The Scholarship Trap for Foreign Students

[ILLUSTRATION OMITTED] Many U.S. colleges and universities recruit foreign students, especially for graduate programs and athletics. Such students often receive full scholarships that include room and board, making them subject to U.S. income taxes. These students may be unfamiliar with the U.S. tax system, but they need to understand how some financial aid can be taxed, particularly if their homeland lacks a tax treaty with the United States. Generally, the portion of a scholarship paid for tuition or related expenses under IRC [section] 117(b)(2) is not taxable for any degree candidate, while any portion paid for room and board or other nonqualified expenses is subject to U.S. taxes. Nonqualified expenses also include travel, research, clerical help or equipment or supplies not necessary for enrollment or attendance. In addition, the portion of a scholarship that is compensation for teaching or other services is taxable. U.S. colleges and universities are not required to report scholarships to the IRS if the recipient is a U.S. citizen or resident alien. But for the majority of foreign students who are nonresident aliens, the IRS has established a reporting and withholding system, generally at a rate of 14%. See IRC [section] 1441(b). The university reports the income and taxes withheld on an information return, Form 1042-5, Foreign Person's U.S. Source Income Subject to Withholding. A NEGATIVE ACCOUNT BALANCE This withholding can be a problem for many foreign students. Most scholarships that include room and board are for exactly those costs, with no additional money included for taxes. Therefore, the withholding is often charged against a student's university account, creating a negative balance. Usually, the deficit must be cleared for the student to graduate or receive a college degree or transcript. Unaware of the extra cost, foreign students often do not budget for it. The problem is compounded for the many foreign students who hold a student visa, which prevents them from working for a U.S. employer to earn money. Under some countries' tax treaties with the United States, room and board scholarship income is not subject to taxation. Even for students from those countries, however, the university may issue a Form 1042-S and withhold tax *** unless the student alerts it that withholding is not require *** Such notification is by Form W-8BEN, Certificate Foreign** Status of Beneficial Owner for United States Tax Withholding. *** Form W-8BEN is required for foreign students to claim any *** exemption from withholding when they are from countries *** with which the United States has an income tax treaty. …