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New Fellow? Pay Your Quarterly Estimated Tax for the First Time This Week!

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Did you start receiving a fellowship this academic year as a graduate student or postdoc? First, congratulations! Second, I must clear up a pernicious misconception about fellowships in the US: you do owe federal income tax (and probably state, too) on your fellowship income. If income tax is not being withheld from your stipend/salary (and the majority of universities do not offer withholding on this type of income), you may be responsible for making quarterly estimated tax payments throughout the year. The next payment is due tomorrow, January 16, 2018! This post will guide you through how to determine whether you owe quarterly estimated tax and how to pay it if so.

Do You Receive Your Gross Income?

The IRS expects to receive income tax payments throughout the year, not just each April. Employees almost always have income tax withheld from their paychecks; instead of receiving their gross (full) income, their employer sends approximately the amount of tax the employee owes from each paycheck to the IRS and the employee receives the rest (net income).

Fellowship recipients (when the term is used conventionally; perhaps not universally) have non-compensatory pay and are not considered employees of their universities. Most universities do not offer income tax withholding on fellowship stipends/salaries. Taxpayers who do not have income tax withheld from their salaries (or who have too little withheld compared to the amount of tax they owe) are sometimes responsible for manually sending money to the IRS. This is called making quarterly estimated tax payments.

If you are a fellowship recipient (e.g., the NSF GRFP), your first step is to confirm that you are in fact not an employee, and your second step is to check whether you are receiving your gross or net income.

Step 1: The easiest way to determine if you are an employee (or rather, confirm that you are not) is to check whether you receive a W-2 for your fellowship income. (If you had an assistantship in this calendar year, you will receive a W-2 for that position, so be sure to check specifically about your fellowship income.) However, if you just started your fellowship in the 2017-2018 academic year, you aren’t due to receive (or not receive) your tax forms until the end of January 2018, and the estimated tax payment is due in mid-January. Your next best option is to inquire into what tax form you will receive for your fellowship stipend/salary. Non-compensatory pay will appear on a 1098-T, 1099-MISC, or courtesy letter or will not be reported in any way. Compensatory pay (indicating that you are an employee) will appear on a W-2. You should try asking your departmental administrative assistant, university fellowship coordinator, Bursar’s Cashier’s office, and/or payroll office. You will most likely be told that they “cannot give tax advice,” but confirming what type of tax form your income generates is not advice.

Step 2: Having confirmed that you are not an employee (if you are, you don’t need this post!), double-check the stipend/salary amount that hits your bank account. If you multiply it by the number of pay periods over which you will receive it, is it equal to the gross fellowship stipend/salary you were told you would receive or is it less? If it is less, did you at any point file a W-4 (e.g., when you had an assistantship)? You may be one of the few students/postdocs who has income tax withheld from a fellowship stipend/salary. As stated earlier, a small minority of universities do offer withholding on fellowship income, and they should use a W-4 to determine the amount of withholding.

If you are not an employee and are not having income tax withheld from your fellowship stipend/salary, you may need to make quarterly estimated tax payments.

Are You Responsible for Paying Quarterly Estimated Tax?

The IRS explains who is responsible for filing quarterly estimated tax on Form 1040-ES p. 1.

Right off the bat, you are not required to pay quarterly estimated tax if in the previous tax year your total income was zero or you did not have to file a tax return (and your return covered all 12 months). For example, if you were a student for all of 2016 and either didn’t have an income or your income was so low that you didn’t have to file a tax return, you aren’t required to make quarterly estimated tax payments.

If that first provision doesn’t apply to you, the IRS has a helpful flow chart on Publication 505 p. 24.

Publication 505 Figure 2-A

At this point, you’re going to have to do a few calculations to determine what amount of additional tax you owe for the year (additional to any withholding you already had). You simply need to fill out the worksheet on Form 1040-ES p. 8 for your household. It looks sort of involved but if you have a simple financial life you won’t actually need to put very many entries into the worksheet. You will need at your fingertips your 2016 tax return (or at least the total amount of tax you paid), your gross income for 2017, the amount of income tax you had withheld in 2017 (if any) and an educated guess as to your 2017 deductions and credits (your 2016 return will be helpful for this).

Once you calculate the amount of tax you owe in total for 2017 (Form 1040-ES line 13c), you can determine whether you are responsible for paying quarterly estimated tax.

First, look up the total amount of tax you paid in 2016. Second, take your total tax due for 2017 and multiply it by 90%. The smaller of these two numbers is the amount of tax you need to pay throughout 2017 to avoid a penalty (Form 1040-ES Line 14c).

Subtract the amount of income tax you had withheld in 2017 (Form 1040-ES Line 15) from the amount you need to pay to avoid a penalty. If the result (Form 1040-ES Line 16) is less than $1,000, you are not required to make a quarterly estimated tax payment. If the result is greater than $1,000, you are required to make a payment.

Please note that just because you are not required to make quarterly estimated tax payments does not mean you will avoid paying tax the whole year, only that the additional tax due does not have to be paid until you file your 2017 tax return this spring. Now that Form 1040-ES has given you some warning, use the next few months to prepare to make that lump sum income tax payment.

How to Pay Quarterly Estimated Tax

If you are required to make a quarterly estimated tax payment, the calculation is pretty simple since this is the last payment due for 2017! You should make a payment for all the additional tax due that you calculated you owe (Form 1040-ES Line 16a). If your calculations were exact, when you file your 2017 tax return in the spring, you won’t receive a refund or owe any additional tax. More likely, filling out your full tax return will bring to light a few adjustments in your calculations, so you may end up receiving a small refund or paying a small amount of additional tax.

The easiest way to make your quarterly estimated tax payment is online at www.IRS.gov/payments (find all your payment options on Form 1040-ES p. 3-4 or Publication 505 p. 32-33).

If you were unaware that you had any income tax liability on your fellowship income and are unprepared to pay what you owe by January 16, 2018, don’t avoid the issue! Give the IRS a call and they may be able to work with you to minimize the penalties you owe (though not the interest).

Calculating your quarterly estimated tax is not very difficult; the most challenging aspect is knowing that you’re supposed to do it! If you are a new fellow and this is your first time making a quarterly estimated tax payment, rest assured that it will be easier going forward. You first quarterly estimated tax payment for 2018 is due on April 17, 2018. You’ll want to freshly fill out the 2018 1040-ES once it’s available, but it should be similar to the form you just worked through.

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Everything You Need to Know about Roth IRAs in Graduate School

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As you are no doubt aware, graduate students are clamoring for information on investing for retirement. I’ve observed this during my seminars and it’s been documented by the Council of Graduate Schools’ Financial Education. Graduate students are wondering how to get started saving for retirement during graduate school or want to be prepared to start immediately following graduate school. Roth IRAs are an integral component of preparing for retirement for graduate students. This article covers everything you need to know about Roth IRAs in graduate school: what an IRA is, why you should use one, the differences between traditional and Roth IRAs, the type of income you need to contribute to an IRA, how much to contribute to an IRA, and how to open an IRA.

Roth IRA graduate school

If you want to know with which firm I have my own IRA and in what I’m invested, sign up for my mailing list to receive a unique 700-word letter. If you have any remaining questions on Roth IRAs in graduate school after reading the article, leave them in the comments or email them to me; I’ll respond directly and update the article with the answer.

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The information in this article is current as of 2023.

What Is an IRA?

IRA stands for Individual Retirement Arrangement. It is a tax benefit offered by the US federal government to incentivize saving for retirement. Anyone with taxable compensation (or a spouse with taxable compensation) can contribute to an IRA; it is not a benefit offered by your workplace like a 401(k) or 403(b). The contribution limit to an IRA in 2023 is $6,500 ($7,500 for people aged 50 and older) or your amount of taxable compensation, whichever is lower.

An IRA is not synonymous with particular investments; you buy investments inside (or outside) of your IRA. An IRA (and other tax-advantaged retirement accounts like a 401(k) or 403(b)) is like a shield that protects your investments from taxes.

If you invest in a regular taxable investment account, every year that you realize a gain you will pay some tax on the gain. This tax effectively suppresses the growth rate you see on your investments, which saps the power of compound interest. An IRA or other tax-advantaged account maximizes that growth rate by eliminating the tax, which ultimately maximizes the amount of money you have in your investments.

However, this tax-advantaged status comes with a trade-off. The purpose of an IRA is to help Americans save for retirement, so there are restrictions on when and for what purpose you can remove money from your IRA. In limited cases, you can remove money from your IRA without incurring any penalty, but in general you have to wait until you are 59.5 years old.

Why Use an IRA Instead of a Taxable Investment Account?

If you were to save for the long-term into a normal investment account, every year you would pay some tax on the gains you realized in the account. If your account had a great deal of turnover in the course of a year, you would pay your marginal tax rate on the gains (10%, 12%, 22%, etc.) plus whatever state tax would be due. If your account had very little turnover, your tax rate(s) would be lower. If instead your money was in an IRA (or a similar tax-advantaged retirement account like a 401(k) or 403(b)), all the gains would be tax-free.

Taxes on a regular investment account amount to death by a thousand cuts. Every year, a fraction of the growth (if there was growth) is removed through taxes and no longer serves as part of the principal for the growth in a subsequent year. Using a tax-advantaged account like an IRA allows the growth to continue unfettered. Over many decades, the balance in an IRA can be hundreds of thousands of dollars larger than the balance in a taxable account to which the same contributions were made.

Further reading: Taxable vs. Tax-Advantaged Savings

For short- or medium-term investing goals, taxable accounts are appropriate because of the complete accessibility of the money contributed. But for long-term investing goals such as retirement, it is very advantageous to use an IRA or other tax-advantaged retirement account.

Why to Contribute to an IRA during Graduate School

Graduate students have a limited income and plenty of claims on that income. They must first and foremost pay for their basic living expenses, which not all stipends can even cover. If there is any money remaining, the student must choose among upgrading his lifestyle, saving up cash, paying down debt, investing, giving, supporting family members, etc. They may very well have higher priorities than saving for retirement. However, there is a very compelling reason for starting to invest for the long term if possible: the power of compound interest aka the time value of money.

As graduate students are most often in their 20s or 30s, time is currently on their side with respect to investing. Many Americans put off saving for retirement until their peak earning years in their 40s and 50s, but the advantage of starting earlier is that you need to save less money overall to reach the same endpoint. This is the time value of money: the money that you invest today is worth more than the money you invest years from now because the intervening time adds value. Investing even small amounts of money during graduate school can massively add to your wealth in retirement, much more so than large amounts of money saved later on.

The mechanism of the time value of money is the power of compound interest.

In qualitative terms, this is how compound interest works: In year 1, you invest some money and it earns a return (we’ll say a positive return, to keep things simple). In year 2, you invest more money which earns a return, plus your contribution and the return from the previous year also earn a return. In year 3, you invest more money and it earns a return, plus your contributions and earnings from previous years earn a return. Before you know it the increases to your account balance each year are coming more so from the growth your previous contributions than on your current contributions; after decades, most of your account balance will be due to growth rather than your direct contributions.

The power of compound interest is modeled by this equation, which represents exponential growth:

compound interest equation

Using the equation for compound growth, you can get an idea of how much money can grow with a given rate of return and time period. In real investing in the stock market, you will not receive the exact same rate of return each year like clockwork; in some years you will lose money, in others you will see a very high return, and everything in between. But on balance, over long periods of time, the math of compound interest reveals the scale of growth possible with even an irregular return like you would see from the stock market. (Investments that give a regular and guaranteed rate of return, such as bonds and certificates of deposit, are comparatively low-returning and not usually considered appropriate long-term investments for a young person.)

For example, if you invested $250 per month at an 8% average annual rate of return for five years during graduate school, in that time you would contribute $15,000 and your ending balance would be $18,369.21. The growth over that time period is nice but not staggering.

But if you then leave that money alone to continue compounding at 8% per year for 50 years – make no additional contributions – your money grows to a mind-boggling $989,688.35!

That’s an extra one million dollars in retirement that you would not have had if you had not started investing during graduate school!

The numbers above are for illustrative purposes only. It’s still incredibly worthwhile to begin investing during graduate school even at a rate of less than $250/month. Compound interest works the same on any sum of money, whether $5 or $5,000. The point is that investing with time on your side turns small amounts of money into large amounts.

Further reading:

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The Difference between Traditional and Roth IRAs

When you open an IRA, you have the choice between opening a traditional IRA and a Roth IRA. (You can contribute to either/both in the course of a year, but the maximum contribution limit applies to them both together, not each separately.) There are a number of differences between the two types of IRAs, especially when it comes to eligibility and withdrawing money in retirement, but there are two key differences that are most salient for young people who are eligible for both types: when you pay income tax and how to withdraw money without penalty prior to age 59.5.

Further reading:

When You Pay Income Tax

With both types of IRAs, you won’t pay any tax while the money is growing inside the IRA.

With a traditional IRA – unsurprisingly, the first type introduced into the tax code – there is an additional tax incentive upon contribution to the IRA, which is that you exclude the amount you contribute from your taxable income for the year (take a tax deduction). You take a tax deduction on the money you contribute, then your money grows tax-free, and then you pay ordinary income tax on the amounts you withdraw each year in retirement. The traditional IRA is a mechanism of tax deferral.

The Roth IRA is the newer type of IRA (named after the senator who introduced it). The tax break on the Roth IRA is the flip of the one for the traditional IRA. You pay the full income tax due on the contribution you make to the Roth IRA, then your money grows tax-free, and you withdraw it tax-free in retirement.

The key to choosing between a traditional and Roth IRA is to guess when you will pay a lower tax rate: upon contribution or withdrawal.

One way to approach this question is by considering when you will be in a lower marginal tax bracket: now or in retirement? The rationale behind this is that you are going to get the tax break on the last dollars of your income, which are likely to fall in your marginal tax bracket. You know your marginal tax bracket today; most graduate students without outside sources of income fall in the 12% marginal tax bracket or even lower (plus your marginal state tax rate). But you have to guess whether the marginal tax bracket you will fall into in retirement will be higher or lower. In the intervening decades, you will experience personal changes in your income and tax bracket, and there are likely to be legislative changes to the tax code and rates.

This guess is probably easier for graduate students than for the average American. Graduate students can make the reasonable assumption that their current income is much lower than their income will be throughout their careers and likely also in retirement. (Ask yourself: Do you want to be living the same lifestyle in retirement that you are in graduate school or would you like it to be more lavish?) Whatever might happen to the tax code more broadly, confidence that you are in a personal low-income and low-tax bracket period is a strong argument for the Roth IRA over the traditional IRA. I and virtually every graduate student I’ve spoken with about this issue chose the Roth IRA over the traditional IRA during grad school.

However, there are more nuanced arguments that you might consider that are more in favor of the traditional IRA, even for someone in a low tax bracket currently. Such arguments are beyond the scope of this article, but there is plenty of reading material available on the decision between the traditional and Roth IRA for you to dive into if you are interested.

Further reading: Traditional vs. Roth IRA: The Unconventional Wisdom

Penalty-Free Early Withdrawal

One of the big planning/psychological barriers to beginning to save for retirement is the nagging question “What if I turn out to need the money in the near future?” After all, life is unpredictable; sustained loss of income or a very expensive emergency might be just around the corner. Some people find it difficult to put barriers between themselves and their money no matter what degree of cash they may have accessible in an emergency fund or other savings. The prospect of sequestering money that can only be used many decades from now in retirement can be daunting.

The Roth IRA (as opposed to the traditional IRA) helps to alleviate this anxiety. While it is rarely a good idea to take already-contributed money out of an IRA (after all, you are unplugging that money from the power of compound interest), you do have that option with the Roth IRA. Because you have already paid your income tax on your Roth IRA contributions, you can withdraw those contributions at any time without penalty (or additional tax). Certain conditions must be met to withdraw earnings early without penalty or tax. For one example of a qualified distribution, the IRA must be at least five years old and the withdrawal is used to buy a first home (up to $10,000); there are other conditions that create qualified distributions as well.

With a traditional IRA, on the other hand, early withdrawals always result in tax due, and penalties are also assessed if the withdrawal is not qualified.

The Type of Income You Need to Contribute to an IRA

Only “taxable compensation” (formerly “earned income”) can be contributed to an IRA; while IRAs are independent of your workplace, they are not independent of work. For most Americans, this is a non-issue, because they work for their income. For example, they might be employees receiving W-2 income or self-employed; both of these types of income are taxable compensation.

Up through 2019, taxable fellowship income not reported on a W-2 was not considered taxable compensation. Starting in 2020, taxable fellowship income not reported on a W-2 is considered taxable compensation. That means that a graduate student receiving a stipend is eligible to contribute their stipend income to an IRA, whether that stipend is reported on a W-2 or some other form (or not at all)—as long as it is taxable in the US.

If none of your income is taxable in the US because you are a nonresident and benefit from a tax treaty, you don’t have “taxable compensation” and are not eligible to contribute to an IRA.

Further reading:

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How Much to Contribute to an IRA during Graduate School

The right amount of money to contribute to an IRA in a given year of graduate school might be $6,500, $0, or somewhere in between.

Graduate school is an extraordinary time of investment in one’s career, possibly to the exclusion of investing for retirement. While many graduate students are paid stipends that more than cover their living expenses, some graduate students are either not being paid a living wage or have unusually high expenses (e.g., have dependents).

To determine the right amount for you to contribute to an IRA, you must explore your means and your goals.

Means: How does your stipend compare to the local living wage? While the local living wage will not exactly match your expenses in every category, it should give you a sense of the baseline cost of living in your county or metro area. If your stipend is at or above the living wage and you aren’t able to save anything, try to reduce your expenses so you can start to invest or accomplish other financial goals. If your stipend is below the living wage, you may not have the means to start saving or investing right now; getting through graduate school without accumulating debt may be an appropriate financial goal.

Goals: Not all graduate students with discretionary income should jump right into investing. There may be higher-priority financial goals such as paying off high-interest debt or saving cash for emergencies or short-term expenses. But if investing for retirement becomes your top financial goal or a goal you work on concurrently with other goals, it is appropriate to contribute to an IRA.

If a graduate student does have the means to invest and investing is their top financial goal, rules of thumb come back into play. The most common (mainstream) retirement savings rates bandied about in the personal finance community are between 10 and 20% of income (gross or net). I think investing 10% of gross income into a Roth IRA is a great initial goal for a graduate student; it was my retirement savings rate when I started graduate school. It may be one easily reached (especially if you build it into your budget from the beginning) or quite challenging. If it takes you years of budget optimization to reach 10% (or you never do), that’s fine. If you want to go higher than 10%, that’s great too, and you’ll have a wonderful nest egg when you transition out of graduate school. (My husband and I reached a 17.5% savings rate from our gross income by the time we defended, but it took years to raise our savings rate to that point.)

A higher retirement savings rate will help you reach financial independence faster, but you always have to balance that against your quality of life in the present. But if you have the means and aren’t working on a more pressing goal, I do recommend regularly contributing to a Roth IRA during graduate school, even if it’s a small percentage. Getting into the habit of saving for retirement is as valuable as the savings itself; if you save during graduate school, once you have a Real Job you’ll never be able to tell yourself that you “can’t afford to save right now.”

Further reading:

How to Open an IRA

The actual process of opening an IRA is straightforward, but choosing where to open it and what to invest in inside the IRA will take some research and decisions on your part.

Briefly, using index funds (a passive investing strategy) is the most effective, least expensive, and most time-efficient manner of investing. You can buy index funds (e.g., the S&P 500 index fund) or a fund of index funds such as a target date or lifecycle fund at any number of brokerage firms. (Brokerage firms that specialize in trading single stocks, i.e., the ones you probably see the most advertisements for, may not offer index funds.)

When you select a brokerage firm, you need to ensure that: 1) it allows you to open an IRA, 2) it offers the investments you are looking for, 3) it is not too expensive to own the funds, and 4) you can meet the account minimums. Index funds are inherently inexpensive, but there will still be some price differences among brokerage firms. Different firms also set different account size minimums, such as between $1,000 and $3,000, but some waive these minimums if you set up an automatic savings rate into the account.

Further reading: Brokerage and IRA Account Minimums

Once you have selected your brokerage firm and investment, you are ready to open your IRA. You should be able to complete the process online in just a few minutes, and the brokerage firm’s website will guide you through the process. You will be asked for your personal information such as your name, SSN, and address. Once you have the IRA open, transfer in the amount of money you need to open the account and/or set up an automatic savings rate, and choose the investment(s) you want to buy with your money.

Does Your University Use Section 117(d)? Please Take Our Survey!

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There have been more developments with the GOP tax plan (the Tax Cuts and Jobs Act) with respect to graduate students’ tuition benefits.

Last week, I gave my interpretation of how the House bill selectively eliminates one form of tuition benefit (tuition reductions) while leaving in place another (tuition scholarships).

Since my writing, an amendment was proposed to maintain the tuition benefits as they currently are, but it was defeated. The House bill is expected to be voted on tomorrow (Thursday, November 16, 2017).

You can find more information and action steps on the NAGPS website.

The Senate version of the tax bill has also been released in the last week, and it apparently does not include the same changes to graduate student tuition benefits that was in the House bill.

If both bills pass as currently written, they will go to a conference committee to create a compromise between the two versions. Then, the agreed-upon version will go back to the House and Senate to be voted upon. It is still important to voice your opinion about this particular provision of the bill to both your representatives and senators so that either the conference committee does not include changes to the tuition benefit in the final version of the bill or your Congresspeople vote against the bill if it does.

tuition tax survey

In the meantime, I am collaborating with two current graduate students, Andrew McCubbin and David Dixon, to figure out which universities are using section 117(a-b) vs. 117(d) for their tuition benefits. My purpose is not to discourage anyone from taking action opposing the TCJA but rather to help students with their personal financial planning and advocacy at the state, university, and department level, should the TCJA pass with the tuition benefit cut in place.

We have a survey up right now; would you please fill it out to the best of your ability and share it with your peers? In the next few days, we’ll start sharing our determinations from the survey on this results page. Also, feel free to comment on this post or email me if you have relevant information but don’t want to fill out the survey!

Which Graduate Students Will Lose Tuition Benefits Under the Proposed House Tax Bill?

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Update: Please fill out this survey on how your university handles your tuition benefit. I and some colleagues are trying to determine which universities use the method slated for elimination in the House bill.

The House GOP released their proposed tax bill (The Tax Cuts and Jobs Act) last week. Over the last several days numerous media outlets have covered the effect the bill would have on graduate students who receive “tuition waivers,” and graduate students have started organizing responses. Students at Carnegie Mellon, for example, calculated how much more tax students in various schools would have to pay if they lost their tuition tax benefits.

Here are articles I read that are most focused on the bill’s effect on graduate students:

lego tuition waiver tax
An excellent illustration of the possible impact of the Tax Cuts and Jobs Act on some graduate students from Lego Grad Student.

When I first started reading about this issue, I got the impression that under the bill all graduate students would see a large increase in their tax burden based on the reversal of their previously untaxed tuition benefits. The strongly worded headlines above certainly imply that graduate students would see such an increase in tax that continuing their educations would be impossible.

However, after spending many hours reading the current tax code, Publication 970, the proposed bill, university websites, news articles, and social media, I think that there is some confused information and hyperbole in the early reports, or at least what the articles are saying is being taken out of context by scared graduate students. However, I haven’t fully figured out what the implications of the new bill are, and I have several questions that are still outstanding. This post details my current thoughts on the issue. My intention is to calm some of the extreme fear I’m observing (in those who do not need to be so fearful), while still imploring you to voice your opposition to the proposed changes to tuition benefits and other effects on higher education funding.

To be clear, I don’t wish to see the net (after-tax) income of any graduate students drop as a result of tax reform. I believe all graduate students who have assistantships or who receive fellowships should be paid at bare minimum a living wage. Honestly, that’s a pretty low bar that not all universities currently meet. If a new tax bill is passed that increases the tax burden on graduate students, the universities should take steps to ensure that current graduate students’ net pay does not decrease. Otherwise, they do risk losing students they have already invested in or putting the students who remain in such a precarious financial position that they are distracted from their research.

But before you panic about your own personal finances, I think you should look carefully at how exactly you are paid. Not all graduate students will be negatively affected by this direct changes made by this bill (should it pass); I think the effects are going to be less widespread and less extreme than what the current coverage and conversations imply.

However, I do think you should lobby your representatives to maintain (more of) the current education benefits. (You just may not be able to use yourself as an example.) This is a moment in which graduate students and academics can band together to advocate for ourselves and academic research in general, whether or not we will be affected in our individual finances. The end of this post lists a few action steps. If the bill does pass, there will be more advocacy to be accomplished within your state and at your university to mitigate the bill’s effect on your and your classmates’ bottom lines.

grad student tuition tax bill

A disclaimer: I’m using a lot of secondary source information for this post. I did read sections of the current tax code and the proposed bill, but as I’m not a policy wonk or lawyer I freely admit that they are difficult for me to parse. If you find any mistakes, wrong conclusions, or omissions, please let me know so I can update the post. Accuracy is very important to me.

What Tuition Benefits Do Graduate Students Currently Receive?

We have to get technical for a bit here because the devil is in the details. I’ve seen students and articles using the terms “tuition waiver” and “tuition remission,” which do not appear in the proposed bill, Publication 970, or (as far as I’ve read) in the current tax code. So I’m going to avoid drawing conclusions from the common terms that are used in academia in favor of figuring out what is actually in the current tax code and bill.

There are three broad tuition benefits that I’ve known graduate students to use:

  • tax-free scholarships, fellowships, and tuition reductions (the most common)
  • the Lifetime Learning Credit
  • the Tuition and Fees Deduction

Basically, if you have any qualified education expenses such as tuition and required fees (the precise definition is not consistent), you can get some kind of tax break.

The proposed tax bill eliminates the Lifetime Learning Credit and the Tuition and Fees Deduction in favor of an expanded American Opportunities Credit (which can only be used in the first five calendar years of post-secondary education and therefore pretty much doesn’t apply to graduate students). This change will increase the tax burden on the students who previously used the Lifetime Learning Credit or Tuition and Fees Deduction, but that hasn’t been the main concern I’ve seen expressed by graduate students in the media.

The big kahuna here are the tax-free scholarships, fellowships, and tuition reductions. There are no monetary limits on these benefits like there are on the Lifetime Learning Credit and Tuition and Fees Deduction. Currently, any scholarship or fellowship that goes toward paying your tuition or qualified fees is not taxed. Also not taxed is any “tuition reduction” you receive. A tuition reduction is the difference between the sticker price tuition and the tuition you are charged.

Scholarships, fellowships, and tuition reductions are all lumped together in Chapter 1 of Publication 970 and Section 117 of the tax code, so I’ve never paid much mind to which is which exactly since they were all tax-free. But the proposed tax bill specifically targets one benefit and not the other.

Which Tuition Benefits May Be Lost and Which May Be Maintained?

The benefits are delineated in Section 117 of the tax code as qualified scholarships (117(a-b)) vs. qualified tuition reductions (117(d)). The tax bill proposes “striking subsection (d) of section 117” (p. 96), presumably leaving intact the other sections.

117(a-b): Gross income does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization described in section 170(b)(1)(A)(ii). The term “qualified scholarship” means any amount received by an individual as a scholarship or fellowship grant to the extent the individual establishes that, in accordance with the conditions of the grant, such amount was used for qualified tuition and related expenses.

117(d): Gross income shall not include any qualified tuition reduction. For purposes of this subsection, the term “qualified tuition reduction” means the amount of any reduction in tuition provided to an employee of an organization described in section 170(b)(1)(A)(ii) for the education (below the graduate level) at such organization… In the case of the education of an individual who is a graduate student at an educational organization described in section 170(b)(1)(A)(ii) and who is engaged in teaching or research activities for such organization, [the above] paragraph shall be applied as if it did not contain the phrase “(below the graduate level)”.

How Can You Tell What Type of Tuition Benefit You Receive?

Section 117(d) explicitly applies only to university employees, which in the case of graduate students means teaching or research assistants. So if you are currently not a student-employee, i.e., you do not receive a W-2 at tax time, your tuition benefit should not change (which further argues for the superiority of fellowship funding over assistantship funding). (An analysis from a Berkeley student concurs this point.) However, I think it’s pretty unusual for a PhD student to complete her degree supported only by fellowships and training grants; most students serve as TAs or RAs for at least a few (if not all) of their semesters.

For student-employees, the question becomes: How do you know if your tuition and fees are paid by a qualified scholarship or a qualified tuition reduction? I do not have a good answer, and I’m hoping a reader can provide one. I don’t know that there is a different reporting mechanism, for example, for qualified scholarships vs. tuition reductions. (The 1098-T, if one is issued, should reflect the required tuition and fees charged to the students and the scholarships applied, but I don’t know if or how a tuition reduction would be reflected in that document. A qualified tuition reduction would not appear on a W-2.)

The best suggestions I can make at this point to figure this out for your situation are:

  • Re-read your offer letter and any employment contract you have with your university for the keywords “tuition reduction” vs. “scholarship,”
  • Check your Bursar/Cashier’s/Financial Aid account for the term “reduction,” and
  • Ask administrators at your university whether you receive a tuition reduction (e.g., the Bursar/Cashier’s office), pressing them to consult the university attorneys if they can’t point you to an answer.

How Common Is the Use of Section 117(d) for Graduate Students on Stipends?

One of the popular articles circulating by Vox pulled a figure from an infographic sheet the College and University Professional Association for Human Resources. (CUPA-HA also created this summary bulletin on Section 117, which makes it clear that section 117(d) is used by many types of university employees beyond TAs and RAs). In turn, the infographic is based on the 2011-12 National Postsecondary Student Aid Study.

vox 117d impact
An infographic from Vox on the number of students taking advantage of the tuition tax benefit in section 117(d).

The relevant number that the Vox article and CUPA-HA cite is that 145,000 graduate students benefit from section 117(d). (I was very curious about how they determined this number as it seems so wonky and specific to help with the unanswered question above, but the version of the 2011-12 National Postsecondary Student Aid Study that I could access did not contain this data. So I would like to dive further into those numbers, but I’m stuck for now.)

Taking the 145,000 students at face value (50% of whom earn more than $50,000/year, so not exactly traditional graduate students who would be unable to continue their studies due to an increased tax bill), what fraction of the total graduate student population is that?

I couldn’t find the answer directly, but the recent NSF survey of earned doctorates cites 54,070 doctorates awarded in 2014. Approximately 50% of PhD students never complete their degrees, so I would peg the current number of doctoral students in the US between 250,000 and 500,000. The 145,000 figure probably also includes master’s students, making the relevant pool of graduate students in the US even larger.

145,000 students using section 117(d) is certainly a large fraction of that total, but definitely not everybody as was my first impression. (Keep in mind, though, that an individual student may use section 117(d) during part of her time in graduate school, so the number using it at any given time is less than the total number who use it at any point.)

As far as how the proposed legislation will affect students at individual universities goes, I have two data points so far (please let me know if you’ve received a definitive answer from your university!):

The Dean of the Graduate School at Cornell released a statement regarding their policies. It reads in part:

 

Cornell University does not rely on 117(d) for favorable tuition-related tax treatment of funded graduate students, who are considered students, not employees, at Cornell.

Because Cornell pays graduate students reasonable compensation for teaching, research, or other services they provide to the university, Cornell graduate students receiving a tuition scholarship are receiving a qualified scholarship as described under sections 117(a), 117(b), and 117(c) of the current tax code, provisions which are not proposed for repeal in H.R. 1.  Thus, the proposed repeal of section 117(d), if passed into law, will not have an impact on how Cornell graduate students’ tuition scholarships are handled.

While the stipend for graduate students may be taxable under the current tax code, the tuition scholarship is not, and would not be affected by repeal of 117(d).  As H.R. 1 is written, Cornell graduate tuition scholarships will continue to be treated as qualifying (tax free) scholarships under 117 (a), thus, there would be no change from current tax law that treats these tuition scholarships for students as tax free.

I graduated from Duke University three years ago, and my understanding was that my tuition and fees were paid by scholarship. In my Bursar account, for example, I would see a tuition charge posted and then a payment posted on my behalf. I assume that payment was a scholarship, and I don’t know how a tuition reduction would have appeared. My recollection was (I think) confirmed by this page that discusses how graduate students are supported: “Full or partial scholarships: Cover tuition and fee expenses.” Tuition reductions are not mentioned. So I think that Duke students, like Cornell students, also do not depend on section 117(d) for their tuition tax benefit.

A Tentative Guess as to the Impact of the Proposed Bill

Here is my intuition on the matter, and I’m curious if it bears out or not. I formed it based on the scantest impressions and it involves far too much extrapolation.

I think perhaps tuition reductions are used mostly by public institutions, whereas qualified scholarships more so by private institutions. Therefore, eliminating the non-taxable status of tuition reductions may disproportionately affect public school students.

However, the large numbers I’ve seen in the media of the “devastating” effect of the tax bill on graduate students are based on tuition charged at private universities and by public universities for out-of-state students. (State policies regarding residency status for the purpose of in-state tuition vary. In some states, students are eligible for in-state residency after the first year. In others, such as Georgia, out-of-state students maintain their status for the duration of their degree.) Public, in-state students might see their taxes increase by hundreds of dollars or a thousand dollars, not the multiple thousands or $10,000+ I’ve seen quoted (except perhaps in the year when they are considered out-of-state students), which is if the full tuition and fees at some private universities were taxed at 12 or (partially) 25%.

I think that if tuition reductions are being used by private universities, they will have more wiggle room to pivot to either compensate their students differently or to pay them more. Well-funded departments and universities may also be able to increase their students’ pay to make up for the additional tax due (perhaps a one-time grant in the first year for out-of-state public university students). Therefore, I hope that the negative effects of the bill will be smaller and more limited in scope than currently anticipated.

Steps You Can Take to Advocate for Higher Education

All that notwithstanding, this is the time for advocacy. I fear that if the proposed tax bill passes as written, the additional tax burden will fall largely upon the students who are least financially secure, namely students in underfunded departments at public universities (earning, for example, less than $20,000/year). A $1,000 increase in their tax bill could easily push them into (further) credit card or student loan debt because their finances are so precarious to begin with. Even if your university does not rely on section 117(d) or you have a fellowship, please stand up for your fellow PhD students who are at risk.

  1. The NAGPS Call Congress Day is TODAY, November 8. You can find all the details about action steps on their Facebook event and website. You can still use their talking points as guidance after November 8.
  2. If you are represented by a union, participate in their lobbying efforts, or consult them on how to organize your own.
  3. Talk with your peers about advocacy steps you can take as a group at the national level and, if this provision of the bill passes, at the state, university, and department levels.
  4. Tell your family members, neighbors, college friends, mentors, etc. about this issue and ask them to advocate for PhD students as well.

In all of this, if you are currently taking advantage of a tuition reduction I encourage you to use your personal numbers (by what absolute amount and percentage your tax bill would increase) like this student did. These numbers are shocking and powerful.

Do you benefit from a tuition reduction or is your tuition paid by scholarship (or both)? Do you expect your tax burden to increase or decrease if the Tax Cuts and Jobs Act passes as written and by how much? How are you advocating for section 117(d) to remain in the tax code?

Options for Paying Down Debt During Grad School

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A version of this post was originally published on GradHacker.

During my presentations on personal finance for grad students, I am frequently asked about debt – more specifically, when and how to pay off debt. Debt often appears to be an attractive option for low-income individuals like graduate students because it can enable you to “buy now, pay later” – acquire possessions or experiences now and spread paying for them out over months or years into the future. However, debt is even more of a trap for low-income people than it is for those with higher incomes because a greater percentage of your pay or cash flow going forward is going to be tied up in debt payments. This leaves even less flexibility in how the person uses his money than he would have without the debt.

Many if not most graduate students are in one or more kinds of debt, be it student loans (from undergrad and/or grad school), an auto loan, credit card debt, a mortgage, personal loans, etc. How a graduate student should manage her debt depends on her ability to repay the debt, her personal disposition toward debt, and the type and terms of the debt. Students who are able to pay down debt during grad school must choose their repayment method and balance that goal with other financial priorities.

debt repayment grad school

Ability to Repay

As a graduate student, what is your current ability to repay debt?

If you are taking on student loan debt during graduate school to pay for your tuition and fees or living expenses, any debt repayment you make is essentially trading your existing debt for student loan debt. While using student loan money to repay other debt might be attractive based on the interest rates, keep in mind that student loans, unlike all other debt, are virtually never discharged in bankruptcy. However, if you are struggling to make ends meet, in terms of taking on new debt, student loans are often preferable to high-interest debt such as credit card debt.

However, if you receive a stipend and tuition waiver, you may have the ability to make your minimum debt payments as well as meet other financial goals, whether they are saving or accelerated debt repayment. Students who grasp the power of compound interest will be motivated to cut back on their spending somewhat to put money toward debt repayment or investing.

Disposition toward Debt

People’s attitudes toward debt vary widely. On one end of the spectrum, some people view debt as a useful tool to help you live a better life or build wealth. (These people might be proponents of the permanent income hypothesis and encourage grad students to calibrate their lifestyles toward their expected future income rather than their current income.) On the other end, some people view debt as a dangerous burden that should be repaid as quickly as humanly possible. While you likely fall somewhere between those two extremes, it is important to reflect on how your debt makes you feel.

People who are quite bothered by their debt are likely to prioritize debt repayment over other financial goals. People who are less sensitive to the risk that comes with debt may use a more mathematical analysis to determine financial priorities, perhaps by paying down only high-interest debt before starting to invest for the long term. Any of those decisions are legitimate if they are congruent with the individual’s disposition and the ‘math’ of the situation (the terms of the debt) has also been taken into consideration.

Types and Terms of Debt

While it’s difficult to define any particular type of debt as “good” or “bad,” the terms of your debt should certainly influence how high of a priority accelerated repayment is. The chief term to pay attention to is the interest rate. What you used the debt for should also influence your repayment priorities. In some cases, you have an appreciating asset that collateralizes the debt, such as a home (in most cases), but other debt may have a depreciating asset as collateral, such as a car, or be uncollateralized. The dangerous aspect of uncollateralized debt or debt on a depreciating asset is that you don’t have associated property to sell to completely pay off the debt if it becomes necessary.

Student Loan Debt

Federal student loan debt and often private student loan debt is a unique type of debt because your student status and income can influence the repayment terms. While you are a half-time or more graduate student, you may be eligible for loan deferment, which means that no payments will be due. If your loans are subsidized, no interest will accrue during deferment. If your loans are unsubsidized, interest will accrue during deferment, and the interest will capitalize at the end of the deferment period and become part of the principal.

Deferment is a good option for graduate students because it gives the payer more flexibility to skip or shift around the now-optional payments if it is inconvenient to make them. Students could even save up for long periods and pay down the debt in lump sums. All students should make a plan for loan repayment during and/or following grad school, even those who cannot make progress until deferment ends.

Mortgage Debt

Graduate students who have taken out mortgages on their homes during and since the Great Recession likely have quite a low interest rate on their mortgage debt. The long-term average rate of inflation in the US is between 3 and 4%, which is similar to recent mortgage rates for top borrowers. After you reach 20% equity in your home and stop paying Private Mortgage Insurance, there is not much of a mathematical argument for making more than the minimum payments on the mortgage.

Consumer and Personal Debt

The terms for consumer debt can vary widely. In the current low interest rate environment, it’s not uncommon to have consumer debt at or close to 0%, but it can also easily be at 15-30%. How you prioritize paying off consumer debt may have a lot to do with the interest rate and other terms. Some debt offers come with a no payment or zero interest period of one or more years, sometimes contingent on the debt being paid off in full during that time. The repayment terms for consumer debt sometimes come with catches, so you should carefully abide by them or risk paying large sums of money in interest or hurting your credit score. Debts that are held by a family member or friend may have more favorable terms, but your relationship will be colored by the debt until it is repaid.

While it can be argued that student loans and mortgage debt have been used to buy appreciating assets, consumer and personal debt usually doesn’t have the same positive associations. For this reason, students may choose to prioritize repaying this debt just to get it out of their lives.

Paying Off Multiple Debts Simultaneously

If you have two or more debts that are immediate-priority payoff goals, there are two popular methods for choosing how to prioritize them: the debt snowball and the debt avalanche methods. Both methods work off the principle of intense focus on only one debt at a time.

With each method, you make the minimum payments on all your debts and throw all your excess cash flow at your top priority debt until you completely knock it out. With the debt snowball method, you rank your debts from lowest payoff balance to highest payoff balance and work on the smallest debt first. With the debt avalanche method, you rank your debt from the highest interest rate to the lowest interest rate and work on the most expensive debt first.

While mathematically the debt avalanche method is supposed to get you out of debt sooner (given the same amount of money contributed under each method), empirically the debt snowball method has been shown to get people out of debt sooner because of the psychological motivation garnered from the early win of paying off one debt completely.

Prioritizing Debt Repayment against Other Financial Goals

You likely recognize that there are financial goals other than just paying down debt that you might set during grad school, such as saving a cash emergency fund, saving for short-or mid-term purchases, and investing for the long term. Only you will be able to determine how those goals rank in comparison with accelerated debt repayment, after considering your personal disposition and the math involved with each scenario.

What is your experience with debt repayment during grad school? Which decisions regarding your debt are you happy with, and which decisions do you regret?

Why It Matters How You Are Paid

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If you look across a sample of graduate students receiving stipends within any given field, you will find that they have quite similar day-to-day activities: taking or teaching classes, researching, writing articles or chapters, applying for funding, etc. However, behind the stipends that allow these students to engage in their studies are two very different types of sources, which the student’s tax forms reveal. (This distinction and the tax-related details herein are for graduate students in the US.) Whether a student has one type of funding or another has implications for his taxes, access to retirement accounts, and possibly university benefits.

A version of this article first appeared on GradHacker.

The two types of pay that provide stipends to graduate students are ‘compensatory’ and ‘non-compensatory.’ Compensatory pay is given in exchange for work. Typically, this work is in the form of an assistantship – research, teaching, or graduate. Non-compensatory pay is given as an award, and there is (according to the IRS) no work requirement for receiving it. Typically, this award is in the form of a fellowship or participating in a training grant. (Scholarships that go toward paying tuition, fees, and/or health insurance premiums are another form of non-compensatory pay.)

why it matter how you are paid

The type of pay that is behind a graduate student’s stipend potentially affects several aspects of her finances, depending on the university’s policies.

1) The tax forms generated by each type of pay differ. Students with compensatory pay will receive a W-2 in January. Students with non-compensatory pay will see their pay listed on, depending on the university’s policies, a 1099-MISC in box 3, a 1098-T in box 5 (probably summed with the scholarships received), or an unofficial courtesy letter. It is also possible that students with non-compensatory pay will receive no additional notification at tax time. Despite these different reporting mechanisms, a graduate student will report both types of pay in line 7 of his 1040 (with “SCH” denoted next to the line to indicate non-compensatory pay).

2) Graduate students receiving compensatory pay will have the opportunity to have income tax withheld from their stipends, while graduate students receiving non-compensatory pay may or may not, depending on the university’s policy. If students receiving non-compensatory pay do not have the option to have income tax withheld, they may have the responsibility of paying quarterly estimated tax.

3) With rare exceptions, graduate students cannot elect to contribute to retirement accounts at their universities. Therefore, graduate students who wish to save for retirement inside a tax-advantaged account typically opt to contribute to an Individual Retirement Arrangement (IRA). However, only compensatory pay (aka ‘taxable compensation’ or ‘earned income’) is eligible to be contributed to an IRA. Graduate students who receive only non-compensatory pay in the course of a calendar year (and are not married to a person with compensatory pay) are not eligible to contribute to an IRA in that year (though they can still save for retirement).

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4) Full-time graduate students typically do not pay FICA tax on their stipends, but the reason for this is different between the two types of pay. Graduate students with compensatory pay enjoy a student exemption to FICA tax, whereas non-compensatory pay is not subject to FICA tax in the first place. This distinction is important if graduate students ever become predominantly viewed as employees rather than students, which sometimes occurs in the summer when they are not enrolled in classes. In that situation, they might lose their FICA exemptions temporarily and have to pay additional tax.

5) The benefits that universities extend to students may differ based on their status. Graduate students receiving non-compensatory pay are unambiguously students in the eyes of the university. Graduate students receiving compensatory pay are both students and employees, and universities have varying views on which half of that balance is dominant. In some cases, when graduate students are considered employees, different or additional benefits may be extended to them that graduate students who are only students do not receive, such as union membership, childcare subsidies, and pensions.

While graduate students receiving compensatory and non-compensatory pay likely have very similar roles within the university, you can see that the IRS and the universities draw a number of distinctions between the groups that become important at some points in a graduate student’s career. If you are unsure which type of pay you are currently receiving or received earlier in the calendar year, you can either wait to see which kind of tax form you receive (W-2 for compensatory, anything else or none for non-compensatory) or inquire within your university’s payroll or financial aid office.

Have you received compensatory, non-compensatory, or both types of pay during graduate school? Was there a time that you realized that your type of pay affected your life materially? Do compensatory and non-compensatory students receive any different benefits at your university?