The short answer is: It depends. If a scholarship is used to pay for tuition, fees, books, or required equipment, then it's not taxed. But if it's used to cover other expenses like room and board, travel, or optional equipment, or if it's awarded as payment for teaching or research, then it's taxable.

But keep this in mind: Scholarships used to cover tuition, fees, or books (making them nontaxable) may impact your ability to claim the Hope or Lifetime Learning credit. That's because these tax credits are based on the amount of tuition and fees you pay, and any tuition and fees paid with a tax-free scholarship can't be counted when calculating your credit.

This rule has the most impact on your ability to claim the Lifetime Learning credit, worth up to $2,000. Because this credit is calculated as 20% of up to $10,000 in tuition and fees, a hefty scholarship applied to these expenses may leave you with less than $10,000 in eligible tuition and fees to count toward the credit. By contrast, the maximum $1,650 Hope credit is based on up to $2,200 in tuition and fees, so even with a scholarship, you might not use up all your tuition and fee expense eligibility.

However, if the scholarship is taxable (for example, in cases where its terms specify that it can't be applied to tuition and related expenses), then the entire amount of tuition and fees can be counted when calculating the Hope or Lifetime Learning credits.