A scholarship is generally an amount paid for the benefit of a student at an educational institution to aid in the pursuit of studies. Only amounts you pay as a qualified scholarship may be excluded from the recipient’s gross income. The student may be either an undergraduate or graduate.

A qualified scholarship is defined as any amount expended for "qualified tuition and related expenses." Qualified tuition and related expenses are tuition and fees required for the enrollment or attendance of a student at an educational institution, fees, books, supplies and equipment required for courses of instruction at such educational organization. Refer to Publication 970, Tax Benefits for Education, and Publication 15, Circular E, Employer's Tax Guide, for more information.

The Form W-2, Wage and Tax Statement, instructions say to give a Form W-2 to each recipient of a scholarship or fellowship grant only if you are reporting amounts includible in income. Amounts are subject to federal income tax withholding (depending on how the Form W-4, Employee's Withholding Allowance Certificate, is completed) but not for withholding of social security or Medicare unless they are employed as a condition for receiving the scholarship.

Note that the Form W-4 instructions state that an individual cannot claim exemption from withholding if their income exceeds $900 and includes more than $300 (for the year 2008) of unearned income and another person can claim the recipient as a dependent on their tax return.

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