“Actually, I get paid to go to school.” How many times have you said that to distant relatives and new acquaintances? If you look at it that way, being a funded grad student is a pretty sweet gig. But there are definitely downsides, like the low pay, sub-par benefits, and the weird tax situations that come with getting paid to be a grad student in the US. Receiving a 1098-T that has seemingly no basis in reality and having to incorporate it into your tax return – or worse, not receiving one – can become a real time- and energy-suck. The whole tax return support system seems to have been set up to help people who are in the red with their universities, not people who are in the black. Fortunately, there are solutions to these weird tax situations for fully funded grad students, and I’ve brought them to light for you in this point.
The points covered in this post are strictly to do with being a funded graduate student at a university. Tune back in next week for the even-weirder tax situations that come with fellowships (at the graduate student and postdoc levels).
- How to Prepare Your Grad Student Tax Return
- Why It Matters How You Are Paid
- Grad Student Tax Lie #4: You Don’t Owe Any Taxes Because You Didn’t Receive Any Official Tax Forms
- Grad Student Tax Lie #5: If Nothing Was Withheld, You Don’t Owe Any Tax
- Grad Student Tax Lie #2: You Received a 1099-MISC; You Are Self-Employed
Download Your Tax "Cheat Sheet"
Essential information to help funded US domestic graduate students with their federal tax returns
You Might or Might Not Receive a 1098-T
The 1098-T looks like a super official tax form, rather like a W-2. However, I like to think of it as a communication between the university and the IRS that you, the grad student, have only been cc’d on. It’s not issued to help you properly report your income to the IRS. Its primary purpose is to let the IRS know that a student (or a student’s parents) might try to take an education tax break so that it can check the amount of the tax break claimed.
But fully funded grad students often do not claim net educational tax breaks. And if a tax break isn’t in order, it’s actually optional for the universities to even create a 1098-T. So as a fully funded graduate student, you might receive a 1098-T or you might not; the choice belongs to your university.
Further reading: What Is a 1098-T?
Your 1098-T Might Mislead You
The only thing worse than not receiving a 1098-T is receiving one that is misleading.
When a 1098-T is issued, it is supposed to contain all of the scholarships and grants the grad student received (Box 5) as well as either the payments received (Box 1) or amounts billed (Box 2) for qualified tuition and related expenses. If Box 1/Box 2 is greater than Box 5, an education tax break is in order, and if Box 5 is greater than Box 1/Box 2, you have some excess income to report.
But wait! It’s not always that simple. See Box 7? If that is checked, we’ve run into a calendar year/academic year issue. Sometimes the tuition, etc. for a winter or spring semester/trimester (beginning in January through March) is charged in or before December of the prior year. But are the corresponding scholarships that pay those charges posted at the same time? Nope! They often are posted in that January to March window. So the charges end up on the 1098-T for one calendar year while the corresponding scholarships end up on the 1098-T for the subsequent calendar year.
It’s not a good idea to take a tax break in one year only to have to pay a boatload of extra tax in the next year. The solution is to pair the charge with the scholarship that is earmarked for it. You do this by pulling the charge forward into the calendar year when the scholarship shows up.
So basically, your 1098-T isn’t reliable if Box 7 is checked, and you have to do your own arithmetic with the charges and scholarships that show up in your student account to find the proper numbers to plug into your tax return.
In addition, your 1098-T might not list in Box 1/Box 2 all the qualified education expenses you are eligible to claim… More on that later!
If You Have Scholarships and Qualified Education Expenses, You Can Choose between a Deduction and a Credit
When you have qualified education expenses such as tuition, you get to use them for some kind of tax break. That’s good news. The bad or at least complicating news is that you have to make a choice about how to use them. With some limitations, you get to choose being using them for a deduction and using them for a credit.
A quick review on deductions vs. credits: Deductions reduce your taxable income, while credits reduce your tax due.
How much a credit is worth to you is pretty easy to calculate. If it’s a $1,000 credit, you knock $1,000 off your tax due. (Be a bit careful because some credits are non-refundable, meaning that they stop working when your tax due hits $0.) If it’s a 50% credit for up to $1,000, if you take the full credit you’re knocking $500 off your tax.
How much a deduction is worth to you depends on your marginal tax rate. You have to multiply the amount of the deduction by your top marginal tax rate (or two tax rates, if the deduction makes you cross tax brackets). If your top tax bracket is the 10% tax bracket, a $5,000 deduction takes $500 off your federal tax due. You also should factor in your state marginal tax bracket if your state honors the deduction.
Further reading: Marginal Tax Brackets, Deductions, and Credits Explained Graphically
With your qualified education expenses, at the graduate level you will choose between two ways to use them to reduce your tax burden. (I’m leaving out some limitations such as what qualifies as an educational institution and income ceilings, so look those up before you make a final decision.) You can:
- Make some or all of your scholarship/grant income tax-free (i.e., take a deduction).
- Use the Lifetime Learning Credit (20% credit up to $10,000 for tax year 2016).
Please note that you can’t use the same qualified education expenses for more than one tax break.
The easiest route for students with as much or more scholarship income than qualified education expenses is to make as much of your scholarship income as you can tax-free using your qualified education expenses. You don’t even have to include this calculation on your tax return; you simply report the net number as income (more on that later).
However, it may be more beneficial to your total tax due – federal, state, and local – to use the Lifetime Learning Credit instead. It all depends on your marginal tax rates. If your federal, state, and local marginal tax rates sum to less than 20%, you’ll pay less tax overall if you use the Lifetime Learning Credit for up to $10,000 of your qualified education expenses. This definitely makes your tax return more complicated – you’ll report a higher gross income and calculate a higher tax due and then take a credit to reduce your tax due – but again it’s your choice if that complication is worth paying a bit less in tax. See “Coordination with Pell Grants and Other Scholarships,” Publication 970 p. 26.
If you choose to take the Lifetime Learning Credit and have more than $10,000 in qualified education expenses, you can use your remaining qualified education expenses to make (part of) your scholarship income tax-free.
(If you have more qualified education expenses than scholarship income, your only available tax break for the excess qualified education expenses starting in tax year 2017 is the Lifetime Learning Credit, even if a deduction would be better for your bottom line. The Tuition and Fees Deduction, a way to deduct qualified education expenses against non-scholarship income, expired in 2016.)
Further reading: How to Prepare Your Grad Student Tax Return
Download Your Tax "Cheat Sheet"
Essential information to help funded US domestic graduate students with their federal tax returns
You Have to Figure Out Your Own Qualified Education Expenses
Oh, and did I mention yet that the definition of a Qualified Education Expense is slightly different depending on the tax break you’re trying to take? Yeah, that’s another weird tax situation for fully funded grad students.
Even though the same term, such as qualified education expenses, is used to label a basic component of many of the education benefits, the same expenses aren’t necessarily allowed for each benefit. – IRS Publication 970 p. 4
Tuition and required enrollment fees are considered qualified education expenses for both the education tax benefits I’ve discussed, but some additional expenses sometimes qualify, such as course-related expenses, e.g., books and supplies. These types of expenses might not appear on your 1098-T in Box 1/Box 2. You should refer to Publication 970 for the full definitions of qualified education expenses under the two different education benefits.
Further reading: What Are Qualified Education Expenses?
One controversial point is whether your student health insurance premium is a required fee/qualified education expense for the purpose of making the scholarship that pays it tax-free. Insurance and student health fees, along with some other expenses, are explicitly disallowed as qualified education expenses for the Lifetime Learning Credit, but not explicitly for making scholarships tax-free. I’ve argued that it is not a qualified education expense, but some people disagree! I couldn’t get a straight answer out of the IRS help line, either. Ultimately, it’s your responsibility to make that decision when you calculate the income to report on your tax return.
You Have to Report Excess Scholarship Income
Funded graduate students with net scholarship (or fellowship) income have to report it on their tax returns. This is a weird tax situation because it’s uncommon at the undergraduate level, so many people, even professional tax preparers, don’t know that you’re supposed to do it. But now that you know, it’s actually quite easy to do.
You report your net scholarship/fellowship income in the same line on your tax return as you report your wages, e.g., Line 7 on Form 1040. You also need to print SCH next to the line so the IRS knows part or all of your income is not reported on your W-2.
Further reading: Where to Report Your Grad Student Income on Your Tax Return
You Might or Might Not Be a Dependent of Your Parents (and It’s Not a Choice)
Because graduate students are students, they might be considered dependents of their parents (or another relative) for tax purposes. You and your parents don’t get to choose whether they should claim you as a dependent or you should be independent based on what’s best for the family’s tax due; rather, you have to follow the IRS’s definition.
The conditions for being considered a dependent (not exhaustive) are:
- You are age 23 or younger at the end of the calendar year.
- You must meet the “Support Test”: You did not provide more than half of your own support in the calendar year (see Publication 17 Worksheet 3-1).
If you’re supporting yourself during graduate school (not accepting money from your parents), you are independent. But remember that we are looking at the calendar year. For example, if you were unemployed prior to graduate school and lived with your parents (and you were enrolled as a student over at least 5 calendar months) or you were a college student supported by your parents, you should go through the support test and other dependency tests in detail to determine whether you were a dependent of your parents’.
You’re (Mostly) Not Paying FICA Tax
FICA (Social Security and Medicare) taxes seem like an unavoidable burden for employees and self-employed people. But even if you’re an employee of your university/graduate school (i.e., you receive a W-2 at tax time), you’re most likely not paying FICA tax because you have a student exemption. This exemption depends on both the primary function of the organization that employs you (i.e., educational) and your primary relationship with the organization (i.e., as a student rather than an employee).
The student exemption is almost universal for graduate students, but I have come across two exceptions that depend heavily on the exact wording of the exemption:
1) Graduate students at research institutions that are not primarily universities might not receive the exemption.
2) Graduate students, even at universities, whose primary relationship with their employer is as an employee rather than a student may pay FICA tax. For example, this might occur during the summer vs. during the academic year, and could happen without the student even perceiving a difference in roles. (This is not common; I’ve seen one example and it was for a senior graduate student at a public university.)
Graduate students receiving fellowships also do not pay FICA tax, but that is because they are not receiving wages rather than due to their student status.
Yes, there are a lot of weird tax situations for fully funded grad students. You have to do a bit of legwork instead of just blindly entering numbers from your 1098-T into tax software or ignoring your excess scholarship income. But if you break the issues down one by one, it’s actually straightforward to determine how to resolve them.
Free Tax Webinar for Grad Students and Postdocs
Emily Roberts will present a tax webinar for funded grad students and postdocs (US domestic) on March 9, 2018 at 7 PM EST / 4 PM PST.
Register for the webinar to attend live and receive a recording!