How Graduate Students Are Financially Distinct from Young Professionals

Two young adults graduate with the same major from the same college in the same year. One of them gets a job and the other enters a funded graduate program. Their financial lives have just diverged, despite their similar professional starting points, and it’s not because the graduate student lacks an income.

Here are the top ways graduate students are financially distinct from their young professional former peers.

Limited Income, Unlimited Training

Graduate students are among the best and the brightest college graduates, but that isn’t reflected in their stipends/salaries.

The value proposition of graduate school is that the student will be provided with training, and therefore the stipend is only intended to cover living expenses (more or less) to keep the student from undertaking outside work. (Of course, some students undertake unfunded PhDs or lose their funding at some point.) So the grad student’s income is suppressed, and there is little opportunity to increase it without engaging in a side hustle. This is very different from a regular job, where there is a chance for promotion or at least opportunity to take a different job with a better salary without derailing your career trajectory.

by Jorge Cham

A compounding factor in this situation is the uncertainty of the length of the training period. It’s unusual for a PhD in the U.S. to take less than five years, and apparently the average is 8.2 years. This is such an issue that asking a PhD student when she’s going to graduate is viewed as a faux pas. It takes an unusually driven graduate student and motivated advisor to accurately set the end date for the graduate degree more than a year in advance, let alone at the start of grad school. And even the end of graduate school doesn’t mean the student will get a big income boost, as 65% of PhDs will continue their training as postdocs.

These factors together mean that a grad student has a low salary for an uncertainly long amount of time: at minimum half a decade, and for many a decade or more.

Not a Full Employee

The exact nature of the relationship between the university and the graduate student is being reinterpreted at many universities around the US due to the recent National Labor Relations Board ruling that allows the unionization of graduate student assistants at private universities.

Graduate students are certainly “students” in the eyes of the university, and graduate assistants are also considered “employees” secondarily. The benefits offered to graduate students therefore often straddle these two statuses; they receive some or all of the benefits that undergraduate students do, but virtually always less than other classes of employees like faculty and staff.

Commonly, graduate students take part in the student health insurance plan, and the premium might be partially or completely paid as one of their benefits. Beyond that, benefits vary widely by university, school, and program. Some graduate students may have defined vacation policies while others’ are left to the discretion of advisors; some get dental and vision insurance alongside health insurance; some receive subsidies for housing or childcare; some receive a free or subsidized gym membership; very few even have access to a 403(b).

Common financial advice to young professionals to take full advantage of employer benefits by contributing to a 401(k) at least to the full match amount and maximizing the value of life, disability, health, dental, and vision insurance benefits therefore does not apply to graduate students. Conversely, graduate students may access to student benefits that are very unusual outside of universities, and it’s very important in those cases that the students are aware of all their benefits.

Fellowships Do Not Provide Taxable Compensation

While grad students receiving stipends have an income, they don’t all have “taxable compensation” or “earned income.” Graduate students (and postdocs) whose salaries are paid by fellowships are not being compensated/earning their income. (Their income is still taxable, however.) They are not employees, but neither are they self-employed. Therefore, they are not eligible for tax benefits that are tied to having compensation or earned income, such as IRA contributions and the earned income tax credit. Having an income that is not reported on a W-2 also may throw a wrench into the process of taking out a mortgage. This situation is very hard to wrap your mind around when you first hear about it because it is so different from what (self-)employed people experience.

Low Taxes

The silver lining to having a low income is that you don’t have to pay much in the way of income taxes. Nearly all graduate students whose only income is their stipend will fall into the 15% marginal tax bracket or lower. Therefore, tax reduction strategies that might be recommended to young professionals are not as beneficial for graduate students. For example, contributing to a Roth IRA is a great idea for a graduate student with taxable compensation, while a young professional with a higher income might benefit more from using a traditional IRA or 401(k).

The unexpected bonus to being in the 15% tax bracket or lower is that the current federal tax rate on long-term capital gains and qualified dividends is 0%. Therefore, even graduate students who are saving for retirement outside of tax-advantaged retirement accounts can minimize the tax bite on their investments.

Finally, graduate students do not have to pay FICA tax, either because they have a student exemption or because they aren’t receiving compensation. Young professionals can’t easily avoid that 7.65% tax bite.

Access to Student Loans

Lastly, graduate students have the option to take out student loans. If the student experiences an income drop or a personal emergency, they could take out a student loan to cover it, whereas a non-student would more likely turn to credit cards or personal loans. While using a student loan in these circumstances might be advantageous in some ways (for example, the interest rate is almost certainly lower than the interest rate on a credit card), student loans are more uniquely dangerous than other kinds of debt because they cannot be discharged in bankruptcy. A graduate student, because of this access, therefore needs enhanced information and counseling when looking to take out a new loan.

In what ways are graduate students financially different from their age-mates who have real jobs?

What Is a 1098-T?

 

1098t

The purpose of a 1098-T is to allow students and the parents of dependents students to take an education-related tax deduction or credit. The 1098-T form (p. 4) states:

“You, or the person who can claim you as a dependent, may be able to claim an education credit on Form 1040 or Form 1040A. This statement has been furnished to you by an eligible educational institution in which you are enrolled, or by an insurer who makes reimbursements or refunds of qualified tuition and related expenses to you. This statement is required to support any claim for an education credit.”

While some universities use the 1098-T to report fellowship stipend income, not all do. Once a student’s non-compensatory (fellowship and scholarship) income exceeds his qualified education expenses (as is the case for many funded graduate students), the university has three choices: 1) generate a 1098-T that reflects all of the fellowship stipend and scholarship income, 2) generate a 1098-T the reflects the scholarship but not fellowship stipend income, or 3) not generate a 1098-T.

Universities do not have to report (net) non-compensatory taxable scholarship and fellowship pay to the IRS, either on a 1098-T or a 1099-MISC, though some choose to. The instructions for the 1098-T (p. 2) state:

“File Form 1098-T, Tuition Statement, if you are an eligible educational institution that received payments for qualified tuition and related expenses from a student. You must file for each student you enroll and for whom a reportable transaction is made… Exceptions. You do not have to file Form 1098-T or furnish a statement for:… Students whose qualified tuition and related expenses are entirely waived or paid entirely with scholarships.”

These instructions reinforce the idea that the purpose of the 1098-T is to claim an education tax benefit, and when an education tax benefit is not available, the 1098-T becomes optional.

Therefore, if you receive a 1098-T, you can reference it for the total amounts of scholarship income and qualified education expenses processed by your student account. Double-check the amounts reported in Box 2 and Box 5 of the 1098-T against the transactions in your student account to verify their accuracy. If you do not receive a 1098-T, likewise you will need to access your student account and your own bank records (or the courtesy letter or 1099-MISC sent to you) to tally all the fellowship and scholarship income you received as well as all the qualified education expenses. Please take note that the definition of qualified education expenses changes depending on the type of education tax benefit you are claiming, so what your university deems qualified education expenses for the 1098-T may not match what you decide to claim.

Parent article: Think about Your Grad Student Income and Assess the Tax Forms Your University Generated

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

What Are Qualified Education Expenses?

Qualified education expenses are education-related expenses for which a student or the parent of a dependent student can claim and educational tax benefit. As grad students have educational expenses associated with their role as students (even if the expenses are paid on their behalf), they can always reduce their tax burden using their qualified education expenses.

The precise definition of what does and does not constitute a qualified education expense varies based on the type of educational tax benefit being claimed. Publication 970 (p. 4) explains:

“Even though the same term, such as qualified education expenses, is used to label a basic component of many of the education benefits, the same expenses aren’t necessarily allowed for each benefit.”

The IRS website has a one-page overview of what is and what is not a qualified education expense. The lists include both general expenses that are always considered or always not considered qualified education expenses as well as the special cases for specific tax benefits.

The qualified education expenses that balance against scholarships and fellowships paid to students to make the scholarships and fellowships tax-free are defined on p. 6 of Publication 970:

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The qualified education expenses that qualify for the Lifetime Learning Credit are defined on p. 23 and 27 of Publication 970:

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The qualified education expenses that qualify for the tuition and fees deduction are defined on p. 39 and 42 of Publication 970:

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Parent article: Think about Your Grad Student Income and Assess the Tax Forms Your University Generated

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

What Is a Courtesy Letter?

A courtesy letter is not an official tax form. Instead, it is a communication sent to you by your university or funding agency that tells you the amount of fellowship income they gave you in the course of the previous year. The letter might also include a warning that the sender will not be able to make any comments about your tax liability or how to prepare your tax return.

Further reading: What Is a Courtesy Letter and Does It Mean I Don’t Have to Pay Taxes?

Parent article: Think about Your Grad Student Income and Assess the Tax Forms Your University Generated

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

What Is a 1099-MISC?

1099misc

The most widely recognized use of a 1099-MISC is to report non-employee compensation aka self-employment income. The fact that Form 1099-MISC is sometimes used to report fellowship pay, which is not self-employment income, can be quite confusing for grad students and the people and software that prepare their tax returns.

If a 1099-MISC is used to report fellowship pay, the pay will appear in Box 3 “Other income.” Fellowship pay is considered similar to an award. In its instructions to organizations, Form 1099-MISC (p. 5) states:

“Box 3… The amount shown may be payments received as the beneficiary of a deceased employee, prizes, awards, taxable damages, Indian gaming profits, or other taxable income.”

The 1099-MISC instructions (p. 5) make explicitly clear that the award should not be compensatory or paid in exchange for work:

“Also enter in box 3 prizes and awards that are not for services performed.”

Interestingly, the 1099-MISC instructions (p. 2) state that fellowships and scholarships should not be reported on a 1099-MISC:

“Scholarships. Do not use Form 1099-MISC to report scholarship or fellowship grants. Scholarship or fellowship grants that are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant are considered wages and must be reported on Form W-2. Other taxable scholarship or fellowship payments (to a degree or nondegree candidate) do not have to be reported by you to the IRS on any form.”

It seems that the universities that use the 1099-MISC to report fellowship pay are skirting this prohibition because the scholarship and fellowship grants are not being given for services. That type of pay is compensatory and usually referred to as an assistantship in the case of graduate students. The instructions clearly state that universities do not have to report non-compensatory taxable fellowships and scholarships to the IRS. However, some universities do report non-compensatory fellowships and scholarships using a 1099-MISC. Even though the 1099-MISC is a confusing form to receive, it might be even more confusing to not receive any communication whatsoever.

I have observed that use of the 1099-MISC to report fellowship income correlates with grad students having taxes withheld from their fellowship pay. The 1099-MISC, unlike the 1098-T, allows the university to report both the gross pay received and the amount of federal and state tax withheld.

If you receive a 1099-MISC that reports your fellowship income, you should report it as fellowship/scholarship income rather than as 1099-MISC “other” income. Your gross income from this source will appear in Box 3. Your amount of federal tax withheld will appear in Box 4, and your amount of state tax withheld will appear in Box 16.

If your income is reported in Box 7 instead of Box 3, this is considered self-employment income and you will pay a much larger amount in tax, so make sure that you were properly categorized. (Again, fellowship pay is not self-employment income, so self-employment pay from a university implies that you served as a contractor on a specific project outside of your direct role as a graduate student, and this was likely explicitly discussed with you in advance.)

Parent article: Think about Your Grad Student Income and Assess the Tax Forms Your University Generated

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

Grad Student Tax Lie #10: You have a low income, so you should claim the Saver’s credit.

The Saver’s credit is an incentive program for low-income people to save for retirement. Basically, if you contribute money to a retirement account and your adjusted gross income is below a certain threshold ($30,500 for single filers $61,000 for married filing jointly filers), you can receive a tax credit. The credit is worth between 10 and 50% of your contribution (the less you make, the higher the percentage) up to $2,000!

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If you are a grad student and contributing to an individual retirement arrangement, you are a rock star. You should be able to take advantage of this awesome credit – but you can’t. One of the three exclusion criteria for the Saver’s credit is being a full-time student (p. 47 of Publication 590A).

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

Where to Report Your Grad Student Income on Your Tax Return

There are two broad categories of grad student income: compensatory and non-compensatory. Both types of pay are supposed to be reported in the ‘wages’ line on your tax return. For Form 1040, report on line 7; for Form 1040A, report on line 7; for Form 1040-EZ, report on Line 1. Read on for the relevant tax code references.

Where to Report Compensatory Grad Student Income

Compensatory income comes from work. Assistantships, whether research, teaching or graduate, provide the grad student with compensatory income, and that income will be reported on a W-2. In this way, grad student income is the same to the IRS as employee income from other sources.

Your gross yearly income from your assistantship will appear in box 1, and the income tax that has been withheld from you pay will appear in box 2 (federal), box 17 (state), and box 19 (local).

Form W-2 contains instructions for the employee (p. 7):

reporting_W2i

Where to Report Non-Compensatory Grad Student Income

Non-compensatory income is given as an award and is not in exchange for work. Scholarships and most fellowships are forms of non-compensatory work. Non-compensatory pay will be officially reported to the student on a 1098-T in box 5 or on a 1099-MISC in box 3. It also might be unofficially reported on a courtesy letter or not at all.

Please note that when you calculate the taxable portion of your non-compensatory income for the year, you have two choices for what to do with your qualified education expenses: to take a deduction or a credit.

Scholarship and fellowship income that is reported anywhere other than on a W-2 or not reported at all should also be added to the ‘wages’ line on your tax return alongside the letters SCH.

reporting_taxfree

The Wages Line on the 1040

The 1040 instructions dictate that W-2 income should be reported in line 7 (p. 21):

reporting_1040_W2

Publication 970 says that fellowship and scholarship income should be reported in line 7 (p. 7):

reporting_1040_SCH

The Wages Line on the 1040A

The 1040A instructions dictate that W-2 income should be reported in line 7 (p. 23):

reporting_1040A_W2

Publication 970 says that fellowship and scholarship income should be reported in line 7 (p. 7):

reporting_1040A_SCH

The Wages Line on the 1040EZ

The 1040EZ instructions dictate that W-2 income should be reported in line 1 (p. 10):

reporting_1040EZ_W2

Publication 970 says that fellowship and scholarship income should be reported in line 7 (p. 6):

reporting_1040EZ_SCH

Parent post: Grad Student Income Tax Guide: 2015 Edition

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

Grad Student TurboTax Guide: 2016 Edition

The purpose of this guide is to help you enter your proper income and qualified education expense data into Turbotax so that it generates an accurate tax return for you. This guide uses the free version of TurboTax.

Before you begin, please review the 2016 tax guide home page to gather all the forms you need. If you do not have documentation for all of your income (both compensatory and non-compensatory), you will need to do some calculations before you start entering data into TurboTax.

The common combinations of tax documents that grad students receive are:

If you made estimated tax payments on your fellowship income, you will also need to enter your estimated tax payments into TurboTax. Read: How to enter estimated tax payments into TurboTax

Related article: Paying Income Tax throughout the Year

Even if your income and expenses don’t exactly match one of the above scenarios, you can likely combine them to figure out how to report all of your income and qualified education expenses.

Parent post: Enter Your Grad Student Income into Tax Software

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

Enter Your Grad Student Income into Tax Software

Grad students frequently choose to prepare their federal and state tax returns using tax software, but using software to prepare an accurate return is not always as straightforward as it should be. The difficulty grad students may encounter when using tax software depends on the type(s) of tax documentation their universities and funding sources send them. Before you start using tax software, you’ll need to think about your grad student income and assess the tax forms you received.

These guides include step-by-step instructions for entering your grad student income and qualified education expenses into different brands of tax software. Preparing the remainder of your return, which might include other sources of income and non-educational deductions and credits is up to you to research.

For the purposes of these guides, I imagined a hypothetical grad student with stipend income.

The ‘personal information’ relevant to the student’s taxes is:

  • 24 years old
  • single
  • living in Durham, NC
  • not a dependent; doesn’t have dependents

The student received a $25,000 stipend. Her scholarships totaled $22,000 and her qualified education expenses totaled $20,000. If she had taxes withheld, they were $1,500 for federal tax and $1,000 for state tax.

How to enter your grad student income and qualified education expenses into TurboTax (2016 Edition)

Parent post: Grad Student Income Tax Guide: 2016 Edition

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.

 

Grad Student Income Tax Guide: 2016 Edition

Welcome to the 2016 edition of the Grad Student Income Tax Guide! While no one really wants to shell out money in taxes, it is part of our civic duty. Our intention with this Guide is to make the process of preparing your grad student tax return as easy as possible. Grad student non-compensatory income (fellowship, scholarship, training grant, etc.) is unfamiliar to many people, including tax preparers, but it’s actually not that complicated to understand and report properly. This tax guide applies to US graduate students who are US citizens, though other students in the US may find aspects of it illuminating.

We here at Grad Student Finances are not tax or financial professionals; nothing you read on this site is advice and you are still entirely responsible for the accuracy of your tax return(s). At every possible point, we will provide references to the tax code to substantiate the steps in the guide.

 

Think about Your Income and Assess Your Tax Forms

Before you start working on your tax return for the year, you must think about what your true taxable grad student income is and assess the tax forms you received from you university. Skipping this step and jumping straight into preparing your return may result in confusion, frustration, incorrect returns, and even the over- or under-payment of your tax due.

Before you begin: Think about your income and assess your tax forms.

Where Your Grad Student Income Should Be Reported on Your Tax Return

It’s also important to understand where your grad student income should ultimately be reported on your tax return. For how confused tax software and tax preparers get over this issue, it has a surprisingly simple answer.

Educate yourself: Find out where your grad student income goes on your tax return.

Tax Return Preparation Methods

The first big step you’ll take toward preparing your income tax return is to choose what method to use. Generally, your options are to prepare it yourself (manually), to use tax software, to outsource it to a professional, or to outsource it to a relative or friend. There are pros and cons to each method, and your decision should largely depend on the complexity of your (tax-related) life and the resources available to you.

If you have a simple (tax) life, the fastest and easiest route to prepare your tax return may be to do it manually. We have provided a step-by-step method for manually calculating and reporting your grad student income. How to incorporate your other income sources and possible deductions/credits into your return is up to you to research.

If you choose to outsource the preparation of your tax return, you should still look over the manual guide so that you can double-check that your grad student income has been calculated and reported correctly.

Probably the most popular route grad students take to prepare their tax returns is to use tax software. While this is probably the least expensive way to have a comprehensive return prepared by a ‘professional,’ because the software is not designed with grad student (non-compensatory) income in mind, it can often be tricky to get it to properly interpret the information you give it. We have generated step-by-step instructions with screenshots for entering your grad student income into tax software (for the rest of your return, you can follow the software prompts).

Further reading: What Method Should You Use to Prepare Your Tax Return?

Understanding Your Grad Student Taxes

At the end of the day, what you need is an accurate tax return, but it’s also highly beneficial to understand how your financial life as a graduate student fits in with the tax code. The best resource for learning about it is IRS Publication 970. If you understand the types of income you (may) receive as a graduate student, you can prevent yourself from falling for the tax lies that are pervasive at universities and answer questions such as can a graduate student contribute to an IRA? To be a financially literate citizen, you should also understand concepts like marginal tax brackets, credits, and deductions.

We at Grad Student Finances are not tax professionals, and none of the content in this section should be taken as advice for tax purposes.