FAQ: Scholarships
- What are the advantages, disadvantages, and likely costs of scholarship programs?
- What do the private foundation rules require, and how should community foundations apply the rules?
- What rules or procedures govern community foundation scholarship programs?
- Does a community foundation need to notify the IRS before starting a scholarship program?
- What are the community foundation's tax reporting requirements in connection with scholarship assistance? What are the tax consequences to the student who receives scholarship aid?
- Can a community foundation make scholarship grants to individuals?
- May a scholarship fund be established through a donor-advised fund?
- What constitutes a charitable class in establishing a scholarship program?
- To whom should the community foundation make out the scholarship check, the student, or the school?
- May a community foundation give a scholarship to a student attending a for-profit school, such as a vocational school?
- Are there sample documents for scholarship funds?
- Can we increase the number or size of awards after recipients are selected?
What are the advantages, disadvantages, and likely costs of scholarship programs?
Scholarship programs focus on youth and education, two central concerns of most community foundations. Good publicity about these programs can help create community awareness of the foundation's existence and resources and can generate contributions from diverse segments of the population. Through convening scholarship granting committees, the community foundation can bring new volunteers into its activities. The drawback of scholarship programs is that they involve a good deal of administrative work on the community foundation's part. Publicizing the existence of the programs, collecting applications, coordinating the work of review committees, disbursing funds, and tracking recipients are among the tasks that are involved in running scholarships. Traditionally, community foundations have estimated that administrative costs run from five to twenty percent of the programs. If administrative costs are to be deducted from the particular scholarship fund to which they are attributable, donors should be made aware of such charges from the start. Similarly, if the community foundation opts to levy a fixed administrative fee on scholarship funds, the donor should be aware of the amount.
What do the private foundation rules require, and how should community foundations apply the rules?
In addition to the existence of a charitable class, the private foundation rules require that grants be made in a objective and non-discriminatory fashion. The selection criteria for a foundation's grants should be reasonably related to the purpose of the grant. Thus, for a scholarship grant, likely criteria on which a decision might be based include prior academic performance; test scores; recommendations from instructors; and conclusions regarding an applicant's motivation, character, and potential that are formed from an interview with them. Financial need is another legitimate consideration. Donors may also want to identify particular skills and achievements; scholar-athletes and musicians are frequently targeted for scholarship aid.
The private foundation rules further provide that people charged with selecting scholarship recipients must not be in a position to derive an economic benefit, directly or indirectly, from the scholarship process. In general, relatives of applicants should not serve on committees that will consider these requests for aid. However, there may be circumstances in which it is impossible to avoid a conflict (when a scholarship committee is required to include the principal of the local high school and she has a son who's a terrific candidate for the award). The community foundation should attempt to spot such conflicts in advance and adopt policies to resolve them (for example, allowing the principal to recuse herself from voting that year so that her child can be eligible).
Private foundations have a duty to monitor the spending of the grant and ensure that it was used for a charitable purpose. Community foundations would be wise to track their scholarship grants as well by, for example, requesting that a recipient to whom a check is made out forward a verified copy of his or her transcript. Grants that are not used for educational purposes should be refunded to the community foundation.
These rules are explained and their relevance to community foundations discussed in Grants to Individuals by Community Foundations (Nober, J. Council on Foundations, 2000).
What rules or procedures govern community foundation scholarship programs?
Like all community foundation grants, scholarship grants must be made for charitable purposes. Since furthering education is a charitable purpose, scholarships are almost by definition a charitable activity, so long as the persons benefited are members of a charitable class (see #4 below). Beyond these general principles, there are actually no specific IRS rules for how community foundations are to make scholarship grants to individuals. In the absence of such guidance, the Council recommends that community foundations look to the very exacting requirements imposed on private foundations. While community foundations need not follow these rules to the letter (although in the case of scholarship programs administered for corporate employees and their children, close attention is highly recommended), they provide a set of guidelines that the IRS has approved. If a community foundation's scholarship program substantially complies with the private foundation rules, the community foundation can be fairly certain that it is operating safely. The guidelines for a community foundation's scholarship program should be clear, consistent, and widely available.
Does a community foundation need to notify the IRS before starting a scholarship program?
Newly formed community foundations that plan to offer scholarships should disclose this proposed activity in their Application for Exemption on Form 1023. Established community foundations that decide to establish scholarship programs should inform the IRS of this new activity when they file their next tax return on Form 990. Unlike private foundations, community foundations need not secure advance approval of their procedures for making scholarship grants to individuals. When private foundations establish scholarship funds through community foundations, however, the advance approval requirement may apply.
What are the community foundation's tax reporting requirements in connection with scholarship assistance? What are the tax consequences to the student who receives scholarship aid?
Under current IRS practice, community foundations making grants for scholarships have no tax-reporting requirements except to the extent that such payments represent compensation for services provided by the recipient. To the extent that the scholarship grant pays for costs other than tuition; fees; or books, supplies and equipment required for study at a tax-exempt institution, a student may be liable for income taxes on the grant, but it is not the community foundation's responsibility to provide tax advice to its grantees. Indeed, because it will be hard to know each individual's circumstances fully, it would be irresponsible and unwise to offer such advice.
Can a community foundation make scholarship grants to individuals?
Generally, yes, but a community foundation wishing to embark on a scholarship program should first determine that its governing instruments authorize the community foundation to make grants to individuals for educational purposes. In some cases a governing instrument will specify that grants may be made only to "organizations," and the community foundation will have to weigh whether it wants to amend the documents to allow grants to individuals. If changing the documents is not desirable, the foundation may still make grants for scholarship purposes to educational institutions and give the institutions the discretion to select the individual scholarship recipients. No community foundation should embark on a scholarship program without consulting expert legal counsel.
May a scholarship fund be established through a donor-advised fund?
No. The Pension Protection Act of 2006 prohibits grants to individuals from a donor-advised fund.
What constitutes a charitable class in establishing a scholarship program?
In general, a charitable class is a group that is large enough so that an indefinite number of individuals may benefit. However, a charitable class may properly be comprised of a comparatively small number of beneficiaries, provided the class is open and the identities of the individuals to be benefited remain indefinite. "All the graduating seniors at a local high school" is a common and generally acceptable class. A class that includes members of a single family, on the other hand, is likely to be too small to qualify as charitable. Potential recipients may be limited to members of one sex or an economically disadvantaged group. Race-based limitations pose special questions and should certainly be discussed with expert counsel.
To whom should the community foundation make out the scholarship check, the student or the school?
Either one is fine, but making the check out to the school may be easier for monitoring purposes. If the community foundation makes the payment to an educational institution and requires that the institution use the funds to defray the student’s expenses only if they are enrolled and their status is consistent with the conditions of the grant, the community foundation essentially places much of the monitoring burden on the school.
May a community foundation give a scholarship to a student attending a for-profit school, such as a vocational school?
To the extent that such a grant is for a charitable purpose, there should be no bar to providing financial assistance to a student attending vocational school. Establishing a fund to assist students at particular for-profit institution may also raise problems that establishing a fund for students attending a particular state university would not.
