I emailed the head of our student finance office and this is the reply I got.
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Below is a memo from 2003 which should answer your question. Any portion of the scholarship or stipend that is taxed as income should be reported on the FAFSA as an income exclusion. This means the dollar amount is subtracted directly off of your AGI so those dollars do not go into your award calculation.
Dear Military Scholarship or NHSC Recipient:
We have recently been informed by the Policy Department of the U.S. Department of Education in Washington D.C. of a new clarification of the Title IV federal regulations. For the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Military Scholarships, the monthly stipend a student receives must be treated as a resource in the total estimated financial aid.
The stipends are considered a resource/estimated financial assistance and will be included as a part of your total financial aid award beginning with the 2003-2004 award year. Those of you who have already received your 2003-2004 award letters may have noticed that in addition to the scholarship, the stipend has been included in your total award as well. This in no way affects your total cost of attendance, and you may continue to borrow up to that maximum cost of attendance.
This new clarification of the Title IV regs is due in part to the IRS regulation which does not require you to count NHSC or military scholarships as income. If you do count it as income on your taxes then we are allowed to subtract this off of your AGI on your FAFSA worksheet C income exclusions, so you are not penalized in the awarding process. The most recent version of IRS publication 520 states, "You do not have to include in income the part of any scholarship, fellowship, or tuition reduction representing payment for teaching, research, or other services if you receive the amount under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program." For more detailed information regarding the tax regulations, please visit
www.irs.gov.