YOUR TAXES : PART FOUR: SPECIAL SITUATIONS : A painful lesson is awaiting students : Some financial aid awards are now considered taxable income

Like thousands of other graduate students, Sacha Nelson has racked up a hefty debt (about $20,000) and squeaks by on a modest annual stipend ($8,000). Now, for the first time, he soon will face the additional hardship of taxation on his meager academic income.

“I’m figuring around $1,000 a year in taxes,” said Nelson, 27, a UC San Diego biology student who does neurophysiology research at the Salk Institute. “At the worst, I’m hoping I’ll have to borrow an additional thousand a year.”

At campuses across the United States, students and administrators are girding for one of the most significant financial changes to hit academia in years. Tax reform has come to their ivy-covered halls, eliminating a longstanding provision that allowed students to enjoy scholarship and fellowship assistance tax free.

As a result, awards made after Aug. 16, 1986, to graduate and undergraduate students for room and board are now considered taxable income. (In addition, fellowships to non-degree candidates, which previously afforded a $300-a-month exclusion for post-doctoral fellows, recipients of Fulbright scholarships and others, are also taxable as earned income as of Jan. 1, 1987.)

The changes might seem simple enough, but ambiguities in the law have precluded simple formulas, and university officials find themselves fielding phone calls from concerned students. “It’s not clear to me that students really comprehend how it affects them,” said Jean Fort, assistant dean of graduate studies at UC San Diego, whose office has so far distributed two memos on the subject to departments and students.

“In principle, (the law) is not too difficult to accommodate,” said Thomas J. Linney, director of government relations for the Council of Graduate Schools in the U.S., a Washington-based organization. “(Legislators) want to make stipends taxable and tuition awards exempt. The difficulty is in the way the bill got written up.”

Primarily at issue is a provision affecting students who must work, teach or perform research to fulfill their degree requirements. For such students, the school pays for tuition, books and other classroom-related expenses but also provides a stipend for living costs in return for the students’ services.

Here the law is subject to interpretation, with the worst-case scenario being that such students would be required to pay taxes not only on the stipend but also on the amount provided for tuition and other fees. Clearly, however, educators expect that Internal Revenue Service interpretations ultimately will exclude tuition aid from taxable income. (Tuition aid for students who are not required to work is still exempt under the new law.)

Students at private schools such as USC and Stanford, where tuition is thousands of dollars higher than at state-supported schools, would be especially hard hit by such a provision.

Marilyn J. Baker, associate dean of the Graduate School at USC, offers an example:

Under the strictest interpretation of the new law, a teaching assistant at USC earning a stipend of $9,600 a year and receiving the equivalent of $12,000 in tuition would total those amounts in determining taxable income. He or she would be allowed to exclude $5,250 of the tuition income (under the “employee educational assistance exclusion,” which expires after 1987) and could take a standard deduction of $2,540 and a personal exemption of $1,900. That would make the taxable income $11,910, with a tax liability of $1,714.50.

“Suddenly, the student has taxable income which puts him in a higher bracket, but he doesn’t have any more money each month,” Baker said, adding: “We don’t think Congress intended to do that, (and) we’re working to get that changed.”

She added that the law could have a dramatic, unintended effect.

“For our very best students, we give large stipends for living and pay all tuition and fees,” Baker said. “They will see the most severe impact. The greatest irony is that the very best students, the ones we give the most money to, will be hurt the most.”

UCSD, a state-supported school, has also estimated the tax burden for students in various circumstances, Fort said. A physics student or one at Scripps Institution of Oceanography performing research duties half the time is expected to pay $900 to $1,000. A student in the humanities--which generally receive less student aid--teaching half time would pay about $650. And a person receiving a $7,000 fellowship (above tuition and fees) for which no service is required would pay about $450.

“When students have to pay tax, it effectively reduces the stipend,” Fort said. One concern is that the university’s budget for next year has no extra money to compensate students for the taxation. “Students will carry the burden,” she said. “All our students will be suffering a net loss in income.”

Linney of the Council of Graduate Schools noted that students who received multi-year funding before Aug. 17, 1986, are believed to be protected by a grandfather clause for the full term of their awards.

He estimated that those most affected by the new law will be the nation’s 350,000 to 400,000 full-time graduate students, and he predicted that universities might suffer drastic long-term effects as scholarship and fellowship programs become less attractive because of taxation.

“We’re at a disadvantage in competitive fields such as engineering and computer sciences,” he said. “The competition is withering. When you can leave school with a bachelor’s degree and make a small fortune directly in industry, where does the next generation of faculty, research and ideas come from?

“The answer is it comes from those people you can attract in highly focused, intellectualized, abstract graduate programs.”

Although the council does not advocate a complete rollback of the measure for students, “we think that tuition assistance awards in all cases, whether or not there is research or teaching assistance required, should be exempt,” Linney said. Bowing to the inevitability of tax reform, he added: “But the stipends will remain taxable.”