Scholarship grants awarded by private foundations

Editor: Mark G. Cook, CPA, CGMA

If you ask college students what their top concerns are, expensive tuition would probably be on the list, especially now, amid the worst inflation the economy has experienced in nearly 40 years. Scholarships have become ever more critical to easing students’ financial burdens.

Some exempt private foundations provide scholarship grants to students to attend two- and four-year colleges. A scholarship grant will not be taxable to the student if it is a qualified scholarship under Sec. 117(b)(1). A qualified scholarship for this purpose is any amount received by an individual as a scholarship or fellowship grant to the extent the individual establishes that, in accordance with the conditions of the grant, the amount was used for qualified tuition and related expenses.

A scholarship grant made by a private foundation to an individual is also potentially a taxable expenditure that is subject to a 20% tax on the foundation and 5% tax on a foundation manager. Under Sec. 4945(d)(3), a grant by a private foundation to an individual for travel, study, or other similar purposes by the individual will be a taxable expenditure unless the grant is described in Sec. 4945(g). Under this section, the grant must be awarded on an objective and nondiscriminatory basis (a requirement that might easily be overlooked) pursuant to a procedure approved in advance by the IRS, and it must be demonstrated to the Service’s satisfaction that the grant meets at least one of the following three criteria:

1. The grant is a qualified scholarship under Sec. 117(b)(1) and is to be used for study at an educational organization that 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 (Sec. 170(b)(1)(A)(ii)). No “strings” can be attached to the award of the grant (e.g., it cannot be made with the clear expectation that future services will be performed by the recipient).

2. The grant constitutes a prize or award in which the recipient was selected from the general public. The recipient should also be selected without any action on his or her part to enter the contest or proceeding, and the recipient is not required to render substantial future services as a condition to receiving the prize or award (Sec. 74(b)).

For example, if the grant consists of a reward that requires the student to work as a teaching assistant, it is not a qualified reward, and the money received by the student should be treated as taxable income.

3. The purpose of the grant is to achieve a specific objective; produce a report or other similar product; or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee.

For example, in Letter Ruling 202223017, the IRS ruled that a private foundation’s proposed scholarship grants to students from a specific county to attend two-year and four-year colleges met the requirements in (1) above, so the grants would not be taxable expenditures by the exempt private foundation.

What kind of expenses can recipients use the money for without making it taxable to them? They may use it for qualified tuition and related expenses, which, per Sec. 117(b)(2), are (1) tuition and fees required for the enrollment or attendance of a student at an educational organization and (2) fees, books, supplies, and equipment required for courses of instruction at such an educational organization. Room and board expenses and books that are not mandatory are not included.

In all, as long as the above rules are followed, scholarship grants can be nontaxable to both the exempt private foundations granting them and the recipients of the grants.

Editor Notes

Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif. For additional information about these items, contact Mr. Cook at 949-623-0478 or mcook@singerlewak.com. Contributors are members of or associated with SingerLewak LLP.