Universities' Power To Alter Graduate Student Tax Status

Graduate students often have a unique mix of income sources, tax credits, and financial obligations that can make tax season feel daunting. While universities can provide tax workshops and software to help students file confidently, they could also implement changes to simplify the process for graduate students. This includes helping students understand their financial situation, such as identifying taxable income and tax benefits, and providing resources for specific tax questions. Additionally, universities could advocate for changes in tax legislation, such as the controversial endowment tax, to reduce the tax burden on graduate students.

Taxing tuition benefits

Currently, in the United States, tuition awards are generally non-taxable, while various types of stipend awards are subject to specific reporting and tax treatments. Stipends from research and teaching assistantships are considered salary income and are, therefore, taxable. This distinction is essential for graduate students to understand when preparing their tax returns.

Proposed changes to the tax code, such as the one suggested by the House bill, could significantly impact graduate students' finances. The bill treats "qualified tuition reductions" as taxable income, which could push students into higher tax brackets, even if their income remains modest. This change would particularly affect graduate students working as research or teaching assistants, who rely on these tuition reductions to cover their education costs.

The potential impact of such a tax reform is concerning, as it may price students out of graduate school. The tax liability for many graduate students could increase by more than 30%, with some facing increases of up to 400%. This could force students to abandon their educational pursuits or choose not to enroll in graduate programs altogether.

To address this issue, universities can advocate for their students by engaging in discussions with policymakers and highlighting the potential consequences of such tax reforms. Additionally, universities can work to ensure that their graduate students are well-informed about their tax obligations and provide resources to help them navigate the tax system effectively.

Taxing scholarships and waivers

Scholarships, fellowship grants, and other grants are generally tax-free if the student is a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and the student uses the funds to pay for tuition and fees required for enrollment or attendance at the educational institution. However, scholarship funds received in excess of a student's qualified educational expenses may be taxable and might need to be reported as taxable income. For example, if a student uses their scholarship funds for optional reading assignments that don't go toward satisfying course requirements and aren't required for every student, they would be subject to taxation.

In the United States, the House Republicans' bill proposed to eliminate section 117(d) of the Internal Revenue Code, which exempts qualified tuition waivers from taxation. Many graduate students work as teaching or research assistants while completing their studies, and universities often waive their tuition and provide a small living stipend as compensation. The bill would treat these tuition waivers as taxable income, which graduate students fear could lead to annual tax hikes of several thousand dollars. However, universities can reclassify their tuition waivers as scholarships and avoid major tax consequences.

Tax breaks for upper-income students

While tax reform is at the top of the congressional agenda, universities are pushing back against proposed provisions that could leave some graduate students with a massive tax bill. For instance, a House bill treats "qualified tuition reductions" as taxable income, pushing students into higher tax brackets.

However, there are also tax breaks that benefit upper-income graduate students. One example is the college tuition tax deduction, passed into law in 2001, which allows tax filers to deduct up to $4,000 of tuition and fees paid for higher education in the tax year. This is an "above-the-line" deduction, meaning filers can claim it without itemizing deductions, and it can be claimed multiple times as long as tuition expenses are incurred. However, there is an income limit: taxpayers with adjusted gross incomes above $80,000 ($160,000 for joint filers) cannot claim it.

Another tax break for upper-income graduate students is the Lifetime Learning Credit, which can reduce tax liability by hundreds of dollars. Graduate students with lower and middle incomes are also eligible for this credit, but they typically receive a larger benefit from it than the tuition and fees deduction. The maximum benefit from the Lifetime Learning Credit is $2,500, and it has a lower income cutoff than the deduction, with single filers becoming ineligible once they earn more than $66,000 ($132,000 for joint filers).

The American Opportunity Tax Credit is another tax benefit that is more advantageous for undergraduates from upper-income families than the tuition and fees deduction. This credit is worth up to $2,500 in tax relief for filers earning up to $90,000 ($180,000 for joint filers). However, due to the income cutoff, graduate students are the only group that can benefit from the original tuition and fees deduction.

While lawmakers did not explicitly intend to provide a tax break for upper-income graduate students, changes to policies over the years have left the deduction benefiting this group alone.

Taxing stipends

Graduate students can receive funding from a variety of sources, including fellowship stipends, scholarships, tuition waivers, and teaching or research assistantships. While tuition awards are generally considered non-taxable in the United States, stipend awards may be subject to specific reporting and tax treatments. Stipends from assistantship awards, such as teaching or research assistantships, are typically paid as salary and are therefore subject to federal and state income taxes.

The tax treatment of stipends can vary depending on the student's residency status and the details of their support package. For example, non-resident and international students at Princeton University have their federal and state taxes withheld and reported by the university, with applicable tax treaty exemptions applied. On the other hand, U.S. citizens and permanent residents may need to keep records and save information related to their stipend awards to prepare their personal tax returns.

The proposed tax reform, which includes treating tuition reductions as taxable income, has been a cause for concern for graduate students. The University of California estimates that the tax liability for many of its graduate students could increase by more than 30%, with some facing increases of up to 400%. This could have a significant impact on the financial stability of graduate students, especially those living on modest stipends.

To reduce their tax liability, graduate students can explore various tax credits and deductions. For example, the Lifetime Learning Credit or the American Opportunity Tax Credit can help offset the cost of higher education. Additionally, tax filers can deduct up to $4,000 of tuition and fees paid for higher education, although there are income limits for this deduction. Proper tax planning and consulting with tax professionals can help graduate students navigate the complex world of stipend taxation and make informed decisions about their financial situation.

Taxing fellowships

The US tax code considers a fellowship grant as an amount paid or allowed to an individual for the purpose of study or research. Fellowship grants are generally tax-free if they are used to pay for tuition and fees required for enrollment or attendance at an eligible educational institution, or for fees, books, supplies, and equipment required for courses. However, if a fellowship grant is used for expenses other than these "qualified expenses", it is considered taxable income.

Fellowship grants are one of the sources of funding for graduate students, along with scholarships or waivers that pay tuition and fees. These sources of funding are rather unusual, so most people and even most professional tax preparers don’t have any experience with them. This can make preparing tax returns challenging for graduate students, especially if they are inexperienced in doing so.

In the US, graduate students can make their awarded income tax-free to the greatest extent possible before applying any remaining QEEs to the Lifetime Learning Credit. Some graduate students may be eligible to prioritise the Lifetime Learning Credit (or the American Opportunity Tax Credit) over making awarded income tax-free to further reduce their tax liability.

In 2021, a proposed change to the US tax code threatened to significantly increase the tax liability of graduate students. The House bill would have treated "qualified tuition reductions" as taxable income, which could have pushed students into tax brackets usually associated with much wealthier households. This could have affected the financial stability of higher education institutions and threatened the overall affordability and accessibility of higher education.

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