.

Tax lie #4 and tax lie #5 expand on why portions of a grad student’s taxable income may not be associated with official tax forms or be subject to tax withholding. See the tax lies home page for a full list of tax lies that graduate students should not fall for.

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

This lie starts with the assumption that the it’s the IRS’s responsibility to collect the tax due. Instead, it is truly up to the taxpayer to send in the appropriate amount of tax due, either once per year in tax season or on a regular basis throughout the year. There are lots of types of income other than grad student non-compensatory pay that do not or may not have taxes withheld from them, and the responsibility is still on those taxpayers to sent in the right amount of tax in a timely manner.

Graduate students with assistantships will receive W-2s at tax time and will likely be required to set up income tax withholding. Domestic graduate students with fellowships, on the other hand, may or may not have taxes withheld from their stipends. Some universities offer graduate students with fellowships the opportunity to have taxes withheld and some do not. If your university does have a system for withholding taxes from fellowship pay, doing so will likely help your money management.

If you are not having tax withheld from your stipend, you need to check whether you are supposed to pay quarterly estimated tax or simply send in your tax due once per year.

Tax lie #1 and tax lie #4 explain in more detail that fellowship pay is taxable. See the tax lies home page for a full list of tax lies that graduate students should not fall for.

We at Personal Finance for PhDs are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.