PLR 200851039: Advance approval for a foundation awarding scholarships on need or academic promise

Plain-English summary

A private foundation that hands money to individuals is in danger by default. Sections 4945(a) and (b) impose excise taxes on taxable expenditures, and section 4945(d)(3) makes any grant to an individual for travel, study or similar purposes a taxable expenditure unless it meets section 4945(g). The safe route is to get the selection procedures approved in advance, which is what this foundation did.

The program funds full-time students at colleges, universities and secondary schools for up to four years, and students at trade or technical schools in the United States for up to two. Eligibility runs to United States citizens resident in the United States who are enrolled or planning to enroll full time, and who either have a financial need or have achieved or promise academic success. That disjunction is the design feature of this program: need and merit are alternative routes in, not cumulative requirements, and the letter carries a separate verification track for each.

For a need-based applicant, the school is asked to confirm the student's eligibility for a Pell Grant, or failing that the parents submit a signed copy of their most recent Form 1040, 1040A or 1040EZ, with an independent student or one who filed a return supplying their own with all schedules. For a merit-based applicant, the school confirms grades or the student sends an official transcript, and ACT and SAT results are considered. For either route the foundation also weighs recommendations from instructors or others unrelated to the candidate, community and artistic activities, athletics and work experience. Awards are made on an objective and non-discriminatory basis, with race, creed, color, sex, age and disability excluded from consideration. Applicants are found through a program website advertised in a newspaper of general circulation, and each submits a short letter about need or achievement, aspirations, any special family circumstances, activities and work history.

The conflict-of-interest structure is what makes the procedure acceptable rather than merely well-intentioned. The selection committee includes the foundation's trustee and an independent third party drawn from the community, anyone related to either of them or to any other disqualified person is ineligible, and the letter records that the selectors are not in a position to derive a private benefit directly or indirectly from choosing one candidate over another.

Payment and follow-up are equally structured. Grants are qualified scholarships under section 117 for use at an educational institution described in section 170(b)(1)(A)(ii), and they are paid directly to the institution, which agrees to apply the money to educational expenses only while the student stays enrolled in good academic standing. The institution writes to the foundation each year confirming academic standing and continuing financial need. The award runs up to four years and no longer than the standard time to the degree or certificate. The foundation keeps the evaluation material, the identity of each grantee, the amount and purpose of each grant and every annual letter, which is what Treas. Reg. 53.4945-4(c)(1) requires when it asks for an objective selection process, a procedure calculated to produce the funded activity, and reports to verify that it happened.

The approval carries the standard limits. It assumes the program runs as proposed, it is conditioned on no material change in the facts, and it is conditioned on no grant going to a foundation manager or a member of the selection committee or for a purpose inconsistent with section 170(c)(2)(B). It is a one-time approval of standards and procedures, extending to later programs only while they do not differ materially. The letter also determines that awards made under the procedures are excludable from the recipients' gross income within the limits of section 117.

One detail of the released text is worth noting for anyone citing it. The letter states that it may not be used or cited as precedent under section 6110(j)(3), which was the location of that rule before it was redesignated as section 6110(k)(3). The letter is quoting the old subsection, and the banner above this summary reflects where the rule now sits. The same slip appears elsewhere in this era of releases.

The scan is clean by the standards of these releases. A stray apostrophe at the start of a line in the quotation of section 4945(g)(1) and a stray bar in the third clause of the regulation have been corrected. Left as released: "grants will be qualified scholarships under Code section 117 to used at an educational institution", where a word is missing; the legend's use of capital X for the foundation and lower-case x for the scholarship amount, which makes the redacted text hard to read closely; and "grant making" unhyphenated in the closing paragraph where it is hyphenated earlier.

Ruling snapshot

• Question: Do a private foundation's scholarship selection procedures qualify for advance approval, so that grants under them are not taxable expenditures?
• Outcome: Approved. The procedures comply with section 4945(g), so awards made under them will not be taxable expenditures within section 4945(d)(3), and awards are excludable from recipients' gross income subject to the limits of section 117. Conditioned on no material change in the facts and on no grant going to a foundation manager or selection committee member or for a purpose inconsistent with section 170(c)(2)(B). One-time approval, extending to later programs only while they do not differ materially.
• Key authorities: IRC sections 4945(a), (b), (d)(3), (g) and (g)(1), 74(b), 117, 117(a), 170(b)(1)(A)(ii), 170(c)(2)(B), 501(c)(3) and 509(a); Treas. Reg. 53.4945-4(c)(1).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
P.O. Box 2508
Cincinnati, OH 45201

Number: 200851039
Release Date: 12/19/2008

Employer Identification Number:
Date: October 7, 2008
Contact Person - ID Number:

Contact Telephone Number:

EO
LEGEND UIL = 4945.04-04
X=
x=

Dear Sir or Madam:

We have considered your request for advance approval of your grant-making program under section 4945(g)(1) of the Internal Revenue Code, dated April 18, 2008.

Our records indicate that X was recognized as exempt from Federal income tax under section 501(c)(3) of the Code and that it is classified as a private foundation as defined in section 509(a).

Your letter indicates that X will make grants for up to four years for the benefit of individuals who are full-time students and enrolled in colleges, universities, and secondary schools, and for up to two years for students who are full-time and enrolled in trade or technical schools in the United States. Each scholarship award shall not be less than x.

To be eligible for a grant, an individual must be a United States citizen and a resident of the United States enrolled or planning to enroll as a full-time student in a college, university, trade or technical school, or secondary school in the United States and who has (1) a financial need or (2) achieved or promises academic success.

X will solicit scholarship requests by establishing a website regarding the scholarship program and by posting a notice of the scholarship website in a newspaper of general public circulation. Possible grantees will be required to submit a brief letter demonstrating their financial need and/or academic success, their interest in the scholarship, aspirations and any special family circumstances that they would like X to consider, previous school and non-school extra-curricular activities in which they have participated, and work experience.

With respect to students who are seeking a scholarship on the basis that they need financial assistance, the college, university, trade or technical school, or secondary school

will be asked to confirm to X the eligibility of the student for Pell Grant, or as an alternate, parents will be asked to submit a true and correct signed copy of their income tax form 1040, 1040A, or 1040EZ for the most recent tax year to X. If the student is an independent student or filed an income tax return, the student will be asked to send a properly signed copy of their income tax form 1040, 1040A, or 1040EZ, including all schedules.

With respect to students who are seeking a scholarship on the basis of academic achievement, the college, university, trade or technical school, or secondary school will be asked to confirm to X the student’s grades, or as an alternate, the student will be asked to submit an official transcript. X will also consider performance on tests designed to measure ability and aptitude for higher education (such as the ACT and SAT).

With respect to scholarships based on either a financial need or academic promise, X will also consider recommendations from instructors or other individuals unrelated to the candidate; and involvement in community activities, artistic activities, athletics, work experience, and other extra-curricular activities. The scholarships will be awarded on an objective and non-discriminatory basis, with neither race, creed, color, sex, age, nor disability being considered.

From the submitted information, X will choose individuals they feel best correspond to its grant-making purposes — to recognize and financially assist students who have succeeded or promise to succeed academically or who are in financial need.

The group of persons selecting the grant recipients will not be in a position to derive a private benefit, either directly or indirectly, should certain individuals be chosen to receive grants instead of others. X has established a scholarship selection committee to select grant recipients, which will include X’s Trustee and an independent third-party who is a member of the community. Potential grantees that are related to X’s Trustee or the independent third party (or any other disqualified person with respect to X) are not eligible for scholarships.

X’s grants will be “qualified scholarships” under Code section 117 to used at an educational institution described in Code section 170(b)(1)(A)(ii) and will be made directly to the institution, which will agree to use the grant funds to defray the grantee’s educational expenses only if the grantee maintains enrollment at the institution in good academic standing. The grantee’s academic standing and/or continued financial need will be verified annually in a letter from the educational institution to X.

The scholarship award can be received for up to a maximum of four years, not to exceed the standard period of time necessary to obtain the specified degree or certificate. It is also anticipated that the recipient will receive the full amount of state and federal assistance grants available.

X will retain all information used to evaluate potential grantees, the grantees’ identification, the amount and purpose of each grant and each annual letter from the educational institution updating each grantee’s academic and financial status.

Sections 4945(a) and (b) of the Code impose certain excise taxes on “taxable expenditures” made by a private foundation.

Section 4945(d)(3) of the Code provides that the term “taxable expenditure” means any amount paid or incurred by a private foundation as a grant to an individual for travel, study, or other similar purposes by such individual, unless such grant satisfies the requirements of subsection (g).

Section 4945(g) of the Code provides that section 4945(d)(3) shall not apply to individual grants awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance if it is demonstrated that:

(1) The grant constitutes a scholarship or fellowship grant which is subject to the provisions of section 117(a) and is to be used for study at an educational organization described in section 170(b)(1)(A)(ii);

(2) The grant constitutes a prize or award which is subject to the provisions of section 74(b), if the recipient of such prize or award is selected from the general public, or

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

Section 53.4945-4(c)(1) of the Regulations provides that to secure approval, a private foundation must demonstrate that:

(i) Its grant procedure includes an objective and nondiscriminatory selection process;

(ii) Such procedure is reasonably calculated to result in performance by grantees of the activities that the grants are intended to finance; and

(iii) The foundation plans to obtain reports to determine whether the grantees performed activities that the grants are intended to finance.

Based on the information submitted and assuming your award programs will be conducted as proposed with a view to provide objectivity and nondiscrimination in making the awards, we have determined that your procedures for granting the awards comply with the requirements contained in section 4945(g) of the Code and that awards granted in accordance with such procedures will not constitute “taxable expenditures” within the meaning of section 4945(d)(3).

In addition, we have determined that awards made under your procedures are excludable from the gross income of the recipients subject to the limitations provided by section 117 of the Code.

This determination is conditioned on the understanding that there will be no material change in the facts upon which it is based. It is further conditioned on the premise that no grants will be awarded to foundation managers, or members of the selection committee, or for a purpose that is inconsistent with the purpose described in section 170(c)(2)(B) of the Code.

The approval of your award program procedures herein constitutes a one-time approval of your system standards and procedures designed to result in awards which meet the requirements of section 4945(g)(1) of the Code. This determination only covers the grant

programs described above. Thus, approval shall apply to subsequent award programs only as long as the standards and procedures under which they are conducted do not differ materially from those described in your request.

Any funds you distribute to individuals must be made on a true charitable basis in furtherance of the purposes for which you are organized. Therefore, you should maintain adequate records and case histories so that any or all award distributions can be substantiated upon request by the Internal Revenue Service.

This determination is directed only to the organization that requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as a precedent.

You must report any future changes in your grant making procedures. Please keep a copy of this letter in your permanent records.

We have sent a copy of this letter to your representative as indicated in your power of attorney.

If you have any questions, please contact the person whose name and telephone number are shown above.

Sincerely yours,

Robert Choi
Director, Exempt Organizations
Rulings and Agreements