Scholarships and Fellowship Grants
I am writing in response to your recent visit during which you asked me whether you must include in your income the money scholarship you received last year. Generally speaking, the scholarship money is a net accretion to your wealth and must be included in income. However, the Internal Revenue Code contains special rules which allow you to exclude the scholarship from gross income provided you meet certain requirements. The intent of this letter is to set down these requirements. Once you have reviewed the facts of your case in light of these requirements, I suggest that we meet again to discuss your situation further.In general a grant, either in the form of a scholarship or fellowship, can be excluded from your income if you are a degree candidate, attend a college or university, are not required to perform services in exchange for the money, and expend the funds for acceptable expenses such as tuition and books. This is a broad generalization of the law, but I will show you how you can comply with the requirements in order to exclude your scholarship.
First, at a minimum, you must be a candidate for a degree and attending a college or university (although the exclusion is also available for education at the primary and secondary school level). If, however, you are a degree candidate and you are expected or required to perform services (such as teaching or research) in return for the funds, then you do not qualify for the exclusion. This is true regardless of whether the grant is in exchange for services you are currently performing or for services which you performed in the past or are expected to perform in the future. Thus, if your employer is paying your scholarship, you clearly can not exclude the amount from income.
Even if the institution (such as your school) making the scholarship or fellowship grant is not your employer, you may still be required to include the grant amount in income if your study or research primarily benefits that institution. Thus, if you are given a fellowship grant to research a particular scientific area for your college and you are required to publish the results of your research, with the college retaining the copyright on your article, your grant will not be excludable because the research is done primarily for the college's benefit.
It is also possible that the grantor of your scholarship or fellowship grant has clearly indicated that a portion of it is paid for studies only and the rest is paid for your services, such as teaching. In that case you will have to make an allocation of the taxable and non-taxable portions.
Finally, once you have passed the threshold tests which I have described above, it is still necessary for you to be able to show that you have spent the funds on specified items. These acceptable expenditure items include tuition, fees, books, supplies and equipment. Expenditures for any other purpose, such as room and board, are not excludable. The terms of your scholarship or fellowship grant, in fact, have a bearing on this treatment since a grant which designates that funds be used for a nonpermissible purpose or prohibits use of the funds for a permissible purpose will both result in the grant amount not being excludable from your income. The fact that you must show how you expended the grant money does not mean that you have to trace the funds from your scholarship check through your bank account to the actual payment. It is enough that you produce receipts showing that you paid for tuition, books and other qualifying expenses.
As you can see, these rules can be complicated and the excludability of any particular scholarship or fellowship grant depends in large part upon the factual situation in which it arises. Therefore, I urge you to review the facts in your own situation and contact me soon for a second meeting.
Tuition Reduction
I am writing in response to your phone call inquiring whether you are required to report the amount of your child's tuition reduction as income on your tax return. Generally speaking, a tuition reduction is a benefit provided by your employer (the educational institution) to you as an employee and thus, should be includible in your gross income. However, there are special rules in the Internal Revenue Code which permit you to exclude the tuition reduction from gross income provided you and your child meet certain requirements. In this letter I shall attempt to summarize these requirements. Once you have reviewed the facts of your case in light of these requirements, I suggest that we get together again in order to discuss your situation.
In general, there are four requirements which you must meet in order to exclude the amount of your tuition reduction from your income. First, your child must be an undergraduate student and your dependent for tax purposes. Second, you must be an employee of the educational institution granting the reduction.
The third requirement is that the recipient of the tuition reduction must attend the college or university granting him the reduction or an equivalent educational institution. Finally, you can not exclude the amount of the reduction if you are an employee who is considered to be a highly compensated employee (generally, earning more than $75,000 per year or in a group of highly compensated employees and earning in excess of $50,000 per year) if the operation of the tuition reduction discriminates in your favor. However, part-time employees and certain others, such as employees who are subject to collective bargaining agreements, are not subject to this restriction.
In addition to these four basic requirements, there can be no exclusion of your tuition reduction from income to the extent your child is also required as a condition of the reduction to perform services of some type (such as teaching or research) in exchange for the reduction. This is true regardless of whether the reduction is in exchange for services he or she is currently performing or for services which he or she performed in the past or is expected or required to perform in the future. Reduction for any such services are considered to be compensation to your child and obviously could not be excluded.
I have addressed these issues in the situation where you are employed by the university and your dependent child is taking advantage of the tuition reduction. The same rules would apply if you or your spouse were to use the tuition reduction program offered by your employer.
As you can see, the rules concerning the excludability of tuition reductions are complicated and depend to a great extent upon the facts involved in a particular case. Therefore, I urge you to review the facts in your own situation and contact me for a follow-up meeting.
Bob Parrish CPA PC For the Firm: Bob Parrish CPA
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