A scholarship or fellowship grant is tax free only to the extent:
•It doesn't exceed your qualified education expenses;
•It isn't designated or earmarked for other purposes (such as room and board), and doesn't require (by its terms) that it can't be used for qualified education expenses; and
•It doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship. For exceptions, see Payment for services, later.
Qualified education expenses. For purposes of tax-free scholarships and fellowship grants, these are expenses for:
•Tuition and fees required to enroll at or attend an eligible educational institution; and
•Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.
Expenses that don't qualify. Qualified education expenses don't include the cost of:
•Room and board,
•Clerical help, or
•Equipment and other expenses that aren't required for enrollment in or attendance at an eligible educational institution.
Taxable Scholarships and Fellowship Grants
If and to the extent your scholarship or fellowship grant doesn't meet the requirements described earlier, it is taxable and must be included in gross income. You can use Worksheet 1-1 to figure the tax-free and taxable parts of your scholarship or fellowship grant.
These paragraphs are from pages 5 and 6 of IRS Pub 970.