Qualified Educational Expenses
Determining whether the IRS considers any of your financial aid as income always involves looking at tuition, books and other mandatory expenses. On the other hand, the IRS almost never considers room and board and other living expenses to be qualified educational expenses. This means that the financial aid you use for these items may, indeed, count as taxable income.
Tax-exempt Student Grants
Pell Grants, Federal Supplemental Educational Opportunity Grants (FSEOG), state-administered grants and financial aid granted by your educational institution are not considered taxable income if they are applied directly towards tuition or qualified educational expenses. If you use part of the money towards qualified educational expenses, that part of the grant or scholarship is exempt from taxes. You do not have to report that portion of the grant or scholarship on your federal income tax return, according to the IRS.
Taxable Student Grants
Scholarships, fellowships and grant funds that you receive in cash and that you do not use for qualified educational expenses are considered taxable income. However, while you are enrolled as a student, you are not obliged to make Social Security payments. If you use part of the money for qualified educational expenses, subtract that amount from the total scholarship or grant, and report the remaining amount on your federal income tax return. Write "SCH" on the same line with the reported financial aid income, according to the website FinAid.
The IRS does not consider student loans to be income and you do not have to report them as income on your federal income taxes. This is true whether your loans are federally insured or commercially issued. In fact, if you make payments on your student loans, you may be eligible for a deduction on your federal income taxes for the interest you paid on your student loans during the previous year.