I am trying to determine whether or not a particular scholarship I received (the Palmetto Fellows Scholarship in South Carolina) may or must (or may not or must not) be considered taxable income.
Based on this information from the IRS, I believe the Palmetto Fellows Scholarship can be considered tax-free.
A scholarship or fellowship is tax free only to the extent:
It does not exceed your expenses;
It is not designated or earmarked for other purposes (such as room and board), and does not require (by its terms) that it cannot be used for qualified education expenses; and
It does not represent payment for teaching, research, or other services required as a condition for receiving the scholarship. (But for exceptions, see Payment for services,later.
However, if I wish to report it as taxable income for the purpose of then claiming the American Opportunity tax credit, is that legal?
I've read several articles online that say you can only count a scholarship as taxable if it is used for educational expenses other than tuition and fees. Truthfully, I only used the scholarship for tuition and fees.
But, according to the Adjustments to Qualified Education Expenses section in this document from the IRS, the regulations don't say anything about what the scholarship is used for but instead what is allowed to be used for.
Generally, any scholarship or fellowship is treated as tax free. However, a scholarship or fellowship is not treated as tax free to the extent the student includes it in gross income (if the student is required to file a tax return for the year the scholarship or fellowship is received) and either of the following is true.
The scholarship or fellowship (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions.
The scholarship or fellowship (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions.
Looking at the 2nd point above, and the below quote from this document on the Palmetto Fellows,
Charges for room and board are to be limited as follows: 1. Room charges shall not exceed the average cost of on-campus residential housing; and 2. Board charges shall not exceed the cost of the least expensive campus meal plan that includes 21 meals per week.
it would appear that since the Palmetto Fellows may be used for room and board, it may also be classified as taxable income.
If that is true, my deduction is that I can claim the scholarship as additional income and claim the amount that I paid my university for tuition and fees as eligible for the American Opportunity Tax Credit.