Q&A #169 – Must a Form 1099 be issued for a scholarship payment?
Question: I am the Executive Director of an organization that awards a scholarship every year to students who meet certain criteria, as selected by a committee of our Board of Directors. We require that the students use the funds towards courses that further their education, but not necessarily through a degree program. Are we required to provide a Form 1099 to the recipients?
Answer: Despite common misconceptions, Treasury Regulations and Internal Revenue Service (IRS) guidance provide that most scholarship payments provided by nonprofit organizations are not required to be reported by the payor on Form 1099 (or Form W-2), regardless of whether the scholarship is a “qualified scholarship” or taxable to the recipient, so long as the primary purpose is to aid the student in pursuing their studies and not as compensation for past, present, or future services.
One common source of confusion related to this question is the distinction between the issues of: (1) whether the scholarship is taxable to the recipient, and (2) whether the scholarship imposes reporting obligations on the organization making the payments.
Section 117 of the Internal Revenue Code governs whether an individual recipient is permitted to exclude a scholarship or fellowship grant from their gross income for income tax purposes. Not all scholarships or fellowship grants qualify for exclusion – generally, a scholarship or fellowship grant can only be excluded from tax if it meets the definition of a “qualified scholarship.” Otherwise, a scholarship or fellowship grant will normally constitute taxable income to the recipient. To qualify for the exclusion, the recipient must be able to establish that the funds were actually used for tuition, fees, and/or certain related expenses required to attend a course of instruction at an educational organization described in Section 170(b)(1)(A)(ii) of the Internal Revenue Code. The exclusion is also subject to sharp limits if the student is not a candidate for a degree.
However, the payor organization’s Form 1099 reporting requirements are an entirely separate issue, and the analysis of this issue does not depend on whether the scholarship qualifies for tax exclusion. Payor organizations are not required to report scholarships or fellowship grants on either Form 1099 or Form W-2 unless the payments were made in exchange for services to the payor organization, regardless of whether the payment is a “qualified scholarship.” If the payments do represent compensation for services, then the recipient will likely be considered an employee, and the payments will be subject to Form W-2 reporting.
The IRS has stated this principle clearly in the Instructions for Forms 1099-MISC and 1099-NEC, which provide as follows (emphasis added):
“Do not use Form 1099-MISC to report scholarship or fellowship grants. Scholarship or fellowship grants that are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant are considered wages and must be reported on Form W-2. Other taxable scholarship or fellowship payments (to a degree or nondegree candidate) do not have to be reported to the IRS on any form … [subject to certain narrow exceptions].”
These instructions are based on longstanding Treasury Regulations that describe certain exempted categories of payments for which no Form 1099 reporting is required. Specifically, Section 1.6041-3(n) of the Treasury Regulations provides (emphasis added):
“Payments to individuals as scholarships or fellowship grants within the meaning of section 117(b)(1), whether or not "qualified scholarships" as described in section 117(b). This exception does not apply to any amount of a scholarship or fellowship grant that represents payment for services within the meaning of section 117(c). Instead, these amounts are required to be reported as wages on Form W-2.”
Thus, in determining whether Form 1099 (or Form W-2) reporting is required with respect to a scholarship, the payor organization must determine whether the payment constituted a “scholarship” under Section 117(b)(1) rather than payment for services. Importantly, the organization need not determine whether the recipient used the funds in a manner consistent with the definition of a “qualified scholarship” or whether the scholarship is taxable or non-taxable to the recipient.
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The definition of a “scholarship” is found in Section 1.117-3 of the Treasury Regulations, which provides that the term “scholarship” generally means “an 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.” Section 1.117-4(c) of the Treasury Regulations further explains that:
“[A]mounts paid or allowed to, or on behalf of, an individual to enable him to pursue studies or research are considered to be amounts received as a scholarship or fellowship grant for the purpose of section 117 if the primary purpose of the studies or research is to further the education and training of the recipient in his individual capacity and the amount provided by the grantor for such purpose does not represent [compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor].”
These regulations make clear that the definition of a “scholarship” is required is relatively broad and likely covers a wide range of payments for educational purposes both inside and outside of the context of seeking a formal degree at a college or university. In summary, if the primary purpose of the payment is to aid the student in pursuing their studies and does not represent compensation for past, present, or future services, then no Form 1099 reporting will be required, even if the payment is taxable to the recipient.
Planning Tip – If your organization provides scholarships for which no Form 1099 reporting is required, it is prudent to alert the recipients that they should seek advice from their tax advisors as to whether or not they are required to report the payments as taxable income. Ideally, recipients should be notified at the front-end of the process when the scholarship award notices are sent out, and again when distributions are made. While organizations should not provide individual tax advice to scholarship recipients, notifying them about the possibility of tax issues will help recipients avoid unwanted surprises from the IRS that can cause resentment and frustration to be directed at your organization.
The distinction between a scholarship and a payment for services can often be difficult to discern, such as where a university provides a scholarship that requires the recipient to fulfill teaching or clinical obligations. However, the facts in your question do not indicate any such issues. And since your organization requires its scholarship recipients to use the funds towards coursework that furthers their education, it is probably reasonably safe to conclude that no Form 1099 reporting is required.
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