Summary of Federal Laws
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Tax Issues Related to Students
26 CFR §1.1174 (Items not considered as scholarlship or fellowship grants)
The institution must determine what its tax reporting and or tax/withholding requirements are with respect to scholarship and fellowship grants. In general, an institution is not required to withhold income tax or file any information returns with respect to taxable scholarship fellowship grants. There are two important qualifications to this rule: 1) the recipient of the grant must be a U.S. citizen or a U.S. resident alien for tax purposes (see withholding and reporting requirements for non-resident aliens, below); and 2) the payments must be a true scholarship or fellowship, and not disguised compensation for services rendered.
Primary Purpose Test:
A requirement that the recipient pursue studies, research or other activities primarily for the benefit of the grantor is treated as a requirement to perform services. Keeping the grantor informed of progress by periodic reports does not equal payment for services.
The IRS recommends, but does not require, that the institution advise the recipient in writing that amounts received in excess of qualified tuition and related expenses under I.R.C. § 117(a) must be reported as taxable income. The university has no responsibility to withhold estimated taxes for these students.
Generally, a scholarship or fellowship grant will not be included in a recipient's taxable income so long as the requirements of I.R.C. §117(a) are met. The three-part test to determine if a scholarship or fellowship is excludable is as follows:
(1) The award must be a "qualified scholarship." A qualified scholarship is one used for:
a. Tuition and fees required for enrollment or attendance at the university; or
b. Fees, books, supplies, or equipment required for courses of instruction.
Expenses like room, board, living allowance, travel, research and clerical help are not covered. In addition, sums spent on recommended texts and/or supplies are not excludable from gross income.
(2) The recipient must be a "candidate for a degree." 26 C.F.R. 1.117-3 defines a candidate for a degree as "an individual, whether undergraduate or graduate, who is pursuing studies or conducting research to meet the requirements for an academic or professional degree conferred by colleges and universities."
(3) The award must be for the purpose of studying or conducting research at an "educational organization", which is defined at I.R.C § 170(b)(1)(A)(ii) as " an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on."
All three parts of this test must be met or the scholarship in order for the scholarship to be excludable from taxable income. In addition, one final inquiry must be made as to whether the scholarship or fellowship is compensation for services. See the Primary Purpose Test above.
If the scholarship or fellowship grant or tuition reduction is compensation for services, the university must file a return of information under I.R.C. § 6041, withhold income taxes using a W-2 form, and report wages to employees under I.R.C. § 6051. FICA and FUTA withholding is dependent upon the nature of the employment.
If the scholarship/fellowship or tuition reduction is granted partly in return for services and partly as an outright scholarship, the grantor must make a good faith effort to determine what should be reported as compensable income. Factors to be considered are the amount paid by the grantor for similar services performed by non-scholarship students with comparable qualification; the amount paid by the grantor for similar services performed by non-students; and the amount paid by other educational institutions for similar services performed either by students or other employees.
The IRS stated in Priv. Ltr Rul. 200113020 (March 30, 2001) that grants paid to fellowship participants who were part of a training program, were true fellowships and not compensation for services. The case involved an educational institution that paid fellowship participants a stipend to help defray living expenses while studying with the institution's faculty and taking part in various training programs (related to music). The IRS specifically stated, "the awards are not paid for or in connection with the performance of services, and appear to be relatively disinterested grants to participants to enable them to pursue programs of independent development, training, and original study, focusing on the experience to be gained by the recipient rather than on any guarantor benefit."
See the Q and A tax page for a specific question about the taxability of an RA's room and board and stipend.
Private Letter Rulings and other IRS pronouncements
This memo offers guidance on whether stipends paid to postdoc fellows should be treated as compensation for services rendered to the institution or as bona fide fellowship payments. Fellowship payments are not subject to income or FICA tax withholding, and the payor does not need to report the payments. In the memo, National Research Service Awards to postdocs were found to be not taxable. Non-NRSA grants analyzed in the memo were taxable, for several different reasons. These are outlined in the memo, and include, but are not limited to the following: the postdocs not being hired until after the school obtained the research contract; fellows are assigned to projects defined by the project leader; and the fellow can be terminated for non-satisfactory performance.
Dated January 23, 2009: This PLR involves a tax exempt foundation that supports youth in a particular sport, and targets the disabled, minorities, inner-city youth, juniors, and women. The Foundation also maintains a scholarship program for college students who meet academic, sport, community service, and financial need requirements and are studying sport management for the particular sport at issue in an accredited program at one of 19 U.S. universities. Foundation now plans to add three new scholarship programs to assist financially needy students to study sport management and to encourage diversity in the sport. One scholarship is open to minorities only. The The IRS ruled that the new scholarship programs would not affect the organization's section 501(c)(3) status since all of the programs benefit a large and indefinite charitable class, are not targeted to pre-selected individuals, and are based on objective criteria.
IRS PLR 200607017 (dated Mar. 7, 2005: released date Feb. 17, 2006)
This Private Letter Ruling confirms that payments made to recipients of National Institutes of Health (NIH) National Research Service Awards (NRSA) training and research programs and "research training programs...modeled" on them will not be considered wage compensation reportable on any IRS forms (e.g. IRS Form W-2 or 1099) nor will such payments be subject to withholding for income or employment (FICA/FUTA) tax. The grants may be eligible for consideration as scholarships or fellowships under 117 of the code.
PLR 200414039 (Release Date 4/2/04 Index # 0117.00-00)
A theological seminary questioned whether funds, awarded to students pursuing graduate degrees in theology and religion, granted by its scholarship program would receive tax-exempt status pursuant to Section 117 of the IRC. Under the scholarship program, the seminary provided grants and/or tuition reduction to students who demonstrated a commitment to the development of practical stewardship skills in the areas of fundraising, development of donor contacts, and solicitation of charitable contributions. Scholarships were not dependent upon the students' success in achieving any of these goals.
Section 117 of the Code provides that students are not required to pay taxes on "qualified scholarships," which includes tuition and related expenses, such as fees and books. Scholarship awards received in excess of tuition and related expenses are subject to taxation, as are awards the IRS deems compensation for services. The IRS determined that the scholarship program did not represent compensation for services despite the fact that students solicited from third parties funds that benefited the seminary financially. Because the overall purpose of the scholarship program was to encourage skills in economic church stewardship, the IRS considered the financial gain enjoyed by the seminary coincidental and inconsequential and the solicitation of funds de minimis. The IRS concluded that the scholarship grants were thus exempt from taxation.
IRS Publications 970 and 54 provide information for students on the taxability of scholarships, fellowships, and tuition reductions. These publications also discuss some of the special rules that apply to U.S. citizens and resident aliens who are studying, teaching or researching abroad under scholarships and fellowships.
Chapter Seven of The Tax Law of Colleges and Universities (2nd Ed.) by Bertrand M. Harding, Jr.
Note that this topic is complicated enough to merit an entire chapter in a book devoted to tax law for higher education. Attorney Harding helps frame the topic in a manner that makes it comprehensible.
For example, on page 211 of the above text, he notes "By way of background, colleges and universities provide many graduate students with two basic benefits- full or partial tuition remission and a cash stipend. Schools generally treat the cash stipend as taxable wages and withhold normal income tax on the stipend amount, but they treat the tuition remission as a scholarship/fellowship and do not withhold income tax on this benefit under the above described provisions of Notice 87-31."
See also Tax Treatment of Scholarships, Fellowships, and Other Student Payments, by Bertrand M. Harding Jr. (Dec. 2001 Presentation at NACUBO).
CCR updated CFR links 7/7/15