San Francisco Examiner, Business Section, Tuesday, April 4, 1995


Student Aid and Pensions

YOU ARE thrilled because a university has just awarded you a scholarship. This is particularly helpful because your father is retired and your mother recently lost her job. None of you is employed; but does that mean none of you will have to pay taxes?

The answer? It depends. Uncle Sam's tax bite can vary according to a variety of provisions affecting students, retirees and the unemployed.


Students are not taxed on scholarships or fellowships for tuition and related expenses (fees, books, equipment and supplies). Yet, living expenses, such as room and board, constitute personal living expenses and are fully taxable. For example, if a student receives a $5,000 scholarship, $4,000 of which is for tuition and related expenses, and $1,000 is for room and board, then $1,000 is taxable.

If a student must perform services -- apprenticeships, student teaching and hospital residencies -- as a condition of a scholarship or fellowship, that income is fully taxable. To identify a nontaxable scholarship, answer these questions:

If even one of these answers was no, that means you received a scholarship, rather than compensation. If the scholarship was for tuition and related expenses (books, equipment, supplies), then it is tax-free.

Parents whose children are full-time students under age 24 may treat them as dependents on their tax return, regardless of the child's earnings. A student must be enrolled full-time for at least 5 calendar months in one year.

Parents also may consider purchasing special U.S. savings bonds in which the income is tax-free if it is used for higher education tuition and fees for themselves, their spouses or dependents. This advantage applies to single taxpayers with adjusted gross incomes of $40,000 or less, and for joint filers with incomes of $60,000 or less. This benefit is phased out for larger incomes.

Educational costs are deductible if they are "ordinary or necessary expenses" of carrying on your business. Expenses incurred for a new occupation are not deductible. Also, personal educational expenses, such as a doctor taking an art class, are not deductible since they do not relate to his or her profession.

Deductible educational expenses must either maintain or improve the skills which are appropriate, helpful or needed by you in your employment or business. Maintaining your intellectual skills is akin to maintaining equipment, both are ordinary and necessary expenses of running an occupation or business. Also, maintaining skills required by one's employer, which serve a legitimate business purpose of that employer, are deductible by the employee.

Educational expenses that could train you for a new profession, even though that education might improve your skills in your current profession, are nevertheless not deductible. Ironically, this rule has victimized IRS agents who attend accounting and law classes to maintain or improve their auditing skills.

Using travel as a form of education is not deductible. This prevents a French teacher from deducting a trip to France to maintain language skills. Travel, room and board taken in conjunction with deductible education expenses, such as a doctor traveling to a relevant medical seminar in Italy, are deductible. Business and personal expenses (such as sight-seeing) must be documented so they can be allocated separately. This means maintaining careful records of your expenses.


Income from retirement plans is fully taxable. Social Security payments may be taxable, depending on your "modified adjusted gross income" (MAGI) -- generally, adjusted gross income plus tax-exempt interest income. If your MAGI is $32,000 or less for joint filers ($25,000 or less for single filers), then none of your Social Security benefits is taxable. If your MAGI exceeds $45,000 for joint filers ($34,000 for single filers), up to 85 percent of your Social Security benefits may become taxable.

If you worked in California and had contributions made to a retirement plan, but retire in another state, California will attempt to tax you on that portion of your retirement income earned in California, California's State Board of Equalization has ruled that a taxpayer who earned a pension while working in California, but actually received the pension as a resident of Idaho, was liable for California taxes, since that income was attributable to a California source. Congress is considering barring states from taxing pensions of nonresidents.


A person who is no longer working may be taxed on the payments received, depending on the reason for the job loss. For those who have been laid off, unemployment compensation is fully taxable, because it is considered a substitute for wages. Workers' compensation payments for injuries incurred on the job are received tax-free. The same is true for benefits payable by the state for occupational injury or illness. Likewise, private insurance payments for sickness, injury or disability are tax-free.

If you lost your job through wrongful termination, subsequent back-pay is taxable, but compensation for acts of discrimination, harassment or emotional distress are tax-free. Therefore, at the time you settle with your employer it is critical to carefully document the allocations made to taxable and non-taxable compensation. Otherwise, your employer may send you a Form 1099 for the entire amount, and the burden will fall on you to prove to the IRS the proper allocation of the proceeds you received.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**