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Five Ways the Tax Code Disadvantages Fellowship Income

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In this episode, Emily details five ways the federal income tax code disadvantages fellowship income, sometimes resulting in a higher tax rate and sometimes just causing a bit of a headache for fellows. Additionally, she covers two ways that the tax code advantages fellowship income and one more difference that has both pluses and minuses. This episode is for current fellows and future fellows as advance tax planning and action can mitigate some of these negative effects. At the end of the episode, Emily also shares how you can advocate for change at the federal level.

Links Mentioned in this Episode

 

 

Intro

Welcome to the Personal Finance for PhDs Podcast: A Higher Education in Personal Finance.

I’m your host, Dr. Emily Roberts, a financial educator specializing in early-career PhDs and founder of Personal Finance for PhDs.

This podcast is for PhDs and PhDs-to-be who want to explore the hidden curriculum of finances to learn the best practices for money management, career advancement, and advocacy for yourself and others.

This is Season 14, Episode 1, and today is a solo episode for me on fellowships and federal income tax. Specifically, I am going to detail for you five ways the tax code disadvantages fellowship income, sometimes resulting in a higher tax rate and sometimes just causing a bit of a headache for fellows. Additionally, I’ll cover two ways that the tax code advantages fellowship income and one more difference that has both pluses and minuses. Keep listening to this episode if you are currently on fellowship or expect to be in the future. Advance tax planning and action can mitigate some of these negative effects. I will also tell you at the end of the episode how you can advocate for change at the federal level.

Speaking of the disadvantages of fellowship income, it’s unfortunately quite common for fellows to have a tough time getting a mortgage. Sometimes they will be preliminarily approved based on their income numbers alone, but once under contract on a home they are dropped by their lender because of their income type and documentation! However, there is one lender who works with PhDs and particularly fellows very regularly.

Sam Hogan is a mortgage originator specializing in grad students and PhDs, an advertiser with Personal Finance for PhDs, and my brother. Years ago, I told him about the issue I just outlined, and he set to work figuring out how to use fellowship income to qualify for a mortgage. While I won’t say it’s as straightforward as using W-2 income, Sam has a great success rate in presenting grad students and PhDs to the underwriters working with his employer, Movement Mortgage, and getting them approved for mortgages. Sam can readily tell you if your fellowship income is likely to be approved or not based on the specifics of your circumstances, and if not what options you still have.

I am hosting an Ask Me Anything with Sam today, Monday, January 9, 2023 at 5:30 PM PT. Come with any question you like about the home-buying process and we will do our best to help you. You can register for the AMA at PFforPhDs.com/mortgage/.

If you’re listening to this later on, you can still check that link for the next AMA date as we hold them periodically, or you can contact Sam directly at 540-478-5803 or sam.hogan@movement.com to discuss your situation.

I wish you all success with your homebuying aspirations in 2023 and following!

You can find the show notes for this episode at PFforPhDs.com/s14e1/.

Disclaimers

Disclaimer #1: This episode is going into production in early January 2023. I rely on IRS forms, instructions, and publications for this material, and at the time of this recording most of these documents have been updated for tax year 2022, but not all of them. In those cases I’m going off the 2021 material. If any content in this episode turns out to be inaccurate for tax year 2022, I will update the show notes page with the corrections, so I suggest visiting PFforPhDs.com/s14e1/ before relying on any of the information. For tax year 2023 and later, please visit PFforPhDs.com/tax/ for my most updated tax content.

Disclaimer #2: The target audience for this episode is postbacs, graduate students, and postdocs at US universities and institutes who are US citizens, permanent residents, or residents for tax purposes. Unless otherwise specified, when I say tax I mean federal income tax.

Disclaimer #3: The content in this episode is for educational purposes only and should not be considered advice for tax, legal, or financial purposes for any individual.

Without further ado, here’s my solo episode on how the tax code disadvantages fellowship income.

Motivation

You might be surprised by the topic of this episode, because striving to obtain funding via a fellowship is a super common if not universal practice in academia. Fellowships are seen as a superior form of funding because of their prestige and that they normally excuse the recipient from teaching responsibilities or similar. In many cases, winning a fellowship results in a raise as well.

I’m not making any kind of argument in this episode that you should stop applying for fellowships or reject a fellowship that you’ve won—doubly so if you will be making more money with the fellowship than without it.

What I am doing is:

  1. Pointing out the tax issues and pitfalls that can or might come with fellowship income. There are certain groups of people who are at risk of actually paying more in income tax with a fellowship, which are people under age 24, parents, and non-students. Even if you don’t end up paying more in income tax, there are certain complexities of fellowship income that you can prepare for or even avoid if you know about them. This is to help you with taking personal responsibility for your tax situation.
  2. Suggesting changes to the tax code that would resolve these disadvantages. This is to help our community know in what ways advocacy for our workforce is needed.

Outline

Here’s where we’re going with this episode. I’m going to define some terms and tell you what I am comparing the tax treatment of fellowship income to when I say that it is disadvantaged by the tax code. I have five points to cover on how the tax code disadvantages fellowship income. The first couple points apply to most fellows but don’t result in a higher tax rate when handled properly. The next couple of points are about when having fellowship income actually results in paying more income tax. The final point is about a tax benefit that is not available to fellows. Then we’re going to switch gears and discuss two ways the tax code advantages fellowship income and one difference that I see as having both pros and cons.

By the way, I am trying to keep this episode focused on how the tax code disadvantages and advantages fellowship income. I could do an entire other episode, and perhaps I will, on the ways universities disadvantage and advantage fellowship recipients through their policies. But for today, we’re sticking with the topic of the federal income tax code.

Terms

I have to establish some definitions of terms here at the start. The subject of this episode is fellowships, but academia doesn’t necessarily use that term exactly the same way the IRS does. Therefore, I have created my own framework to explain the two types of higher education income.

The most common way the word fellowship is used in academia is to describe an amount of money that is awarded to an individual, as IRS Publication 970 states, “to aid in the pursuit of study or research.” Usually these are awarded for merit via a competitive process, such as a unique application for a specific fellowship program or your application to a postbac, graduate, or postdoc program. I call this income ‘awarded income’ in my framework.

The other type of income in my framework is ‘employee income.’ This is payment for services such as teaching or research, and the postbac, grad student, or postdoc is an employee of the university or institute. Employee income is reported on a Form W-2 at tax time. It’s unusual for programs to use the word fellowship to describe employee income, but it does happen occasionally.

For the purposes of this episode, we are only discussing awarded income, which is to say fellowship income that is not reported on a Form W-2. I will continue to use the word fellowship throughout the episode, but please understand that we’re only discussing that particular variation of the term, which is the most common in academia. If you’re unsure whether your fellowship is awarded income or employee income, reference the type of tax form or forms you receive during tax season. More on that in a moment.

Income Tax Basics

Another point I need to get out of the way at the start here is to clarify that fellowship income is subject to income tax. There are nuances and special scenarios that we’ll get into later in the episode, but very generally speaking, your stipend or salary is going to be taxed at the same rate whether it is awarded income or employee income.

When I speak about fellowship income being disadvantaged by the tax code, what I am pointing out are the ways that fellowship income ends up being treated differently or ultimately taxed at a higher rate than how employee income is treated and taxed. Conversely, in some ways fellowship income has an advantage, and again that is relative to employee income. 

If you’ve heard that fellowship income is tax-free, that is either a false rumor, a misunderstanding, or a statement that requires a lot more caveats. Fellowship income used to be exempt from income tax, but that changed with the Tax Reform Act of 1986. I’ll tell you more about why these rumors and such persist throughout this episode, but for now just know that you should expect to pay income tax on your stipend or salary, unless your gross income for the year is quite low or you can take lots of deductions and/or credits. That is true whether your stipend or salary comes from a fellowship or an employee position. You can learn more about that in Season 2 Bonus Episode 1 of this podcast, which you can find at PFforPhDs.com/s2be1/.

Now we’ll get into the meat of this episode: my list of five tax-related disadvantages of receiving fellowship income, two advantages, and 1 neutral difference.

Disadvantages

Disadvantage #1: There is no single correct way that fellowship income is required to be reported to the postbac, grad student, or postdoc recipient. This is in contrast to employee income, which must be reported on a Form W-2.

Because there is no single correct way to report fellowship income, universities, institutes, and funding agencies take a variety of approaches. The most common form issued is a Form 1098-T, but sometimes Form 1099 is used, such as Form 1099-MISC, Form 1099-NEC, or Form 1099-G. Sometimes a courtesy letter is sent in lieu of an official tax form. Many organizations choose to not communicate at all with the fellowship recipient. When fellowship income goes unreported entirely, it contributes to the rumor mill that it is not taxable income.

These approaches can mislead fellows into not reporting their income, resulting in underpayment of tax, or misreporting it, which often results in overpayment of tax.

To put fellowship income on even footing with employee income, the IRS could require that a tax form be used to report fellowship income, whether one that currently exists or a new or adjusted one. This would greatly reduce the confusion among taxpayers and tax preparers about whether and how to account for this income on tax returns.

Disadvantage #2: The issuers of fellowships are not required to withhold income tax on behalf of the recipients, and they almost never take the responsibility to do so.

Employers virtually always withhold income tax on behalf of their employees. This is the situation that most Americans experience and are familiar with. Your employer sends in income tax payments on your behalf throughout the year, and then after you file your tax return, you receive a refund or owe some additional tax.

However, for fellowship income, the issuing organizations have no such withholding requirement. With very few exceptions, they leave paying income tax entirely up to the fellowship recipient, which is typically a very unfamiliar arrangement.

This lack of withholding also contributes to the rumors that fellowship income is not subject to income tax. I have even seen university administrators label fellowship income “tax-free.” What they mean is that it is not subject to income tax withholding; they are speaking from their own perspective. But when a fellow sees that label, they read it from their own perspective, and it is highly misleading.

By default, the IRS expects to receive income tax payments throughout the year. In the absence of employer withholding, the taxpayer is supposed to make quarterly payments through the estimated tax system, unless an exception applies to them.

This typically goes one of two ways: 1) The fellow learns about the estimated tax requirement close to the start of their fellowship, sets aside money for their future tax payments as their paychecks come in, and makes their estimated tax payments if required. This is the ideal and something I am constantly beating a drum about. 2) The fellow does not realize that they are responsible for their own income tax payments until they are hit with a large tax bill and possibly a penalty upon filing their tax return. This is at minimum extraordinarily unpleasant and in some cases dangerous to the financial, physical, or mental well-being of the fellow. I further discuss this scenario of a large, unexpected tax bill in the videos titled “Why Is My Fellowship Tax Bill So High?!” and “What to Do When Facing a Huge Fellowship Tax Bill,” which you can find on my YouTube channel, Personal Finance for PhDs.

A rare few universities and institutes do offer income tax withholding on fellowship income. My alma mater, Duke University, did so when I was a graduate student there. This relieves the fellow from calculating and making estimated tax payments and prevents large, unexpected tax bills.

To put fellowship income on even footing with employee income, the IRS could require that universities and institutes at least offer income tax withholding on fellowship income. To go along with the previous disadvantage, a specifically designed fellowship reporting form could explicitly list federal, state, and local income tax withheld.

Until such reform comes about, I recommend that fellows take my workshop, Quarterly Estimated Tax for Fellowship Recipients, which you can find linked from PFforPhDs.com/tax/.

Disadvantage #3 and this is the big one: Fellowship income is not usually considered “earned income,” and without that designation many postbacs, grad students, and postdocs pay more in income tax than they would if it were considered earned income.

The term “earned income” is actually used all over the tax code and publications, and you have to be really careful because its definition can change depending on which benefit is being discussed. For example, for the purpose of calculating the standard deduction, taxable fellowship income is included in the definition of earned income. But for the Kiddie Tax, the Earned Income Tax Credit, and the Child and Dependent Care Tax Credit, fellowship income is not considered earned income.

Let’s discuss each of these scenarios briefly in turn.

  1. The Kiddie Tax, which is a colloquial name, is when the unearned income, above a certain threshold, of a person under age 24 is taxed at their parents’ marginal tax rate. There’s a whole history behind the Kiddie Tax that I won’t go into now, but you can read my article about it linked from PFforPhDs.com/tax/. What is both perplexing and infuriating to me is that fellowship income is included in the definition of unearned income. So if you are a student under age 24 on fellowship, even if you are not claimed as a dependent on your parents’ tax return, you could be hit with the Kiddie Tax. I’m not saying you definitely will because there are calculations that go into this, but it can happen. If it does, your income is taxed at your parents’ marginal tax rate. If your parents have a low to moderate adjusted gross income, the Kiddie Tax either won’t apply or won’t increase your tax liability by much. But if your parents’ top marginal tax bracket is 22% or higher, your tax liability will be much higher than it would have been without the Kiddie Tax. And, again, it does not matter if you’re financially independent from your parents, this tax can still apply. Ugh!
  2. The Earned Income Tax Credit is a super valuable credit for people who are low-income, especially if they have children. For example, if you are single with one child and qualify for the credit, you’ll receive a benefit from the Earned Income Tax Credit if your income is below $43,492 in 2022. The lower your income is under that threshold, the more of the benefit you’ll receive, up to a maximum of, again for example, $3,733 for one child in 2022. This credit is refundable, which means that if it wipes out your entire tax liability, the IRS can end up paying you money. Again, just an incredibly valuable credit for low-income individuals and families, which you know many postbacs, grad students, and postdocs would be considered. However, as the name implies, your household has to have earned income during the calendar year to qualify, and fellowship income isn’t earned income. I will never forget a heartbreaking comment I received on my website years ago from a grad student who was married with two children and supporting the entire household on his grad student stipend. He was devastated when his tax return showed that because he switched onto fellowship and didn’t have any earned income for a calendar year, that his family lost out on thousands of dollars of a benefit they had received in prior years when he had employee grad student income. Can you imagine? Why would the IRS, Congress, we the people, exclude vulnerable families like that one from this benefit?
  3. The Child and Dependent Care Tax Credit is a tax credit that helps parents, among others, pay for daycare, preschool, after school care, etc. so that they can work or look for work. The benefit inversely scales with your income, like the Earned Income Tax Credit, but for example if you had one child in care and your income was low enough that you received the maximum benefit, this credit would reduce your tax liability by $1,050 in 2022. Pretty good benefit. However, here’s that catch again, you and your spouse if you’re married must both have earned income to qualify. There is an exception for students, so grad students will still qualify for the credit for all the months in which they are students, but postbacs and postdocs won’t. This issue was brought to my attention by a married couple with a baby, both postdocs on fellowship, who were taken aback that they weren’t able to claim this credit. And why? Does being on fellowship mean that they don’t need childcare? Or do they not deserve a similar carve-out to the one that students get?

I have to stop here because I’m getting really worked up about these issues. Pretty simple change here, IRS. Include fellowship income in the definitions of earned income everywhere. Or make exceptions for fellowship income in all of the above benefits and any other relevant ones.

I haven’t even covered how fellowship income relates to the definition of “support” for determining if someone is a dependent or subject to the Kiddie Tax, and I won’t take the time to illustrate it now. It’s a similar problem that the IRS could solve by saying that fellowship income counts as support… anyway. See my tax return workshops for further discussions of that rat’s nest. Let’s move on.

Commercial

Emily here for a brief interlude!

Tax season is about to start heating up, and the best place to go for information tailored to you as a grad student, postdoc, or postbac is PFforPhDs.com/tax/. From that page I have linked to all of my tax resources, many of which I have updated for tax year 2022.

On that page you will find free podcast episodes, videos, and articles on all kinds of tax topics relevant to PhDs. There are also opportunities to join the Personal Finance for PhDs mailing list to receive PDF summaries and spreadsheets that you can work with.

The absolute most comprehensive and highest quality resources, however, are my asynchronous tax workshops. I’m offering three tax return preparation workshops for tax year 2022, one for grad students who are US citizens or residents, one for postdocs who are US citizens or residents, and one for grad students and postdocs who are nonresidents. Those tax return preparation workshops are in addition to my estimated tax workshop for grad student, postdoc, and postbac fellows who are US citizens or residents.

My preferred method for enrolling you in one of these workshops is to find a sponsor at your university or institute. Typically that sponsor is a graduate school, graduate student association, postdoc office, postdoc association, or an individual school or department. I would very much appreciate you recommending one or more of these workshops to a potential sponsor. If that doesn’t work out, I do sell these workshops to individuals, but I think it’s always worth trying to get it into your hands for free or a subsidized cost.

Again, you can find all of these free and paid resources, including a page you can send to a potential workshop sponsor, linked from PFforPhDs.com/tax/.

Now back to my expert discourse.

Disadvantages Continued

Disadvantage #4: There is no mechanism for making fellowship money that pays your health insurance premium tax-free unless you are a student.

This disadvantage requires a bit of background.

Think of a regular employment situation, not related to academia. Unfortunately in the US, health insurance is tightly tied to your employer partly because of a tax benefit afforded to them. When your employer provides your health insurance plan, the cost of the premium is tax-deductible for both you and the employer. That means that you don’t pay income tax on the portion of your income that goes toward that particular purpose. It’s as if you earned less money than you actually did. This is accounted for automatically for you on your Form W-2. The income listed in Box 1 is your gross income less your pre-tax payroll deductions such as your health insurance premium. Easy peasy. If you’re self-employed, there is also a mechanism to deduct your health insurance premium.

But if you’re not employed or self-employed, the only way you can perhaps deduct your health insurance premiums is if you itemize your deductions. Even in that case you can only deduct the portion of your medical expenses that exceeds 7.5% of your adjusted gross income. If you are a relatively healthy single person who wouldn’t otherwise itemize your deductions, I doubt itemizing will help you overall. Most people in this situation effectively cannot deduct their health insurance premiums or at best can only deduct a portion of them.

I need to back up now and talk about the situation with health insurance provided by universities. If you receive your health insurance through your parents, the following is not relevant to you. If you’re an employee of the university and receive health insurance because of that status, that’s a normal straightforward deduction as I just discussed. Let’s set that aside and discuss what happens when fellowship or scholarship income pays your health insurance premium, either automatically before you receive your paycheck or out of your own pocket.

If you are a grad student, there is a mechanism to make that fellowship income tax-free. We’re actually going to discuss that in the upcoming section on the tax advantages of fellowship income. However, if you’re a postbac or postdoc, this mechanism isn’t available to you. There is no way that I know of, short of itemizing their deductions, for postbacs and postdocs to make the fellowship money that pays their health insurance premiums tax-free. And that sucks.

This conundrum has been highlighted by many postdocs and postdoc associations. If a university or institute pays postdoc employees and postdoc fellows the same amount, the postdoc fellows effectively receive a pay cut because they have to pay income tax on the portion of their fellowship income that pays their health insurance premiums while postdoc employees do not.

The general solution to this whole issue is universal healthcare, but even without going that far, Congress could change the tax code so that all health insurance premiums are tax-deductible even without having to itemize deductions. I don’t know, maybe that would have disastrous effects somehow. Another way to fix this would be to expand the benefit that students use to non-student trainees as well.

Disadvantage #5: Fellowship recipients cannot contribute to their university or institute’s 403(b) or 457 plans. These are employer-sponsored tax-advantaged retirement accounts, and they are only available to employees.

Similar to the health insurance situation, the tax code has incentivized saving and investing for retirement primarily through employer-sponsored plans. These plans are exclusively offered to employees. That goes for 401(k)s as well as 403(b)s and 457s.

Looking at the situation for postdocs again, it’s typical for postdoc employees to be able to contribute to the university or institute’s 403(b) or 457, albeit usually without a match. However, postdoc fellows do not enjoy this benefit. While the universities administer these plans, again this is a policy issue at the federal level that excludes non-employees. Side note: If you’re wondering why grad student employees don’t usually have access to their university’s 403(b)s or 457s, that is a university-level policy issue as far as I can tell.

Not exactly the same but as a related issue, there is a type of tax-advantaged retirement account that is available to everyone with “taxable compensation,” which is an Individual Retirement Arrangement or IRA. You do not have to be an employee to contribute to an IRA. Up until 2019, the definition of “taxable compensation” excluded fellowship income, but the SECURE Act changed that definition starting in 2020. Taxable fellowship income for graduate students and postdocs is now considered taxable compensation for the purpose of contributing to an IRA. We know from this example that change is possible when it comes to fellowship income and federal tax benefits. You can learn more about this issue in Season 4 Bonus Episode 1 of this podcast, which you can find at PFforPhDs.com/s4be1/.

I think the most accessible solution to this particular disadvantage is actually not to somehow extend the employee-only workplace-based retirement benefit to fellows but rather to increase the contribution limit for IRAs to solve this for everyone. The contribution limits in 2023 for someone under age 50 are $6,500 for an IRA and $22,500 for a 403(b), 457, or 401(k). Why should there be such a big advantage for employees?

Advantages

Alright, it’s time for a dose of positivity. There are two advantages to fellowship income that I have come across.

Advantage #1: Students can make fellowship income tax-free by pairing it with qualified education expenses or QEEs. Basically, if your awarded income paid for a QEE, that amount of awarded income is tax-free. You essentially get to deduct the QEEs from your awarded income before you even report it on your tax return. This federal income tax benefit is found in Publication 970 Chapter 1, and I call it Tax-Free Scholarships and Fellowships or TFSF. Again, this benefit is only available to students.

How does this work differently for grad students with awarded vs. employee income for their stipends? This comes into play when you use your stipend to pay for an education expense rather than having it paid on your behalf via a scholarship or waiver.

Let’s take as a very simple example a grad student who has only two education expenses, tuition and a student health fee. The tuition is paid on their behalf by a scholarship, and they pay the student health fee out of pocket.

The scholarship that pays their tuition is awarded income, but it is made tax-free via TFSF because it pays for tuition, which is a QEE. So that awarded income doesn’t become part of the grad student’s taxable income.

The student health fee is a QEE under TFSF, so if the grad student’s stipend is from a fellowship, the student health fee makes that amount of fellowship income tax-free. It’s like taking a deduction. However, if the grad student’s stipend is employee income, no part of it can be made tax-free by the student health fee. Furthermore, student health fees are not qualified education expenses under the other two available higher education tax benefits, the Lifetime Learning Credit and the American Opportunity Tax Credit. So in this particular example, there is no tax benefit available to a grad student employee for their student health fee, whereas a grad student fellow can use the student health fee to reduce their taxable income.

That was a very simple and contrived scenario, but it turns out that this benefit can be uniquely applied, under specific circumstances, to lots of other common education expenses, such as textbooks, computers, software, and health insurance premiums.

If you are a grad student on fellowship, I highly recommend taking my tax workshop How to Complete Your Grad Student Tax Return (and Understand It, Too!) to understand TFSF and the other higher education tax benefits fully. This goes double if you did pay out of your fellowship stipend for the kinds of education expenses I just mentioned. You will learn under what circumstances you can use them to make your fellowship income tax-free and under what circumstances you cannot. Go to PFforPhDs.com/tax/ for the link to the workshop.

Advantage #2: Fellowship income is not considered taxable income in some states. For this advantage only we are leaving the realm of federal income tax. I won’t say too much about this except that I’ve run across it in two states, Pennsylvania and Alabama, and there may be others. But this is a truly fantastic benefit that puts fellowship income at a great advantage over employee income in those states.

Neutral Difference

Finally, we have a difference with fellowship income that has both pros and cons. For this one we’re also not discussing federal income tax but rather FICA tax, which pays into the Social Security and Medicare systems.

Fellowship income is not wages, so it is not subject to FICA tax. Postdoc and postbac fellows do not pay FICA tax, but postdoc and postbac employees do. Grad students by and large qualify for a FICA tax exemption, so they usually don’t pay it whether their stipends or salaries are fellowship or employee income.

When I was a grad student, I thought these exemptions were great. I was not interested in losing 7.65% of my paycheck toward a dubious far-future benefit. I still think keeping an extra 7.65% of your paycheck is super valuable for grad students, postbacs, and postdocs. However, now that I’m older and I’ve learned more about Social Security and Medicare, I think forgoing all those quarters of credits during grad school plus any postbac or postdoc fellowship years might be a little foolhardy. For example, if you become disabled as a young adult before paying into the system for the required number of quarters, you are at risk of not qualifying for the disability benefit. That’s a pretty remote possibility, but it’s scary that people could be left unprotected by this supposed last resort insurance plan because of these exemptions. And I really don’t think Social Security is going to disappear entirely. Ideally, I’d like to have both the money in my pocket and the insurance coverage, please and thank you.

At the beginning of this episode, I told you there were two purposes: First to help you with tax planning and second to direct your attention to issues about which you can advocate for change.

On that first point, the best place to go to learn more or take one of my tax workshops is PFforPhDs.com/tax/.

On the second point, I have three ideas for you if you would like to advocate for change to one of the federal tax policies I’ve mentioned:

  1. You can write to your representative in the House and/or your senators and ask your peers to do the same explaining how the tax law negatively affects your life and in what way it could change. The component of the SECURE Act that updated the definition of taxable compensation started as a bill called the Graduate Student Savings Act, which was sponsored by a bipartisan group of members of the House and Senate for several years before it was finally included in the SECURE Act.
  2. You can submit an explanation of your issue through the IRS’s Systemic Advocacy Management System. Just search for IRS SAMS and it will be the first result. The IRS will evaluate these issues and decide which to move forward with trying to correct.
  3. You can get involved with organizations that advocate for the workforce in your field or for PhD trainees generally, such as the National Association of Graduate-Professional Students and the National Postdoctoral Association. You can make them aware of these tax problems, if they aren’t already, and partner with them to advocate at the federal level.

It’s been lovely to have you with me for this wonky episode. One final time: I offer educational tax workshops both on preparing your annual tax return and calculating and paying estimated tax. I would really appreciate you recommending my workshops to a potential sponsor at your university. If that doesn’t work out, you can purchase the appropriate one for you as an individual. You can find the links to take either one of those actions at PFforPhDs.com/tax/.

Outro

Listeners, thank you for joining me for this episode!

I have a gift for you! You know that final question I ask of all my guests regarding their best financial advice? My team has collected short summaries of all the answers ever given on the podcast into a document that is updated with each new episode release. You can gain access to it by registering for my mailing list at PFforPhDs.com/advice/.

Would you like to access transcripts or videos of each episode? I link the show notes for each episode from PFforPhDs.com/podcast/.

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 by Lourdes Bobbio and show notes creation by Meryem Ok.

How Fellowship Recipients Can Prevent Large, Unexpected Tax Bills

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In this episode, Emily details the steps that graduate students, postdocs, and postbacs who are switching onto non-employee fellowship funding should take to adequately prepare for next tax season. Fellows should set up a system of self-withholding starting with their first paycheck so they are prepared to pay their future tax bill(s). To avoid being fined for underpayment, fellows should assess whether they are required to pay estimated tax and do so if required. Emily has a workshop that walks fellows through these processes, which can be sponsored by your institutions.

Links Mentioned in this Episode

Image for S12E6: How Fellowship Recipients Can Prevent Large, Unexpected Tax Bills

Introduction

Welcome to the Personal Finance for PhDs Podcast: A Higher Education in Personal Finance.

I’m your host, Dr. Emily Roberts, a financial educator specializing in early-career PhDs and founder of Personal Finance for PhDs.

This podcast is for PhDs and PhDs-to-be who want to explore the hidden curriculum of finances to learn the best practices for money management, career advancement, and advocacy for yourself and others.

This is Season 12, Episode 6, and today I don’t have a guest, but instead will detail the steps that graduate students, postdocs, and postbacs who are switching onto non-employee fellowship funding should take to adequately prepare for next tax season. Fellows should set up a system of self-withholding starting with their first paycheck so they are prepared to pay their future tax bills. To avoid being fined for underpayment, fellows should assess whether they are required to pay estimated tax and do so if required. I have a workshop that walks fellowship recipients through these processes, which can be sponsored by your institution.

You can find the show notes for this episode, including a full transcript, at PFforPhDs.com/s12e6/.

This episode is for you if all of the following are true:

  • You are a US citizen, permanent resident, or resident for tax purposes.
  • You are a graduate student, postdoc, or postbac at an institution in the US.
  • You recently switched or will soon switch to being funded by a fellowship or training grant that will pay your stipend or salary in full or in part. More specifically, because the name of this type of funding does vary by institution and funding source, this is income that will not be reported at tax time on a Form W-2. You are not considered an employee of your institution, at least with respect to this funding source.
  • Once you switch funding sources, you will not have income tax withheld from your paychecks. This is typically what happens for non-W-2 income, though there are rare exceptions.

If all those points describe you, please keep listening as what I’m about to explain is super important to your financial health! However, this podcast episode is for educational purposes only and should not be considered tax, legal, or financial advice for any individual. I am not a Certified Public Accountant or Certified Financial Planner. In this episode, I’m going to focus only on federal income tax, although in most cases what I’m saying applies at the state level as well.

I’ve just outlined the problem. You’re receiving income, but income tax is not being withheld from your paychecks. If you are not aware that this is happening or don’t know how to address it, you might be hit with a large, surprise tax bill and even a penalty once you prepare your tax return next spring. Every single tax season, I hear from graduate students and postdocs facing large, unexpected tax bills and they are desperate and panicking and it’s a really hard situation to be in. This podcast episode is one of my efforts to spread awareness of the tax complications that come with being a non-employee fellow so that no one else gets blindsided in this way.

Standard Employee Tax Liability

I want to back up for a moment to explain what most Americans experience with respect to their paychecks and define some terms so that we are on the same page about the unique situation that non-employee fellowship recipients are in.

If you are an employee, as you very likely have been at some point in your life, and you earn an income, you likely have a tax liability associated with that income. Your tax liability is the amount of money that you owe the IRS and possibly state and local tax agencies based on your income and some other factors like deductions and credits. Now, if you have a small income and/or lots of deductions and credits, you might have zero tax liability or even a negative tax liability. Pre-pandemic, 56% of Americans had a positive federal income tax liability.

Your employer helps you pay that income tax liability by withholding income tax on your behalf. So when you receive a paycheck, you don’t receive your full gross income, you receive your income less the applicable income taxes, payroll taxes, etc. Your employer sends this money to the IRS and it’s counted against your total tax liability for the year.

Each tax season, we prepare our income tax returns. That’s when you or your tax preparer or your tax software of choice fill out IRS Form 1040 and other forms to precisely calculate your tax liability for the year that just ended. The tax liability that you calculate on your tax return is compared to the amount of income tax that was withheld and sent to the IRS on your behalf. If the amount withheld exceeded your tax liability, the excess amount is refunded to you. If your tax liability exceeded the amount withheld, you will pay the balance when you file your tax return.

That’s the normal employer withholding situation that most Americans experience. But what if you are paid by a fellowship or training grant and your university or institute, who is not your employer, doesn’t withhold any income tax on your behalf?

Non-Employee Fellowship Recipient Tax Liability

Some fellows, upon seeing that no income tax is being withheld from their paychecks, think that their income is exempt from income tax. This is not the case. Fellowship income of the type I describe is taxed as ordinary income. Prior to tax reform in the 1980s, it was not subject to income tax, and I’m sure that’s part of where the confusion comes from. If you want a deeper exploration of the taxability of fellowship income, please listen to Season 2 Bonus Episode 1, “Do I Owe Income Tax on My Fellowship?”

So, your income is subject to income tax, but no income tax is being withheld from your paychecks. The natural outcome of this situation is that when you fill out your tax return next spring, you are likely to find that you owe some money to the IRS. How large or small the amount of money is depends a lot on your personal circumstances, but somewhere in the $1,000 to $4,000 range is pretty typical.

However, the IRS actually isn’t too keen on people owing large bills at tax time. They’d rather receive their pound of flesh gradually throughout the year. And, frankly, a lot of people simply wouldn’t be able to pay their tax owed if presented with a large, one-time bill. That’s why employers withhold income tax on behalf of their employees and send it off to the IRS incrementally throughout the year.

To resolve this issue for people who don’t have employers, like fellows, the IRS deployed the estimated tax system. The estimated tax system is a mechanism by which the IRS accepts income tax payments four times per year from anyone who might otherwise have one of these large outstanding bills at tax time.

PF for PhDs Tax Resources

With that background, what should a new fellow do to stay on top of their unique tax situation? There are two important steps to take.

We will dive deep into those answers momentarily, but first I want to point you to additional resources on this topic.

You can find all my free articles and podcast episodes on this topic linked from PFforPhDs.com/tax/. Most notably, check out my article “The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients.” It covers a lot of the same ground as this episode.

If you want some additional assistance, I recommend joining my paid workshop, Quarterly Estimated Tax for Fellowship Recipients. It takes you step-by-step and in great detail through the processes I’m about to describe, plus you have the opportunity to ask me questions during live Q&A calls.

If you would like to take this workshop, you can purchase it as an individual from PFforPhDs.com/qetax/. However, I also make it available to university clients at a discounted bulk rate. Please ask your graduate school, graduate student association, or postdoc office if they will sponsor this workshop for you and any interested peers, and point them to the link PFforPhDs.com/sponsorQEtax/.

Finally, if you are discovering this episode during the 2022 tax season or a subsequent tax season and you’re already facing a large, unexpected tax bill due to your fellowship, I recommend viewing two of my videos, “Why Is My Fellowship Tax Bill So High?!” and “What to Do When Facing a Huge Fellowship Tax Bill.”

You can find all of those pages linked from the show notes, PFforPhDs.com/s12e6/.

Step #1: Estimate Your Tax Liability

Now back to the two vital steps you should take at the point that you switch over to receiving paychecks with no income tax withholding.

Step #1 is to estimate your tax liability for this year and set up your system of self-withholding. “Self-withholding” is what I call this process, not necessarily what anyone else calls it. Basically, you are going to set aside the fraction of each of your paychecks that you expect to ultimately pay in income tax and save up those sums for when you have to pay your tax bills.

The first part of this step is to estimate your tax liability for this year so you know how much you’ll owe to the IRS and your state and local tax agencies, if applicable. Again, I’m just focusing on federal income tax in this episode. I know of two good ways to make such an estimate.

Method A: Form 1040-ES

Method A is the most accurate, and that is to fill out the Estimated Tax Worksheet on page 8 of IRS Form 1040-ES. I’m going to talk more about the Estimated Tax Worksheet in Step #2, but for now all you need to know is that it helps you estimate your tax liability for the current tax year. If you’re listening to this in real time, the 2022 Estimated Tax Worksheet is basically a high-level draft of your 2022 tax return. It will take into account the income and income tax withholding you had in the former part of 2022 and well as the income you expect to receive in the latter part. You will also factor in your expected tax deductions and credits for 2022, if any. The worksheet processes all of this information and in Line 14b presents the amount of your 2022 tax bill above whatever might have been withheld earlier in the year. If you’re married filing jointly, the worksheet incorporates both your information and your spouse’s. In a typical fellowship case, though certainly not every case, the fellow has some additional tax liability there in Line 14b, as I mentioned earlier, usually in the low 4-figures. Keep in mind for Method A that it is the most accurate estimate of the size of your tax bill, but it’s specific to the tax year you filled it out for. Once we roll into 2023 and subsequent years, if you’re still not having income tax withheld from your paychecks, you’ll need to fill out that year’s version of the Estimated Tax Worksheet for what specifically is going on for you in that tax year as soon as it’s available.

Method B: Income Tax Calculator

Method B is the fastest, and that is to use an income tax calculator. This is a good approach if you expect to have a super simple tax return, for example taking the standard deduction and no tax credits. I’d also say this method is better for single people, not married couples. The calculator I like best is from smartasset.com. Just search ‘smartasset income tax’ and it should be the first result. Because I’m keeping this approach really fast and simple, I actually suggest that you plug your 12-month fellowship income into the Household Income field. For example, if you’re starting to receive the NSF GRFP award in fall 2022, that’s $34,000 paid out throughout the 2022-2023 academic year. So even though you’re only getting part of that in 2022 and maybe you had some other income level earlier in the year, just put $34,000 in that household income field to get an idea of how much tax you can expect to owe over the first 12 months of receiving that award. Then, fill in the remaining details the calculator asks for and scroll down to the populated table. Looking at the federal income tax line will show you an estimate of your federal income tax liability due from your next 12 months of income. Method B is not going to be very accurate for your actual 2022 tax liability—Method A is better for that—but it is an easy way to get a decent number to use in the second part of Step #1.

Start Saving for Future Tax Bills

The second part of this step is to start saving for those future tax bills. If you used Method A, take that estimated tax bill and divide it by the number of fellowship paychecks you expect to receive in 2022. For example, if you’re paid monthly starting in August, that’s 5 paychecks, so divide your estimated tax bill by 5. If you used Method B, divide that 12 month expected tax liability by the number of paychecks you expect to receive over those 12 months. This is the dollar amount that you should set aside from each paycheck to go toward your future tax bill.

To actually, mechanically, set up your system of self-withholding, I recommend opening up a savings account that is solely dedicated to housing money that you expect to pay in tax in the future. Yes, you could keep this money in your checking account or a multipurpose savings account, but in my opinion it is way too easy to dip into this savings balance for another expense, whether intentionally or accidentally. When you open this account, make sure that you aren’t paying any fees and there are no minimum balance requirements, because you are expecting to pretty much drain this account at some point or points in the future. Online-only banks like Ally offer these kinds of savings accounts in case your current primary bank does not.

Once you have the savings account open, set up an automatic contribution. For example, if you are paid on the first of every month into your checking account, set up a recurring transfer in the proper amount for the 5th of the month from your checking account into this dedicated savings account. And when you set up the amount, round up on that calculated transfer amount in case your estimated tax liability was a bit low. Better to have a little money left in this account that you can transfer out and use for another purpose after you pay your tax bill than to come up short. If you do have savings left over, this is what I call a self-tax refund. It’s like receiving a refund from the IRS after filing your tax return, but better because that money was in your account gaining interest that whole time instead of in the IRS’s coffers.

If you would like to hear more about this system of self-withholding, listen to my Season 6 Episode 9 podcast interview with Lucia Capano titled “How This Grad Student Fellow Invests for Retirement and Pays Quarterly Estimated Tax.” 

Step #2: Determine Tax Bill Due Dates

Now that you are all set up to pay your future tax bill or bills, we can move on to Step #2, which is to figure out when those tax bills are actually due.

Step #2 is to figure out if you owe estimated tax and to pay it quarterly if so. If you are expected to pay estimated tax and fail to, you may be assessed a fine after you file your tax return.

Earlier, I mentioned that the IRS expects to receive tax payments throughout the year via the estimated tax system if you aren’t having income tax automatically withheld. While that is a blanket true statement, there are exceptions. Certain graduate students, postdocs, and postbacs may not be required to make estimated tax payments.

One of the exceptions is if you owe less than $1,000 in a tax bill at tax time. So for example, if you started receiving fellowship income really late in the calendar year and it didn’t add up to all that much or if your tax withholding in the earlier part of the year was rather excessive, your additional tax liability above the level of your withholding might not rise to $1,000. In that case you wouldn’t be required to make any estimated tax payments. Keep in mind that you still have that tax liability though, and you’ll pay all your tax due when you file your income tax return during tax season.

Estimated Tax Worksheet

To figure out for sure whether you’re required to pay estimated tax, you have to fill out the Estimated Tax Worksheet on page 8 of Form 1040-ES. I said for Step #1 Method A that the Estimated Tax Worksheet will give your most accurate estimate of your tax liability for the current year, and its other function is to answer this question about the requirement to pay estimated tax. There are multiple ways you can be exempted from this requirement, not just the one I outlined a moment ago, so it really behooves you to fill out this worksheet in its entirety.

If you get all the way to Line 15 of the worksheet, it tells you your expected quarterly payment amount. Now, this part is a little tricky for people who switch onto fellowship mid-calendar year because you aren’t going to make four quarterly payments in the current calendar year, only the 1-2 remaining payments, so you need to recalculate your payment amount using the number in Line 11c.

If I’ve lost you a little bit with this discussion of the Estimated Tax Worksheet in Form 1040-ES, don’t worry. It’s hard to understand just from listening to a podcast episode. I expect it will make much more sense once you’re looking at the worksheet. But if it doesn’t, you can join my workshop, Quarterly Estimated Tax for Fellowship Recipients, which walks you line by line through the worksheet and answers the most common questions I receive from PhD fellows about things like switching funding sources mid-calendar year and being married to someone with automatic income tax withholding.

The important takeaway from this Step #2 is that you should use the Estimated Tax Worksheet to determine whether you are required to pay estimated tax.

If you are required to pay estimated tax, make the payments using the money that’s built up in your dedicated savings account. You can view your payment options at IRS.gov/payments. The payment deadlines are typically April 15, June 15, September 15, and January 15 unless a holiday pushes one back. Yes, you heard me correctly! Confusingly, the so-called quarters are not all 3 months in length.

If you are not required to pay estimated tax, you don’t need to take any further action until tax season. You can draw upon your earmarked savings to pay your tax balance due when you file your tax return.

One last note about the Estimated Tax Worksheet. It is specific to each tax year, so if you’re still on fellowship at the start of next calendar year, please fill that year’s version out when it becomes available, which is usually around March. Your 2022 Estimated Tax Worksheet might have concluded that you weren’t required to pay estimated tax in 2022, but you can’t assume that’s going to be the case for 2023 as well. Even if you are required to pay in both years, your quarterly payment amount might change. I suggest filling out a new Estimated Tax Worksheet at the start of every calendar year and every time your income changes until you once again have automatic tax withholding on your paychecks.

Conclusion

We have come to the conclusion of this episode. Here are your action steps if you switched or will switch onto fellowship income without automatic income tax withholding near the start of this academic year: 1) Estimate your future tax bill and start saving for it. 2) Determine whether you are required to pay estimated tax and follow through if so.

If you found this episode valuable, please share it with your peers over social media or an email list-serv. Know that probably every time you do so, you are playing a role in preventing a severe financial hardship from occurring in someone’s life.

If you would like to take my workshop, Quarterly Estimated Tax for Fellowship Recipients, please attempt to find a sponsoring office or group at your university before purchasing it yourself. Even if you don’t need the workshop now but you wish you had taken it in a prior year, please recommend it. The potential sponsor can find more information at PFforPhDs.com/sponsorQEtax/. The workshop includes 1.75 hours of pre-recorded video content, a spreadsheet, and invitations to live Q&A calls with me leading up to each quarterly deadline for the current tax year. I’m here to help anyone who needs assistance with these matters. Thank you in advance for making that recommendation and helping to prevent large, unexpected tax bills and penalties among your peers.

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

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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

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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.

How and When Will I Receive My Stimulus Check?

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In this episode, Emily explains how and when the stimulus checks from the CARES Act will be sent to qualifying individuals. She points to new IRS tools to help you track your payment and ensure that your payment arrives in a timely fashion. A minority of citizens and residents may need to submit their 2019 tax returns or other information prior to receiving their checks.
 
Links Mentioned in the Episode
 
stimulus checks PhD
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 Bonus Episode 2, and in this episode I will answer the question: How and when will I receive my stimulus check?
 
I’m recording this on April 15, 2020. The Coronavirus Aid, Relief, and Economic Security Act aka the CARES Act was signed into law a little less than three weeks ago, and one of the major components of the bill was economic impact payments aka stimulus checks sent to qualifying individuals.
 
Stimulus checks have just started arriving in people’s bank accounts this week. In fact, my family’s stimulus check showed up this morning.
 
If you are expecting a stimulus check but it hasn’t arrived yet, you are probably quite anxious to know when it will come and if there is anything that you need to do to hasten the process, so that is the subject of this podcast episode.
 
For most Americans, the stimulus check will be delivered automatically, without having to take any action. However, some people do need to take steps to receive the payment or to receive it sooner.
 
While you’re listening to this episode, I suggest you go to the URL IRS.gov/coronavirus/economic-impact-payments. That link will be in the show notes for this episode as well.
 
On that page you will find a link to the Get My Payment tool, which was launched earlier today. That is where you can check on the status of your stimulus check so you know when it will arrive. You can also provide the IRS with your banking information to enable direct deposit.
 
If you received a tax refund last year by paper check, chances are the IRS does not have the ability to directly deposit your stimulus check into your bank account. The same goes for if in the last two years you paid additional tax along with your tax return, which is common for fellowship recipients who don’t have automatic income tax withholding. In that case, you should use the Get My Payment tool to submit that information. If you’re eligible for a stimulus check but don’t have that direct deposit information on file, you’ll likely wait several months to receive your paper check rather than just days or weeks for the direct deposit.
 
 
If you were not required to file a tax return in 2019 or 2018, you should go to the other link on the webpage I referenced, which is called Non-Filers: Enter Payment Info Here and fill out the application. It is a very short form to collect your information so that IRS can issue the payment. You do not need to take this step if you receive Social Security retirement, disability, or survivor benefits or Railroad Retirement and Survivor Benefits.
 
For some of the younger members of my audience, perhaps 2019 was the first year in which you were ever required to file a tax return. In that case, according to the Get My Payment webpage, you do have to file your 2019 tax return to get your stimulus check. If you need help doing that, you can find all my best resources at PFforPhDs.com/tax.
 
Now, let’s say you qualify for a stimulus check but for some reason you don’t receive it or the one you receive is not as large as it should have been. You can rectify this on your 2020 tax return.
 
The stimulus money is technically a new refundable credit for 2020 paid out in advance of the tax filing season. Therefore, on your 2020 tax return, you can show that you should have received more of this stimulus money, and the IRS can add the missing money to the tax refund you receive in spring 2021.
 
If you are not sure if you are eligible for a stimulus check or have other CARES Act-related questions, I recommend purchasing the webinar I gave last Saturday, April 11. You can find the webinar page at PFforPhDs.com/CARES.
 
I’ll leave you with one final note about scams. IRS scams have run rampant in recent years, and the stimulus checks are an enormous opportunity for scammers. Please be vigilant against phishing or scam attempts both for yourself and your elderly loved ones, who are particularly vulnerable. The IRS will not ask you for your personal information via phone, text, email, or social media. Don’t open unexpected emails that appear to be from the IRS. Please report phishing attempts directly to the IRS.
 
That’s it for this episode! I’ll catch you again on Monday for our next regularly scheduled interview.
 
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 Podington Bear from the Free Music Archive and is shared under CC by NC.

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.