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awarded income

Is Fellowship Income Eligible to Be Contributed to an IRA?

February 6, 2022 by Emily 27 Comments

Update 2/22/2022: Great news! The point of this article has been fulfilled because the IRS re-revised Publication 970 for tax year 2021 to reflect the current tax code, which permits taxable graduate student and postdoc income, whether reported on a Form W-2 or not, to be contributed to an IRA.

Publication 970 p. 5 NOW states: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. A scholarship or fellowship grant is generally taxable compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. However, for tax years beginning after 2019, certain non-tuition fellowship and stipend payments not reported to you on Form W-2 are treated as taxable compensation for IRA purposes. These include amounts paid to you to aid you in the pursuit of graduate or postdoctoral study and included in your gross income under the rules discussed in this chapter. Taxable amounts not reported to you on Form W-2 are generally included in gross income as discussed later under Reporting Scholarships and Fellowship Grants.”

The rest of this article is unchanged from its original publication date on 2/6/2022.

Believe it or not, I look forward to the release of each new version of the IRS’s Publication 970, which covers how fellowship and scholarship income is taxed. I read it thoroughly and make sure that what I teach is in line with it. However, when I opened up the new 2021 version a few days ago, I was disappointed to read on p. 5: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive “taxable compensation” (formerly “earned income”). Under this rule, a taxable scholarship or fellowship grant is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement.” Disappointed doesn’t really touch the depths of my feelings… I was momentarily devastated! I’ve been telling you for over two years now that fellowship income is eligible to be contributed to an IRA regardless of how it is reported or not reported at tax time. Was I wrong? Let’s explore the relevant texts. I have great respect for the IRS publications and find them very useful, but they are not the final word on tax law… the tax code is.

Further reading/listening:

  • Fellowship Income Is Now Eligible to Be Contributed to an IRA!
  • Do I Owe Income Tax on My Fellowship?
  • Weird Tax Situations for Fellowship and Training Grant Recipients
  • What Your University Isn’t Telling You About Your Income Tax
  • Fellowship and Training Grant Tax Forms

Pre-2020 Status

You must have “taxable compensation” to contribute to an IRA in a given tax year. You can contribute up to the cap for that year ($6,000 in 2019-2022) or your amount of taxable compensation, whichever is lower.

Through tax year 2019, with respect to PhD trainee income, only income reported on a Form W-2 was considered “taxable compensation.”

The text from the 2019 version of Publication 970, Tax Benefits
for Education
, reads on p. 5: “Individual retirement arrangements (IRAs). You can set up and make contributions to an IRA if you receive taxable compensation. Under this rule, a taxable scholarship or fellowship grant is compensation only if it is shown in box 1 of your Form W-2, Wage and Tax Statement. For more information about IRAs, see Pub. 590-A and Pub. 590-B.”

Similarly, the text from the 2019 version of Publication 590A, Contributions to Individual Retirement Arrangements (IRAs), reads on p. 6: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.”

This text is very clear and reflects the widely held understanding of eligibility for IRA contributions. It was very disappointing for many members of the PhD community; winning a fellowship often comes with a pay raise and therefore an enhanced ability to save for retirement, yet those recipients were barred from making IRA contributions. Keep in mind, these fellowships were taxable as ordinary income, just not considered taxable compensation for IRA contribution purposes. I didn’t like this rule, but I taught it as part of my personal finance material.

The Graduate Student Savings Act

Somehow, the plight of graduate students and postdocs who received fellowship income was heard! The Graduate Student Savings Act proposed to change the definition of taxable compensation. It was put before Congress as a bill in 2016, 2017, and 2019.

An excerpt of the fact sheet for the Graduate Student Savings Act of 2019 reads: “While fellowship or stipend income is taxed by federal and state governments, it doesn’t qualify as “compensation,” meaning that none of a student’s fellowship funds can be saved in an IRA… Many postdoctoral fellows… also receive taxable fellowship income, yet these fellows are also barred from using their fellowship income to contribute to tax-preferred retirement accounts. The Graduate Students Savings Act of 2019 would ensure that any graduate student or postdoctoral fellow who is
paid for their work or their studies can save a portion of their stipend in an IRA.”

While not using super specific or technical language, this excerpt makes clear the intent of the bill: to allow “any graduate student or postdoctoral fellow who is paid for their work or their studies” to contribute to an IRA, i.e., change the definition of taxable compensation.

Graduate Student Savings Act was not successful in being passed as an independent bill in any of those years. Then, in 2019, it was included in the SECURE Act.

The SECURE Act

The Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) is described by Investopedia as a “far-reaching bill includes significant provisions aimed at increasing access to tax-advantaged accounts and preventing older Americans from outliving their assets.” It was signed into law on December 20, 2019.

The Graduate Student Savings Act was included in the SECURE Act. Here is the relevant text from the bill:

“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.”

This expands the definition of taxable compensation for the purposes of contributing to an IRA beyond what is reported on a Form W-2. To me, this definition clearly includes taxable fellowship and training grant income paid as stipends and salaries not reported on a Form W-2.

The Tax Code (2021)

From the current Internal Revenue Code section 219 on Retirement Savings, section (f)(1) reads:

“(1) Compensation For purposes of this section, the term “compensation” includes earned income (as defined in section 401(c)(2)). The term “compensation” does not include any amount received as a pension or annuity and does not include any amount received as deferred compensation. For purposes of this paragraph, section 401(c)(2) shall be applied as if the term trade or business for purposes of section 1402 included service described in subsection (c)(6). The term “compensation” includes any differential wage payment (as defined in section 3401(h)(2)). 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.”

Again, I read this as any type of grad student and postdoc salary or stipend with no clauses about being reported on a Form W-2. The language is very similar to how IRS Publication 970 describes fellowship income on p. 5: “A fellowship grant is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research.”

The Internal Revenue Code does seem, to me, to reflect the intent of the Graduate Student Savings Act of expanding the definition of taxable compensation with respect to graduate student and postdoc income beyond what is reported on a Form W-2.

The 2021 Publications

Publication 970

As I stated at the start of this article, Publication 970 disappointingly has not changed its tune on the definition of taxable compensation. It says the same thing in 2021 that it did in 2019 as if the Graduate Student Savings Act had never passed.

Publication 590-A

Publication 590-A, to its credit, now has some mixed language regarding taxable compensation and fellowship stipends and salaries. I’ll compare the 2018 and 2021 versions of this publication.

The 2018 version of Publication 590-A contains exactly one reference to fellowship income on p. 6 in the section titled What Is Compensation?: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.”

The 2021 version of Publication 590-A contains this language on p. 6 in the section titled What Is Compensation?: “Scholarship and fellowship payments are compensation for IRA purposes only if shown in box 1 of Form W-2.” So no change there.

However, further down in the same section it says: “Graduate or postdoctoral study. Compensation includes any income paid to you to aid you in the pursuit of graduate or postdoctoral study.”

Are they trying to draw a distinction between “any income paid to you to aid you in the pursuit of graduate or postdoctoral study” and “scholarship and fellowship payments”? What could “any” income mean if not, at least in part, fellowship payments?

To further muddy these waters, Publication 590-A includes Table 1-1, Compensation for Purposes of an IRA. The 2018 version of this table doesn’t mention either fellowship income or graduate or postdoctoral study. The 2021 version lists “taxable non-tuition fellowship and stipend payments” as included in the definition of taxable compensation.

This language in the table is consistent with both employee and non-employee graduate student and postdoc income, again, with no mention of a Form W-2 reporting requirement.

Furthermore, the 2021 version of Publication 590-A says under the Reminders section on p. 2: “Certain taxable non-tuition fellowship and stipend payments. For tax years beginning after 2019, certain taxable non-tuition fellowship and stipend payments are treated as compensation for the purpose of IRA contributions. Compensation will include any amount included in your gross income and paid to aid in your pursuit of graduate or postdoctoral study.”

I am not sure what “certain” means in this paragraph. “Non-tuition fellowship and stipend payments” reads to me as stipend or salary as long as your tuition is being paid by another source of funding. “Any amount included in your gross income and paid to aid in your pursuit of graduate or postdoctoral study” reads to me as both your employee income (reported on a Form W-2) such as from a graduate assistantship position or postdoctoral employee position and taxable non-employee (not reported on a Form W-2), often sourced from a fellowship or training grant.

My Conclusion

My conclusion is that the very clear language in Publication 970 and Publication 590-A excluding taxable fellowship and scholarship income from the definition of taxable compensation unless it is reported on a Form W-2 is not consistent with the spirit of the Graduate Student Savings Act or the current tax code. The changes made by the SECURE Act to the tax code included in the definition of taxable compensation “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.” To me, this means that if you receive a taxable stipend or salary as a graduate student or postdoc, even if it is not reported on a Form W-2, it is taxable compensation for the purpose of contributing to an IRA.

What Do You Think?

I am really struggling with this and I honestly want to know: Do you see a flaw in my reasoning? Is there some difference between “fellowship” and “any income paid… in the pursuit of graduate and postdoctoral study”? Leave a comment here or email me ([email protected]). I am open to the idea that there is something I don’t see or understand. Or let me know if you agree with me.

What Can We Do?

If my argument is valid and the text in IRS Publication 970 and Publication 590A (in part) is incorrect, what can be done? Hit me with your ideas for getting this text updated.

My initial idea is to write to the offices of the Senators (Elizabeth Warren, Mike Lee, Ron Wyden, and Tim Scott) who sponsored the Graduate Student Savings Act to see if they can clarify why the IRS’s language in these publications doesn’t reflect the change the Act brought about. Do you have any other ideas?

The big win for our community was getting the Graduate Student Savings Act passed. The follow-through on that win is making sure that people (and tax software/preparers) know about the change so that graduate students and postdocs can functionally contribute to IRAs.

What to Do at the Start of the Academic Year to Make Next Tax Season Easier

August 16, 2021 by Emily

In this episode, Emily teaches what various types of PhD trainees can do at the start of the academic year to make next tax season go more smoothly. She covers tracking qualified education expenses, quarterly estimated tax, the Kiddie Tax, and state residency. Please consider sharing this episode on social media or with an email list-serv so your peers have access to this information as well!

Links Mentioned in the Episode

  • How to Prepare Your Grad Student Tax Return (Tax Year 2020)
  • What Your University Isn’t Telling You About Your Income Tax
  • Do I Owe Income Tax on My Fellowship?
  • Quarterly Estimated Tax for Fellowship Recipients
  • Fellowship Income Can Trigger the Kiddie Tax
  • How to Complete Your Grad Student Tax Return (and Understand It, Too!)
easier tax season

Introduction

Welcome to the Personal Finance for PhDs Podcast: A Higher Education in Personal Finance. I’m your host, Dr. Emily Roberts.

This is Season 10, Episode 2, and I don’t have a guest today, but rather I will tell you what various types of PhD trainees can do at the start of the academic year to make next tax season go more smoothly. We will discuss tracking qualified education expenses, quarterly estimated tax, the Kiddie Tax, and state residency. Please consider sharing this episode on social media or with an email list-serv so your peers have access to this information as well!

We are at or near the start of a new academic year, which means it’s time to take a moment to think about taxes. A few minutes of consideration at this time of year can save you a big headache and wallet-ache during tax season, so it’s worth it.

This episode has four sections, and I’m going to clearly identify at the beginning of each section who the information is for, because it will switch around. Overall, this episode is for US citizens, permanent residents, and residents for tax purposes living in the US. The various intended audiences for the sections are full-time graduate students; postbacs, grad students, and postdocs receiving non-W-2 stipends or salaries; full-time graduate students age 23 and younger; and grad students who either moved states in 2021 or whose income is coming from a new state. Our overarching topic is what you can do now to make next tax season easier.

Please note that I am not a Certified Public Accountant or Certified Financial Planner. This content is educational in nature only and should not be considered tax, financial, or legal advice for any individual. You are entirely responsible for your own financial decisions.

Tracking Education Expenses

Section A is for full-time graduate students.

In early 2022, once you get into preparing your annual tax return, you are going to need to use your so-called “qualified education expenses.” You can use these expenses to reduce your tax liability. Depending on which higher education tax benefit you employ, your qualified education expenses will either be used as a deduction or a credit. I’m not getting into all the details now because you will figure that out during tax season, but if you want to read more, go to PFforPhDs.com/prepare-grad-student-tax-return/ for my article updated for 2020.

The action step for you at this point in the year is to keep track of any education expenses that you suspect might be qualified education expenses. Now, the education expenses that are paid through your student account are already tracked for you, and you should be able to access your 2021 statement during tax season to look at all of the transactions for items like tuition and fees. What I’m suggesting that you manually track is any education expense that you transact outside of that student account, such as textbooks, course-related expenses, and computing purchases.
What I mean by tracking is to save two types of documents: 1) The receipt of the purchase showing the price paid. 2) The document stating that the purchase was required by your course instructor, your department, your school, or your university. The document could be a course syllabus, an email, or a screenshot from a webpage. You can choose how you want to save these records, but I suggest a digital copy maintained in cloud storage.

Now, not every education expense that you track may turn out to be a “qualified education expense” as that will depend on which higher education tax benefit or benefits you choose to use for your tax return. I suggest you leave the task of figuring out what is qualified and what is not to Future You. Present You only has the responsibility to track the expenses, and Future You will thank you for that.

Awarded Income and Estimated Tax

Section B is for postbacs, grad students, and postdocs receiving non-W-2 stipends or salaries.

Right up front, I need to define what I mean by a non-W-2 stipend or salary. I use a framework wherein there are two basic classifications for a stipend or salary that a PhD trainee might receive: employee income and awarded income. These are my own terms, so you won’t find ‘awarded income’ in IRS documentation or used by universities.

Employee income comes from the work than an employee performs for their employer. At the graduate student level, employee positions are often but not exclusively called assistantships, e.g., research assistantship, teaching assistantship, or graduate assistantship. If you have employee income and are a US citizen, permanent resident, or resident for tax purposes, this income will be reported on a Form W-2 at tax time.
The other type of income, awarded income, is more difficult to define. It is given as an award rather than for work performed. At the postbac, grad student, and postdoc levels, awarded income is often but not exclusively called fellowship income. If you are a US citizen, permanent resident, or resident for tax purposes, this income could be reported on a Form 1098-T, a Form 1099-MISC, a Form 1099-NEC, or a courtesy letter. However, there is actually no IRS reporting requirement for this type of income, so many PhD trainees receive absolutely no documentation whatsoever.

If you want to understand this framework more fully, I suggest listening to Season 8 Episode 1 of this podcast, which is titled “What Your University Isn’t Telling You About Your Income Tax.”

Now, the important things to know about awarded income, which I also call non-W-2 stipends or salaries, at this time of year are that 1) this is taxable income and 2) your university is likely not withholding income tax from your paychecks.

There are endemic rumors running around universities that this non-W-2 type of income is not taxable. While it is very tempting—and self-serving—please do not believe these rumors. Listen to Season 2 Bonus Episode 1 of this podcast, titled “Do I Owe Income Tax on My Fellowship?”, in which I clearly delineate which portion of your awarded income is taxable and which is tax-free.

One of the reasons these rumors sound believable is that, with rare exceptions, universities and institutes do not withhold income tax on behalf of their non-employees.

If your stipend or salary recently switched to an awarded income source or this is the first time you’re learning about this income tax issue, you have a few action items:

1) Figure out if income tax is being withheld from your paychecks. If it is, you’re done until tax season.

If income tax is not being withheld:

2) Fill out the Estimated Tax Worksheet on p. 8 of Form 1040-ES. Essentially, you will do a high-level draft of your 2021 tax return, and the worksheet will tell you whether you are required to pay estimated tax and if so in what amount. The principle behind estimated tax is that the IRS expects to receive income tax payments from each taxpayer throughout the year as they receive their paychecks. If your employer does not withhold income tax on your behalf, this becomes your responsibility. However, there are some situations in which estimated tax is not required, and the Estimated Tax Worksheet will tell you if you fall into one of the exception categories. If you are required to pay estimated tax, please be aware that the next due date is September 15, 2021. The due dates typically fall in mid-April, mid-June, mid-September, and mid-January of each year. If you are required to pay estimated tax and fail to, you may be fined by the IRS.

3) Whether you are ultimately required to pay estimated tax or not, the Estimated Tax Worksheet will tell you how much you can expect to pay in tax above your withholding for the year. I strongly encourage you to start saving up for your eventual tax payment or payments. Divide your additional tax liability in Line 14b by the number of remaining paychecks you’ll receive in 2021 and start saving that amount of money from each paycheck. Personally, I have a dedicated savings account named Taxes into which I transfer money from each paycheck. Then, when my quarterly bills are due, I have the money ready to go, and the payment doesn’t strain my cash flow at all.

Please keep in mind that if you have a state tax liability in 2021, you may be required to pay estimated tax to your state as well.

If you want some help with filling out your Estimated Tax Worksheet, please check out my workshop, Quarterly Estimated Tax for Fellowship Recipients at PFforPhDs.com/QEtax/. The workshop explains how to fill out every line of the Estimated Tax Worksheet plus how to handle common scenarios that PhD trainees encounter, such as switching onto or off of fellowship mid-year and being married to someone who has income tax withholding. The workshop comprises numerous pre-recorded videos, a spreadsheet, and an invitation to the next live Q&A call, which will take place on September 12, 2021. To join the workshop, go to PFforPhDs.com/QEtax/. That’s q for quarterly, e for estimated, t a x.

By the way, I give a discount for bulk purchases of this workshop, and it’s not too late to ask your department, graduate school, graduate student association, postdoc office, etc. to buy it on behalf of a group of graduate students, postdocs, or postbacs. Simply email me at emily at PFforPhDs dot com to get the ball rolling on that purchase.

Commercial

Emily here for a brief interlude!

We have a special event coming up on Friday, August 27, 2021! It’s the fourth installment of my Wealthy PhD Workshop series. The subject is debt repayment.

This workshop is for you if you are in debt of any kind and want to learn the best strategies for getting out of debt. These strategies are tailored to the PhD experience, particularly that of graduate students. We will cover student loans, of course, which are such a complex topic, as well as mortgages, credit card debt, auto debt, medical debt, etc. I’ll give you a spreadsheet that will help you work through in which order to tackle your debts, taking into account the type of debt, the interest rate, and the payoff balance. We’ll also discuss how to sustain your motivation through a long debt repayment process.

This is going to be a value-packed session, so please join us on August 27th. You can register at PFforPhDs.com/WPhDDebt/. That’s PF for PhDs dot com slash W for Wealthy P h D D e b t.

Now back to our interview.

The Kiddie Tax

Section C is for full-time graduate students age 23 and younger.

I want to give you a heads up that a higher tax rate might apply to you if you meet the following criteria:

  1. You are age 23 or younger on 12/31/2021.
  2. You are a full-time student.
  3. You receive a non-W-2 stipend or salary for at least part of 2021.

If you checked all of those boxes, you might be subject to the Kiddie Tax, which means that part of your income may be taxed at your parents’ marginal tax rate instead of your own. The Kiddie Tax can apply even if you aren’t being claimed as a dependent.

I can’t say for sure that you will or will not be subject to the Kiddie Tax as there are more calculations that have to be performed, but I suggest that you look into this before the end of the calendar year and possibly take some mitigation measures if your parents’ marginal tax rate is higher than yours. You may need to engage a professional tax preparer to help you and your parents with tax planning and preparation for 2021. You may need to save more from each paycheck for your eventual tax bill than I laid out in Section B.

I have an article about how the Kiddie Tax affects funded PhD students at PFforPhDs.com/kiddietax/. That P F f o r P h D s dot com slash k i d d i e t a x.

State Residency

Section D is for graduate students who moved states in 2021 or are receiving income from a new state.

I find that people get rather mixed up about state residency and taxes, especially when they are in graduate school. For a traditional college student who is a dependent of their parents, it is common to maintain your residency in the state your parents live in even while you attend college in another state. However, I rarely come across a compelling reason that a graduate student should do the same.

The pandemic has also thrown a wrench into the question of state residency due to how common remote work is now. So even if you lived in only one state in 2021, if your income comes from a different state, that’s something to contend with.

What I think you should do at this time of year to make tax season easier is to figure out and/or decide in which state or states you will be a resident, part-year resident, or non-resident in 2021. This will require you to read about how your new state and your old state define residency and how they tax residents, non-residents, and part-year residents.

My totally generic, blanket recommendation if you have moved states to start grad school is to consider yourself a resident of your new state, even if technically your former state allows you to still be considered a resident due to your student status. You’re a full-fledged adult with a more-or-less proper income now. Why would you want to keep close ties to your parents’ address? In almost all cases, there is no financial advantage to doing so plus you’ll likely have to file two state income tax returns, one as a non-resident in the state you live and work in and one as a resident in the state you don’t live or work in. For how long do you want to keep that up?

If you agree that you don’t want to keep filing two returns indefinitely if there’s nothing in it for you, take a few steps this fall to firmly establish your ties to your new state. Reference how your new state defines a resident for the definitive word on how to do so, but for some starting ideas you should get a new driver’s license, register to vote, change your address with your car insurance, and update your mailing address with all your financial institutions.

Now, if you really do have a compelling reason for maintaining your residency in your old state while you’re a student, by all means try to do so. You still have to read all the material I mentioned before, but this time with the goal to maintain your residency in your old state and avoid being considered a resident in your new one. By the way, in all my conversations with grad students about taxes, I’ve only ever heard one reason that I considered compelling: A resident of Alaska who was attending graduate school in another state wanted to maintain their Alaska residency so they could continue to receive universal basic income. Please remember that even if you do have a great reason to want to maintain residency in your old state, you have to cross all your ts and dot all your is to make sure you meet the requirements.

Conclusion

That it for this episode! I hope you’ll check in with me during next tax season for more tax education and support for PhD trainees. I offer a workshop titled How to Complete Your Grad Student Tax Return (and Understand It, Too!) during each tax season, which can be purchased by individuals or groups at a discounted rate. I’m making plans for how I can help PhD trainees with their tax returns in brand-new ways in the upcoming tax season. Join my mailing list at PFforPhDs.com/subscribe/ to stay in the loop! You can expect to receive 2-3 emails per week from me on various personal finance topics.

Before you go, would you please share this episode with your peers, especially new graduate students? Join me in helping to make next tax season go smoothly for all PhD trainees!

What Your University Isn’t Telling You About Your Income Tax

January 4, 2021 by Emily

In this episode, Emily lists six things that your university isn’t telling you about your income tax. Point 1 is on why and how this lack of communication manifests. Point 2 is on what your Form 1098-T, if you even receive one, is not telling you. Points 3 through 5 are on the extra steps that grad students, postdocs, and postbacs on fellowships or training grants need to take but are rarely instructed on or even warned about. Finally, point 6 is on the tax pitfalls that anyone under age 24 needs to watch out for.

Links Mentioned in the Episode

  • Tax Center for Personal Finance for PhDs
  • How to Complete Your Grad Student Tax Return (and Understand It, Too!)
  • Quarterly Estimated Tax for Fellowship Recipients
  • Emily’s speaking services
  • Season 2 Bonus Episode 1: Do I Owe Income Tax on My Fellowship?
  • Season 4 Bonus Episode 1: Fellowship Income Is Now Eligible to Be Contributed to an IRA!
  • Podcast hub
  • Subscribe to the mailing list
university income tax

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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 8, Episode 1, and I don’t have a guest today, but rather will list for you six things that your university isn’t telling you about your income tax. Point 1 is on why and how this lack of communication manifests. Point 2 is on what your Form 1098-T, if you even receive one, is not telling you. Points 3 through 5 are on the extra steps that grad students, postdocs, and postbacs on fellowships or training grants need to take but are rarely instructed on or even warned about. Finally, point 6 is on the tax pitfalls that anyone under age 24 needs to watch out for.

Please keep in mind that I’m recording and publishing this episode in early January 2021 for tax year 2020, so if you are listening to this at a later date, please check the Tax Center on my website, PFforPhDs.com/tax/ for any relevant tax law changes or other updates.

For Season 8 of the podcast, I’ve shifted up the format! There are two new short segments, one before and one after the interview or, in the case of this episode, expert discourse. I hope this new format will encourage more interactions between me and you, the listener!

Book Giveaway

Without further ado, here’s my episode on what your university isn’t telling you about your income tax. I have seven points for you today.

Preliminary Comments

Before we get into my list, I need to make a few general comments.

First, this episode is for US citizens and residents living and working in the US who have household incomes below about $150,000. I am discussing federal income tax only, but don’t forget that you might be subject to state and local income tax and other types of taxes as well.

Second, I am not a CPA or any kind of tax advisor, so none of this is advice for financial, legal, or tax purposes.

Third, I’m going to use the terms employee income and awarded income throughout the episode, so I need to define them for you up front because I semi made them up.

Employee income is the stipend or salary you receive in exchange for working for your university or institute. It is reported on a Form W-2 at tax time. Typically, employee positions at the graduate student level are called assistantships and max out at half-time positions.

Awarded income is the stipend or salary you receive from your fellowship or training grant, provided it is not reported on a Form W-2 at tax time. You are not considered an employee with respect to awarded income. Awarded income also includes the money that pays your tuition and fees if you are a funded grad student and your health insurance premiums if you are a postdoc or postbac non-employee. We’ll talk more about the tax forms awarded income may or may not show up on momentarily.
Fourth, if you want to learn more from me about any of the subjects I mention, the best place to go is PFforPhDs.com/tax/, where you can find many free articles, podcast episodes, etc. If you want to really dive in deep, I have two paid workshops available.

How to Complete Your Grad Student Tax Return (and Understand It, Too!) goes over how to handle your higher education income and expenses with respect to your tax return, whether you ultimately prepare it manually, using software, or through a human tax preparer. You can find that at PFforPhDs.com/taxworkshop/.

Quarterly Estimated Tax for Fellowship Recipients explains how you know if you’re responsible for paying quarterly estimated tax and goes line-by-line through the relevant tax form to show you how to estimate your tax due. You can find that at PFforPhDs.com/QEtax/. That’s q for quarterly. e for estimated, t, a, x.

Finally, if you want to bring this tax content and more to your peers at your university or institute, I am available for live speaking engagements. Head to PFforPhDs.com/speaking/ for more info on that.
All right! With that out of the way, here is my list of six things your university isn’t telling you about your income tax.

1. Anything

Your university is not telling you anything about your income tax. This can happen in one or both of two ways.

The first mode of non-communication is through tax forms or a lack of tax forms. Now, employees definitely will receive a Form W-2 at tax time that lists their stipend or salary. But the university isn’t necessarily required to send you any forms regarding your awarded income. It’s actually quite common for grad students and postdocs to receive zero tax forms or any kind of formal or informal communication regarding their income. And that obviously leaves them totally adrift, and many don’t even realize that they are supposed to account for their stipends or salaries on their tax return.

Not all universities take this zero communication approach for their PhD trainees receiving awarded income. A lot of them report grad student awarded income on Form 1098-T in Box 5, even though the IRS does not require them to. A minority report awarded stipends or salaries on Form 1099-MISC in Box 3. Some send an informal letter listing the amount of the awarded stipend or salary. These approaches are helpful to a degree, but it would be even better if there was one standard way of reporting awarded income that was used by all universities in the US.

The second mode of non-communication is through staff members. Almost universally, staff members are instructed to not discuss income tax with individual students or postdocs. The university does not want to make itself liable for erroneous tax returns. Even though that’s frustrating, I think it is understandable.

As a sidebar, despite this prohibition, grad students and postdocs frequently repeat misinformation to me that they heard from staff members. Now, whether the staff member said something incorrect or the student simply misinterpreted what was said, I can’t be sure. A perfect example is the phrase “Your stipend isn’t subject to income tax,” which many students have repeated to me. What I think the staff member said or meant to say is “Your stipend is not subject to income tax withholding.” However, what the student hears is “You don’t have to pay income tax on your stipend.” You can see that this is a topic that needs to be discussed carefully.

The best case scenario seems to be when universities host educational workshops on higher education tax topics. Those are typically led by knowledgable staff members, volunteers from local accounting firms, or me, an outside contractor. None of us are giving individual tax advice, but we are teaching grad students and postdocs how the university reports their income and higher education expenses and how the IRS views the same.

So super best case scenario, you receive some kind of tax form or letter and have the opportunity to attend a workshop. Worst case scenario, no forms or letters and everyone clams up.

2. Your Form 1098-T Lacks Vital Information

I want to like Form 1098-T, I really do. It’s the best we have. And, without getting too much into the weeds, Form 1098-T has undergone a couple edits recently that make it far, far easier to use. So that is great. I wish its usage was universal.

Where Form 1098-T still falls short is in failing to catalog all awarded income and all higher education expenses that are relevant to a funded grad student.

On the income side, it’s typical to include tuition and fee scholarships and waivers in Box 5. Often, though not always, the awarded stipend or salary appears as well. But you might have received other awarded income as well during the year from your university or another source, and if that funding was not processed by the department that prepares the Form 1098-T, it may be left out. So you can look at the number in Box 5 of your 1098-T, but you still need to wrack your brain to come up with any additional awarded income you might have had for the year.

On the expenses side, Form 1098-T Box 1 reports “payments received for qualified tuition and related expenses.” A lot of people and software conflate the sum listed in that box with the total of their qualified education expenses for the year. Qualified education expenses are used to reduce your taxable income or your tax liability. I don’t want to get too technical in this episode, but if you make that assumption, you might be missing out on hundreds or even thousands of dollars of qualified education expenses, meaning you could overpay your true tax liability by tens or hundreds of dollars. This is because the definition of “qualified education expenses” is actually different depending on which higher education tax benefit you’re using them for, and Form 1098-T uses the most conservative definition. So unfortunately you can’t just go with the number listed in Box 1. You have to look into all of your higher education expenses individually to determine which you can use for the tax benefit you chose. That means combing through your student account as well as considering other spending you’ve done.

I wish Form 1098-T were completely trustworthy so you wouldn’t have to track down all the underlying expenses in your student account, but it’s just not the case right now.

If you would like some support through this process, I recommend joining my tax workshop at PFforPhDs.com/taxworkshop/. I provide a detailed discussion of what qualified education expenses are missing from Form 1098-T and worksheets to help you keep all the numbers straight.

3. Your Fellowship or Training Grant Income Is Taxable

I just wanted to close the loop I brought up in point #1. In case you were not aware, awarded income is taxable to the extent that it exceeds your qualified education expenses such as tuition and required fees.

Now, just because some income is taxable doesn’t mean you will actually end up paying income tax on it. If your total income is low enough or your have enough deductions and credits to claim, you may not end up paying any income tax. But you have to go through the exercise of filling out your tax return to determine if and how much income tax you owe, and that is true whether your income is awarded or employee or both.

There is a persistent rumor within many universities and departments that awarded income is tax-exempt. That actually used to be the case several decades ago, so there is a kernel of outdated truth in the rumor. And I can understand why the rumor lives on and spreads, because it is what people want to hear. Plus, at many places it is not countered by direct communication from the university as in point #1.

If you would like to hear my full argument with IRS references to prove that awarded income is taxable, please listen to Season 2 Bonus Episode 1 of this podcast, titled “Do I Owe Income Tax on My Fellowship?” It is linked from the show notes for this episode.

4. Your Paycheck Is Pre-Tax, Not Post-Tax.

I’m going to expand on the issues related to awarded stipends and salaries now.

With employee income, your employer withholds income tax on your behalf to send to the IRS and gives you a paycheck for the rest of your income, which is your net or after-tax income. A pay stub is also generated for each paycheck that lists your gross income and all the tax that has been withheld, though you might have to proactively seek it out.

While it is possible to withhold income tax from awarded income, most universities and institutes don’t offer this benefit. There is typically no pay stub generated, either. In the absence of clear communication, harkening back to point #1, many, many fellows who are on board with point #3 assume that their income has already had income tax withheld. After all, that is how paychecks work for the great majority of people who receive them.

It’s a nasty surprise when they realize that their pay is pre-tax, not post-tax, and they have a large tax bill to pay.

5. Your Income Tax Is Due Four Times per Year, Not One

This point follows on on from point #4 for those who do not have income tax withheld from their awarded stipends or salaries:

If the amount you owe in income tax exceeds $1,000 for the year and you don’t fall into an exception category, you are required to make what are called estimated tax payments. This is when you, personally, send the IRS money up to four times per year to stand in for income tax withholding.
Going along with point #1, this is rarely discussed or even mentioned to grad students and postdocs receiving awarded income. A heads up would be nice.

Ideally, fellowship recipients would be told that they might owe income tax—point #3—and that tax is not being withheld from their paychecks—point #4—and that the best practice is to set aside money from each paycheck for their future tax payments, whether that is once per year or up to four times per year—this point.

If you would like more information about estimated tax for fellowship recipients, I have a great long-form article on it that I’ll link to from the show notes. If you want my help to determine if you are required to make estimated tax payments and in what amount, I recommend checking out my workshop at PFforPhDs.com/qetax, that’s qe for quarterly estimated t a x.

6. Those of You Under Age 24 Need to Be Extra Cautious

If you are under age 24 at the end of the tax year and receive primarily awarded income, there are two tax potholes for you to watch out for. Your university won’t tell you about these subjects because it comes way too close to giving tax advice.

The first is potentially being claimed as a dependent by your parent or other relative, which generally speaking is not good for your bottom line but good for theirs. I have observed that parents and the people who prepare their tax returns tend to default to assuming that anyone under age 24 who is a student is a dependent. The thing to know about being claimed as a dependent is that it’s not a matter of preference. There is a set of five objective tests to determine if a young person is a dependent, which you can read about in Publication 501. There is a tricky part of one of the tests, though, the support test, which is different depending on if your stipend or salary is employee income or awarded income, so watch out for that. You should go the extra mile to discuss with your parent or relative whether you can be claimed as a dependent before either of you files in case there is a difference of opinion to work out, because it’s much easier to do it that way than to mediate a disagreement via the IRS.

The second is the Kiddie Tax. The Kiddie Tax is an alternative way of calculating your tax liability based on your parent’s marginal tax rate instead of your own graduated tax rates. Ostensibly, the Kiddie Tax is supposed to disincentivize high-earning parents from sheltering income-generating assets in their children’s names, but in a mind-boggling twist, the Kiddie Tax applies to awarded income, not just investment income. I have an article on my site on the Kiddie Tax linked from PFforPhDs.com/tax/. I sincerely hope that it does not apply to you or you can find a way to avoid it or minimize it, but in any case it is something to be aware of and watch out for.

I have a whole video in How to Complete Your Grad Student Tax Return (and Understand It, Too!) dedicated to people who were under age 24 during the tax year, so if you want a more in-depth exploration of these topics, please go to PFforPhDs.com/taxworkshop/.

Conclusion

I’m really glad you joined me for this episode! If you found something of value in it, please share it with your peers. You can save them a lot of emotional and financial turmoil and stress by giving them a heads up about the topics I covered. I really appreciate it! Good luck this tax season, and don’t hesitate to reach out if you need any help!

Listener Q&A

Outro

Listeners, thank you for joining me for this episode!

pfforphds.com/podcast/ is the hub for the Personal Finance for PhDs podcast. On that page are links to all the episodes’ show notes, which include full transcripts and videos of the interviews. There is also a form to volunteer to be interviewed on the podcast and instructions for entering the book giveaway contest and submitting a question for the Q&A segment. I’d love for you to check it out and get more involved!

If you’ve been enjoying the podcast, here are 4 ways you can help it grow:

  1. Subscribe to the podcast and rate and review it on Apple Podcasts, Stitcher, or whatever platform you use. If you leave a review, be sure to send it to me!
  2. Share an episode you found particularly valuable on social media, with a email list-serv, or as a link from your website.
  3. Recommend me as a speaker to your university or association. My seminars cover the personal finance topics PhDs are most interested in, like investing, debt repayment, and taxes.
  4. 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.

Do I Owe Income Tax on My Fellowship?

February 19, 2019 by Emily

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

  • Publication 970

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:

  • Weird Tax Situations for Fellowship Recipients
  • How Much Tax Will I Owe on My Fellowship Stipend or Salary
  • The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients
  • How to Prepare Your Grad Student Tax Return (Tax Year 2019)
  • Scholarship Taxes and Fellowship Taxes

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