PLR 1328020: IRS says community service requirements do not make scholarships compensation

Plain-English summary

The IRS ruled that scholarship funds awarded through a charitable program would not constitute payment for services under IRC § 117(c). Participants had to complete academic and community-service requirements, but the service was performed for unrelated organizations, participants had meaningful choice over some service options, and the scholarship funds were paid directly to post-secondary institutions after high school. The IRS viewed the service requirement as a limited condition supporting public and educational purposes rather than a substantial quid pro quo. The ruling did not decide whether the awards were qualified scholarships under § 117(b) or whether recipients could exclude them under § 117(a).

Ruling snapshot

• Question: Did the program’s community-service requirements make its scholarship awards payment for services?
• Outcome: Approved, the service requirements do not constitute payment for services under § 117(c) on the stated facts.
• Key authorities: IRC §§ 117, 501; Bingler v. Johnson, 394 U.S. 741 (1969); Rev. Ruls. 73-256, 76-122, 76-183, and 77-44.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201328020 Third Party Communication: None
Release Date: 7/12/2013 Date of Communication: Not Applicable
Index Number: 117.05-02, 117.05-03
Person To Contact:
-------------------------- ----------------------------, ID No. --------------
---------------------------------------------------- -----------------
----------------------------------------- Telephone Number:
------------------------------------------------ ----------------------
Refer Reply To:
------------------------------------------------------------ CC:TEGE:EOEG:ET2
--- PLR-144205-12
-------------------------- Date:
-------------------------------- April 12, 2013
-

LEGEND:

Taxpayer = --------------------------------------------
Program = -------------------------------------

Dear --------------:

This is in reply to your request for a ruling of October 2, 2012, on behalf of Taxpayer
regarding certain service requirements under Taxpayer’s scholarship program. The
Program requires participants to perform unpaid services for unrelated community
service organizations in order to qualify for scholarships awarded by the Program.
Taxpayer has requested a ruling that scholarship funds awarded to participants do not
constitute a payment for services within the meaning of section 117(c) of the Internal
Revenue Code (the “Code”).

FACTS:

Taxpayer is an organization exempt from tax under section 501(c)(3) of the Code.
Taxpayer operates the Program, whose purpose is to encourage academic
performance, community service, and pursuit of a college education among middle and
high school students. Students in grades 8 through 12 are eligible to participate in the
Program. Participants are chosen through nomination by unrelated partner agencies.
The Program establishes minimum annual academic performance and community
service requirements and students who meet these requirements are awarded college
scholarship funds on an annual basis. Academic performance and community service
requirements as well as scholarship award amounts increase with each grade level after
grade nine.

Participants may satisfy 50 percent of the community service required by the program
by volunteer work in any capacity of the participant’s choosing. Participants satisfy the
PLR-144205-12 2

remaining 50 percent of the community service requirement by monthly participation in
one of several public service projects organized by Taxpayer. Taxpayer partners with
various partner organizations in offering these public service projects. The partner
organizations are exempt from tax under section 501(c)(3) of the Code and are not
related to Taxpayer by common control or otherwise. Participants in these public
service projects provide services to the partner organizations and not to Taxpayer. The
partner organizations, not Taxpayer, supervise participants in these projects.

The funds used for the Program’s scholarship awards are pooled in a single account,
with specific amounts electronically credited to each participant as they earn scholarship
awards. The Program disburses scholarship award funds only after participants have
completed high school and enrolled in a post-secondary educational institution.
Participants notify the Program of the institution they will be attending and the Program
distributes the funds directly to the institution as payment toward participants’ tuition
(scholarship funds are modest amounts and are generally absorbed by one year’s
tuition). The Program never disburses scholarship funds directly to participants. A
participant has one year from the date of eligibility (graduation from high school) to use
scholarship funds; this time period is increased to four years if the participant joins the
military after high school. If the participant does not access the scholarship funds within
this time period, he or she forfeits the funds.

ANALYSIS

The federal income tax treatment of qualified scholarships and fellowship grants is
addressed in section 117 of the Code. Section 117(a) provides that gross income does
not include any amount received as a qualified scholarship by an individual who is a
candidate for a degree at an educational organization described in
section 170(b)(1)(A)(ii) (describing, generally, a school).

Only “qualified scholarships” may be excluded from income. A qualified scholarship is
defined as an amount expended for “qualified tuition and related expenses.”
Section 117(c) of the Code, implementing changes made by the Tax Reform Act of
1986, Pub.L. No. 99-514, provides that the exclusion for qualified scholarships 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 or fellowship. Regulations governing the includability of
compensatory grants in income have been upheld by the Supreme Court of the United
States, which has described excludable grants as “relatively disinterested, ‘no-strings'
educational grants, with no requirement of any substantial quid pro quo from the
recipient.” Bingler v. Johnson, 394 U.S. 741 (1969).

A scholarship or fellowship grant represents payment for services when the grantor
requires the recipient to perform services in return for the granting of the scholarship or
fellowship. A requirement that the recipient pursue studies, research, or other activities
PLR-144205-12 3

primarily for the benefit of the grantor is treated as a requirement to perform services. A
scholarship or fellowship grant conditioned upon either past, present, or future services
by the recipient, or upon services that are subject to the direction or supervision of the
grantor, represents payment for services under this section.

Although scholarships that represent payment for services are not excludable under
current law, not all grants that are subject to conditions or limitations represent payment
for services. Determining whether a particular awards program makes compensatory
payments within the contemplation of section 117(c) of the Code is an inherently factual
matter, requiring a consideration of the nature and extent of the impositions, and of all
other relevant facts and circumstances of the program.

Our review of the Program sponsored and funded by Taxpayer indicates that
scholarship funds awarded to participants do not constitute a payment for services
within the meaning of section 117(c) of the Code. The community service commitment
imposed on participants, briefly described above, does not constitute the requirement of
a substantial quid pro quo from the recipients; on the contrary, we find the grants to be
relatively disinterested grants, designed to accomplish public rather than any private or
proprietary purposes of Taxpayer. The Program disburses scholarship awards only
after participants have completed high school and enrolled in a post-secondary
educational institution. Additionally, the Program does not disburse scholarship funds
directly to participants and there is no temporal or proximate relationship between the
participant’s community service and the Program’s disbursement of funds.

Participants can fulfill 50 percent of their service commitment through nearly any
volunteer position of their choosing. Furthermore, while the Program limits the options
for the other 50 percent of the required service commitment, the limited options consist
of projects performed for the benefit of and supervised by organizations completely
unrelated to Taxpayer. The Program does not require participants to work for, or as
directed by, Taxpayer, and the participants’ services do not inure in an impermissible
manner to the benefit of Taxpayer. The community service commitment is in this case a
de minimis limitation, designed to assure that grantees perform services to meet social
and educational needs, the very charitable purposes for which the Program was
established. Any benefit inuring to Taxpayer appears remote, insubstantial, and
inconsequential for purposes of section 117(c).

We note that the Program’s service commitment is substantially different from that
imposed on participants in programs of the type considered in Rev. Rul. 76-183, 1976-1
C.B. 43, where grant recipients are required to perform services in a manner
determined by the grantor. Also, we have determined that the Program is
distinguishable from the situations considered in Rev. Ruls. 73-256, 1973-1 C.B. 56 and
77-44, 1977-1 C.B. 355 (where grant recipients were expected to perform services in a
specific location determined by the grantor), and in Rev. Rul. 76-122, 1976-1 C.B. 42
(where grant recipients were expected to accept employment in offices of the grantor).
PLR-144205-12 4

In the case of Taxpayer’s Program, participants choose the location and manner of
services to perform from several options. In addition, for all service options available to
participants, unrelated agencies, not Taxpayer, determine what services are performed
and direct and supervise participants in performing them. Finally, upon completion of
the Program, there is no requirement or expectation that participants will accept
employment with Taxpayer or any other employer.

Based on the information presented and representations furnished, and assuming
Taxpayer conducts the Program as proposed, we have determined that scholarship
funds awarded to participants do not constitute a payment for services within the
meaning of section 117(c) of the Code. This ruling applies narrowly to the status of
Program’s service requirements under section 117(c) and is contingent on the timing
and method of disbursing scholarship funds described herein. It does not address
whether scholarships awarded under the Program are “qualified scholarships” under
section 117(b) or whether recipients of Program’s scholarships may exclude awarded
scholarship funds from income under section 117(a).

This letter ruling is based on the facts and representations provided, and is limited to the
matters specifically addressed. No opinion is expressed as to the tax treatment of the
transactions considered herein under the provisions of any other sections of the Code
or regulations which may be applicable thereto, or the tax treatment of any conditions
existing at the time of, or effects resulting from, such transactions which are not
specifically addressed herein.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter ruling must be attached to any federal income tax return to which it
is relevant.

                                  Sincerely,




                                  Neil D. Shepherd
                                  Senior Counsel, Employment Tax Branch 2
                                  Office of the Division Counsel/Associate Chief
                                  Counsel