It shouldn't take a PhD in math from Berkeley....

...so much time to figure out their income taxes.

A bunch of very smart mathematicians on the Secret Blogging Seminar are having a great discussion of the bed buffaloes in the tax code that apply to taxpayers with fellowship income.

As I pointed out in the comments there:

There is a lot of misinformation circulating out there, much of it promulgated by people from my generation, who do not realize that tax law has changed significantly since they were in grad school. Prior to 1986, all scholarship and fellowship income was tax-free, including NSF stipends. However, since then, only the part of scholarships/fellowships applied to narrowly defined tuition and qualified expenses is excludible from income. Living expenses, even if paid as room and board to a university, are NOT qualified expenses! Books and equipment REQUIRED for a course of instruction do count as qualified expenses, but recommended books and equipment do not. A surprising number of faculty and administrators are still confused about this. They vaguely remember that they didn't have to pay taxes on their graduate fellowship stipends back when they were in grad school decades ago, and far too often they mislead current students into believing they don't have to do so either.

Some useful resources:
IRS Pub 970 Tax Benefits for Education, especially this section

Princeton's tax advice page for graduate students seems especially helpful in pointing students in the right direction. Cornell's grad student tax advice website is also very good. Some other universities have good tax advice sites as well. More universities should follow their lead in providing such clearly written and useful information, including information about state income tax requirements.

I'll add some thoughts of my own for grad students and postdocs with fellowship income.

1) In many cases, a university may not be required to issue you a W-2 or 1099 for taxable fellowship income. That does NOT mean you don't have to report it on your 1040. You do need to report taxable income regardless of whether you got a W-2 or 1099 from the payer. That goes for any kind of taxable income.

2) An important general principle to keep in mind: all income is subject to federal income tax unless you can find an explicit provision in the tax code excluding it from taxable income. Here's a link to the tax code to research it yourself.

3) Include your taxable scholarship income in the total wages you report on line 7 of your 1040. If you are reporting taxable scholarship income, the IRS wants you to give it a heads-up by writing SCH and the amount of the taxable scholarship income included next to the line 7 box.

4) Yes, you can efile a tax return declaring taxable scholarship income! We do it routinely at our VITA site, using TaxWise, the professional software provided to us under contract from the IRS. Most graduate students and postdocs qualify for the IRS Free File program. You have a choice of programs to use. If one doesn't work, you can try another. Mathematicians have reported some difficulty in using the free version of TurboTax in the past, but at least one said he succeeded this year. If all else fails, you can use the free fillable forms efile option.

5) In many cases, your university is not required withhold taxes on your taxable fellowship stipend payments. Waiting until next April 15 to pay your tax bill is not only painful, it can lead to substantial penalties for failure to pay estimated taxes. You can avoid those penalties if you make quarterly estimated payments during the tax year. ("Quarterly" is something of a misnomer, as the four payments are due on April 15, June 15, September 15, and January 15.) More information about quarterly payments is available here.

6) Many tax software programs will help you compute rough estimates of the amounts you need to pay in quarterly estimated taxes. Alternatively, you can use my favorite tax simulator model, TaxSim from the National Bureau of Economic Research to estimate your tax liability for the year. Given all the bed buffaloes in the tax code, you may want to use several different methods to estimate your tax liability in order to get a "reality check" on the accuracy of your figures.

7) Even though taxable scholarship income should be included in line 7 along with wages on your 1040, it does NOT constitute "earned income" for the purposes of the Earned Income Credit. At least one commenter has reported difficulties with the IRS giving him too much earned income credit, so getting the IRS to handle this properly may present some challenges, especially if you have children.

8) Taxable scholarship income apparently DOES constitute "earned income" for the purposes of avoiding the so-called "kiddie tax," which can apply to fulltime students up to age 24, even those who are not financially dependent on their parents in any way. (The rule is that a full-time student under age 24 can be subject to kiddie tax unless his own "earned income" provides more than 50% of his support. When the kiddie tax applies, it can be expensive--it results in the student paying taxes at his parents' top marginal tax rate on all his "unearned income," which includes prizes as well as investment income.)

9) Don't complain too much about your income tax burden. Many people who get a comparable amount of income to yours in plain vanilla W-2 wages pay a lot more tax than you do, because their income is subject to payroll taxes for Social Security and Medicare tax as well as income tax. Most fellowship income is exempt from payroll taxes. (Moreover, much of your fellowship income probably comes from the taxpayers at large in the first place! In addition, the institution where you are pursuing your studies and research benefits from many generous provisions in the tax code.)

10) Beware of "helpful advice" from the clueless but well-meaning, even tax professionals. Remember that under current law, in 48 states, anyone is allowed to hang out his or her shingle as a "professional tax preparer." No need under current law to pass a test to demonstrate even basic literacy or numeracy, let alone knowledge of the tax code. CPAs, attorneys, and "enrolled agents" are government regulated, but audits have shown surprisingly high error rates on returns they prepared as well. Volunteer Income Tax Assistance (VITA) volunteers like my students get training and certification based on IRS tests, but you should "kick our tires" too. IRS employees have given erroneous advice as well. Relatively few tax preparers are familiar with all the details of different kinds of fellowship programs. Remember that YOU are the one ultimately responsible for the accuracy of the information you provide on your tax return. Reliance on advice from a credibly reputable tax preparer may be a defense against penalties, but it will not excuse the tax liability or interest on that tax liability.

The irs.gov website is a great resource, but the ultimate authority is the tax code as written by Congress and interpreted by the courts. Here's a place where you can search past Tax Court opinions by keywords.

11) Try to keep a sense of humor about it all. The IRS website quotes Albert Einstein as saying: “The hardest thing in the world to understand is the income tax.”

If you need a few laughs, check out Daniel Velleman's If the IRS had invented the quadratic formula.