Financial aid comes in many forms: need-based government grants, federal loans, private scholarships, institutional aid and fellowships. The source of your financial aid has nothing to do with its taxability. It is the type of aid that determines whether or not you’ll owe money on it. Refund money from student loans isn't subject to taxes, but refund money from other types of financial aid may be taxable.
Gift aid includes grants, scholarships and fellowships, which you usually receive for free. These are types of financial aid you may receive from the government -- the Pell Grant, for example -- or private sources -- dean’s scholarships or sports scholarships. If you receive a refund in grant or scholarship money after paying required school expenses, this money is taxable. Any money left over from gift aid qualifies as income, which means it is taxable.
If you receive financial aid through a work-study program, this funding counts as income because you are working to earn it. Any refund money you earn from your work-study program is subject to federal income tax. However, your employer will typically report your earnings in a work-study program and deduct your taxes automatically from each paycheck.
Determining What You Owe
If you are working toward your college degree and using financial aid for mandatory school expenses, that portion of the money doesn’t qualify as part of your income, meaning it’s not taxable. You can exclude the cost of required tuition and fees, as well as books, supplies and other course materials for your program of study. This money will never be taxable. However, you must report any refund money that you use on housing, food and personal expenses as part of your taxable income. Note that if you’re receiving student financial aid but you’re not eligible for a degree, the total amount of your grants, scholarships and fellowships is taxable.
Keep detailed records of your school expenses, including receipts for tuition payments and minor school expenses. It is your responsibility to keep track of your taxable financial aid, and the better records you have, the better shape you’re in if the Internal Revenue Service decides to audit you. As a student, you also may be eligible for education-related tax deductions and credits -- another reason it's essential to keep detailed records.