When Are Scholarships Tax Free to the Recipient?
Many not-for-profit organizations (“NPOs”) provide grants to individuals in the form of scholarships as part of their charitable mission. It’s important to understand which scholarships are excludable from taxable income for the recipient, as opposed to other forms of remuneration which might have tax consequences.
A scholarship will be tax-free to the recipient if the following three criteria are met:
- The recipient is a candidate for a degree,
- The recipient attends an eligible educational institution which is defined by the Internal Revenue Code as an educational institution 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, and
- Payments are made for qualified education expenses which include payments for either (i) tuition and fees required for enrollment or (ii) fees, books, supplies or equipment that is required as part of the curriculum.
In general, the NPO has no Form 1099 reporting responsibilities for awards as long as the payments meet the criteria listed above and are not considered compensation for services performed. In assessing whether the award represents compensation, the NPO must consider whether the award is funding a student’s activities that are performed for the primary benefit of the educational organization. If there is a component of the payment deemed to be a reimbursement for services performed, the payment would be taxable and therefore, the NPO will have to issue the recipient a Form W-2.