Tax Issues Relating to the

“Cost of Attendance” Rule

1A FAR 2015 Annual MeetingSeptember 20, 2015

Professor William H. LyonsRichard H. Larson Professor of Tax Law

University of NebraskaCollege of Law

In addition to tuition, fees, books and room and board, athletic scholarships may now include expenses such as academic-related supplies, transportation and other similar items.

• As the NCAA points out, the value of those benefits can differ from campus to campus.• Payments to students reflecting

“cost of attendance” raise federal and state income tax questions, including:

• Are these payments “scholarships” within the meaning of I.R.C. Section 117(a)?• If so, can any part of these

payments be excluded from a student’s income as a “qualified scholarship”?

• If such payments are not “qualified scholarships,” must the students receiving the payments report them as part of their “gross income” for federal income tax purposes?• What about state income taxability?

• Do schools making such payments have to report the payments to the IRS or state revenue departments?• What sort of information about

taxation of such payments should schools offer students ?

Taxation of Scholarships:Basic Federal

Rules

1954 through 1986

Old I.R.C. Section 117• Unlimited exclusion for a

“scholarship” received by a “degree candidate” attending an “educational organization.”• Amounts received for and spent on

travel, research, clerical help, and equipment also excludible.

“Scholarship”• Treas. Reg. § 1.117-3:• “[A]n amount paid or allowed to,

or for the benefit of, a student, whether an undergraduate or a graduate, to aid such individual in pursuing his studies.”

Covered “room, board, laundry service, and similar accommodations which are received by an individual as part of a scholarship” and “tuition, matriculation, and other fees . . . furnished or remitted to a student to aid him in pursuing his studies.”

Also covered “any amount received in the nature of a family allowance as a part of a scholarship.”

“Degree Candidate”“[A]n individual, whether an

undergraduate or a graduate, who is pursuing studies or conducting research to meet the requirements for an academic or professional degree conferred by colleges or universities.”

“Educational Organization”“[O]nly an educational

organization which normally maintains a regular faculty and curriculum and normally has a regularly organized body of students in attendance at the place where its educational activities are carried on.”

ExampleUndergraduate degree candidate

who attended a traditional U.S. college or university and received a traditional “full ride” scholarship (tuition, room and board, and fees) could exclude the entire scholarship.

Post-1986:“Scholarship”

versus“Qualified Scholarship”

Since 1987, I.R.C. Section 117(a) has provided an exclusion limited to “qualified scholarships” for “degree candidates” at certain “educational organizations.”

• The terms “degree candidate” and “educational organization” have essentially the same meaning as under prior law.• A major change from prior law is

the limitation of the exclusion to “qualified scholarships.”

What Is a “Scholarship” Under

Current Law?

Prop. Treas. Reg. § 1.116-6(c)(3)

“Generally, a scholarship . . . is a cash amount paid or allowed to, or for the benefit of, an individual to aid such individual in the pursuit of study or research.”

“A scholarship . . . also may be in the form of a reduction in the amount owed by the recipient to an educational organization for tuition, room and board, or any other fee.”

“A scholarship . . . may be funded by a governmental agency, college or university, charitable organization, business, or other source.”

“To be considered a scholarship . . . , any amount received need not be formally designated as a scholarship.”

What is a “Qualified Scholarship” Under

Current Law?

I.R.C. Section 117(b)(1)“‘[A]ny amount received by an

individual as a scholarship . . . to the extent the individual establishes that, in accordance with the conditions of the grant, such amount was used for qualified tuition and related expenses.”

Prop. Treas. Reg. § 1.116-6(c)(1)

“[T]o the extent that the terms of the grant specify that any portion of the grant cannot be used for tuition and related expenses or designate any portion of the grant for purposes other than tuition and related expenses (such as for room and board, or for a meal allowance), such amounts are not amounts received as a qualified scholarship.”

I.R.C. Section 117(b) (2)• “[Q]ualified tuition and related expenses”

means:–Tuition and fees required for the

enrollment or attendance of a student at a proper educational organization, and–Fees, books, supplies, and equipment

required for courses of instruction at such an educational organization.

Prop. Treas. Reg. § 1.116-6(c)(2)

• “Incidental expenses” are not “related expenses.”• “Incidental expenses” = Expenses for

room and board, travel, research, clerical help, and equipment and other expenses not required for either enrollment or attendance at an educational organization.

Recordkeeping Requirements

The burden is on the student who receives a scholarship to keep and make available records sufficient to establish the student’s right to an exclusion under I.R.C. Section 117(a).

Prop. Treas. Reg. § 1.116-6(e)

“[T]o be eligible to exclude from gross income any amount received as a qualified scholarship, . . . the recipient must maintain records that establish amounts used for qualified tuition and related expenses . . . as well as the total amount of qualified tuition and related expenses.”

“Such amounts may be established by providing to the [IRS], upon request, copies of relevant bills, receipts, canceled checks, or other documentation or records that clearly reflect the use of the money.”

“The recipient must also submit, upon request, documentation that established receipt of the grant, notification date of the grant, and the conditions and requirements of the particular grant.”

IRS Form 1098-T

• Starting in 2004, an “eligible educational institution” must provide scholarship students and the IRS with IRS Form 1098-T (Tuition Statement).• Prior t0 2004, such reporting was

voluntary.

Eligible Educational Institution”

“[A] college, university, vocational school, or other postsecondary educational institution that is described in section 481 of the Higher Education Act of 1965 as in effect on August 5, 1997, and that is eligible to participate in the Department of Education's student aid programs. This includes most accredited public, nonprofit, and private postsecondary institutions.”

ExceptionsTreasury Regulations under IRC

Section 6050 recognize exceptions to the reporting requirement, including:

• No Form 1098-T is required for students whose qualified tuition and related expenses are entirely waived or paid entirely with scholarships. Treas. Reg. § 1.6050S-1(a)(2)(iii).

• No Form 1098-T required for nonresident alien students, unless requested by the student. Treas. Reg. § 1.6050S-1(a)(2)(i).

Form 1098-T (Tuition Statement), if issued by the student’s university, may assist a student in meeting the record-keeping requirements for “qualified tuition and related expenses.”

Payments for Services

I.R.C. Section 117(c)(1)“The exclusion in section 117(a)

“shall not apply to that portion of any amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship . . . .”

A Bit of a Silver Lining

Prop. Treas. Reg. § 1.117-6(h)

If a student must treat a portion of a scholarship as gross income, that portion is “earned income” of the student for purposes of computing the student’s “standard deduction” and the tax return filing requirements for the student.

In 2015, an unmarried student who is a dependent for tax purposes has a “standard deduction” equal to the greater of (1) $1,050, or (2) the sum of $350 and the individual’s earned income (not exceeding $6,300, the 2015 “standard deduction” for an unmarried taxpayer).

Example #1• Rachel, who is 18 and a degree

candidate at University of Nebraska, has a $15,000 scholarship for 2015 and no other “earned” or “unearned” income.• The non-excludible amount of her

scholarship is $5,000.

• Rachel must treat the $5,000 as “gross income.”• Because her parents claim her as a

dependent, she cannot claim the $6,300 “standard deduction” usually available to a single person.

• However, because the $5,000 is treated as “earned income,” Rachel can claim a “standard deduction” of $5,350 [$350 + $5,000 of “earned income”].

• Rachel will not have to file a federal income tax return for 2015 because her “gross income” does not exceed her “standard deduction” amount and she has no other income.

Example #2Same as Example #1, except

Rachel has a full-ride scholarship and her non-excludible amount is $15,000.

• Rachel’s 2015 “standard deduction” cannot exceed the $6,300 “standard deduction” available to an unmarried person.• She will have to file a federal income tax

return and will pay some federal income tax on the $8,700 excess of $15,000 over $6,300.

Note CarefullyIf Rachel has either “earned”

or “unearned” income (or both) in addition to the taxable amount of her scholarship, her federal income tax consequences could change dramatically.

Information Reporting

IRS Form 1099 (MISC)

• James, who is 18 and a degree candidate at University of Nebraska, has a full-ride scholarship, of which $15,000 not a “qualified scholarship.”• Must the University issue James an

IRS Form 1099 (MISC)?

Treas. Reg. § 1.6041-3(n)No information reporting (IRS

Form 1099 (MISC)) required for: Payments to individuals as scholarships . . . within the meaning of [I.R.C. Section 117(b)(1)], whether or not they are “qualified scholarships” as described in [I.R.C. Section 117(b)].

• Treas. Reg. § 1.6041-3(n) does not apply to any amount of a scholarship or fellowship grant that represents payment for services within the meaning of [I.R.C. Section 117(c)].• Payor must file IRS Form W–2.

Foreign StudentsTreas. Reg. § 1.1461-1(c)(2)(K) requires

reporting on IRS Form 1042-S of “[s]cholarship . . . income and compensation for personal services that is not excludible from gross income under [I.R.C. Section 117] (whether or not the taxable scholarship, fellowship, grant income, or compensation for personal services is exempt from tax under an income tax treaty) paid to foreign students. . . .”

In general, the taxable portion of a scholarship paid to a nonresident alien is subject to Federal income tax withholding at the rate of 30%, unless the payments are exempt from tax under the Internal Revenue Code or a tax treaty.

Payees who are temporarily present in the United States in F-1, J-1, M-1, Q-1, or Q-2 nonimmigrant status are subject to a reduced 14% withholding rate on the taxable portion of the scholarship.

State Income Tax Issues

If a scholarship recipient resides in a state with an income tax, the student will have to consider whether any portion of the scholarship is taxable under state law.

• Some states (e.g., Nebraska) in effect adopt the federal income tax law as the state’s income tax law.• Nebraska’s state income tax

computations start with federal “adjusted gross income.”

The federal “adjusted gross income” of a scholarship recipient subject to Nebraska income taxation would thus include the taxable portion of the scholarship.

Would any state with an income tax assert a claim for state income tax based on a scholarship awarded to a nonresident student?