Taxable Scholarship - "Candidate for degree" is broadly interpreted


Frank S. Duke, Jr.

I found the answer to this question and thought you might be interested in
case you ever encounter it. My resource was Beanna Whitlock from San
Antonio TX, who was a past president and lecturer with the National Society
Of Tax professionals. She and her husband have run a tax service for a very
long time and she also spent considerable time working in the IRS National
office. She spoke to Steve Toomey, an IRS attorney about this issue and
this was his answer. The regulation as currently written is overly
restrictive and never enforced as it reads. Since the late 1980s, the IRS
has followed a very broad interpretation of ³candidate for a degree² that
includes any course from an accredited school that could be counted toward a
degree, even as an elective. There is no requirement to provide any proof
of registration or to even show intent of getting a degree in order to
exempt a scholarship from income. It just has to be a course that grants
credit and comes from a university that grants degrees.

Beanna said that in all her years of practice, she has never run into this
before and so far, I have not found anyone else who has either.

Frank S. Duke, Jr.

Original message
I have a client who is a 50 year old high school teacher who took two
courses in 2008 for college credit, one at University of Cincinnati and one
at Miami of Ohio. He received a1098-T from each college showing the cost
of the tuition and reflecting a scholarship in box 5 for an equal amount so
the courses were ³free². IRS Pub 970 and Section 117 indicate that
scholarships are tax free only if you are a ³candidate for a degree² and you
use the money to pay for qualified educational expenses. He was not
formally enrolled as a degree candidate, just taking professional enrichment

I have not run into this before but, being enrolled as a degree candidate
seems to be a clear requirement. The total amount is $6630 in income so it
makes a significant difference. The devil seems to be in defining,
³candidate for a degree². There is no definitive measure. The closest I
have come is Treasury Reg. 1.117-3 Definitions which say, "The term
"candidate for a degree" means an individual, whether undergraduate or a
graduate, who is pursuing studies or conducting research to meet the
requirements for an academic or professional degree conferred by colleges
and universities. It is not essential that such study or research be
pursued or conducted at an educational institution which confers such
degrees if the purpose thereof is to meet the requirements for a degree of a
college or university which does confer such a degrees. A student who
receives a scholarship for study at a secondary school or other educational
institution is considered to be a "candidate for a degree".This whole thing hinges on whether you check the box on the 1098-T worksheet
that says not a "degree candidate". If you do, the scholarship goes
straight to line 7 of the form 1040. The above definition would seem to
require a measure of future intent. Even if he were pursuing a degree, what
happens if he drops out? Does his scholarship become taxable. If this is
taxable, it costs my client about $1300 in federal and state tax. I have not
found one other tax professional who has encountered this. I guess if I
could not find a definition, perhaps the IRS cannot either. Even more
daunting is that this would be an error of omission, unlikely to be
detected. It strains ones sense of ethical honor.

§ 117. Qualified scholarships
(a) General rule
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).
(b) Qualified scholarship
For purposes of this section‹
(1) In general
The term ³qualified scholarship² means any amount received by an individual
as a scholarship or fellowship grant 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.
(2) Qualified tuition and related expenses
For purposes of paragraph (1), the term ³qualified tuition and related
expenses² means‹
(A) tuition and fees required for the enrollment or attendance of a student
at an educational organization described in section 170 (b)(1)(A)(ii), and
(B) fees, books, supplies, and equipment required for courses of instruction
at such an educational organization.
(c) Limitation
(1) In general
Except as provided in paragraph (2), subsections (a) and (d) 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 qualified tuition reduction.

Frank S. Duke, Jr. CPA
Cincinnati, OH USA


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