IRS Information Letter 201833031 (May 22, 2018)
Available at https://www.irs.gov/pub/irs-wd/201833031.pdf
The IRS has approved a private foundation’s procedures for awarding scholarships to an employer’s employees and their children, concluding that the scholarships will not be considered taxable despite the foundation’s inability to guarantee that certain percentage tests will be met. The foundation requested the ruling because it wanted to establish a scholarship program offering a small number of scholarships that would be available only to a particular employer’s employees and their children. The Code generally treats such scholarships as taxable expenditures, but their taxation can be avoided if they are not provided as compensation for services, and certain other requirements are met. IRS guidelines for the employer-related scholarship programs of private foundations establish seven conditions and separate percentage tests for employees and their children. If no applicable percentage test can be met, whether the scholarships are nontaxable will be determined based on all of the facts and circumstances. (The employee test requires that scholarships for employees not be awarded to more than 10% of the employees who applied and were considered for scholarships. Scholarships for children, however, must either not exceed 25% of all children who applied and were considered, or 10% of all children who were eligible regardless of whether they applied.) The foundation represented that it would satisfy the seven conditions, but it could not guarantee satisfaction of the separate percentage tests for grants to employees and employees’ children. And due to the small number of scholarships and their small size, the expense of annual testing would be unreasonable.
The IRS reviewed the foundation’s program and found that it would meet the applicable standards under IRS guidelines. As an alternative to the percentage tests, the guidelines allow foundations to show that the relevant facts and circumstances ensure that the primary purpose of a scholarship program is not to provide employee compensation or other employment incentives, but to educate recipients in their individual capacities. In this instance, scholarship recipients would be selected by an independent committee; scholarships would not be used for recruiting or terminated upon employment termination; selection standards would be objective and entirely unrelated to employment; and scholarships would not limit recipients to the study of subjects that benefit the foundation or the employer. Based on these representations and other assurances—e.g., that grants would not be made to the foundation’s creators, officers, directors, trustees, managers, or members of the selection committee or their relatives—the IRS concluded that expenditures made under the foundation’s procedures would not be taxable, and that the scholarship awards made under the procedures would not be taxable to recipients if used for qualified tuition and related expenses as defined in Code § 117(b).
EBIA Comment: Scholarship programs that favor employees or their family members will raise compensation issues for private foundations that can be more difficult to address for smaller employers. While this ruling cannot be relied upon by other private foundations (it applies only to the foundation that requested it and cannot be cited as precedent), it illustrates how a foundation might use the facts and circumstances test as an alternative to the percentage tests to show that its grants should not be treated as compensation, if the number of potential applicants may be small or the expense of testing is disproportionate to the amount and number of scholarships awarded under the program. For more information, see EBIA’s Fringe Benefits manual at Section X.A.1.c (“Qualified Scholarships”).
Contributing Editors: EBIA Staff.