IRS approves a private foundation's merit-based scholarship procedures for a university program

Plain-English summary

A private foundation set up a merit-based scholarship to help students earn an
undergraduate or graduate degree at a particular university. It asked the IRS to
approve, in advance, how it selects and pays scholarship winners. That advance
sign-off matters because a private foundation normally owes an excise tax when
it makes grants to individuals for study, unless the IRS has first blessed the
award procedures under Code Section 4945(g). The IRS approved the procedures,
finding recipients are chosen on an objective, nondiscriminatory basis by a
selection committee that donors cannot control, with the money paid directly to
the school for tuition and fees. Because the procedures qualify, the grants are
not taxable expenditures for the foundation, and they are tax-free scholarships
to recipients under Section 117 when used for qualified educational expenses.

Ruling snapshot

• Question: Do the foundation's merit-based scholarship award procedures qualify for advance approval under IRC § 4945(g)(1) so the grants are not taxable expenditures?
• Outcome: Approved
• Key authorities: IRC § 4945(g)(1); IRC § 117; IRC § 170(b)(1)(A)(ii); IRC § 170(c)(2)(B)

Full text (IRS public release)

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

Release Number: 201846008
Release Date: 11/16/2018

Employer Identification Number:

Date: August 20, 2018
Contact person - ID number:

Contact telephone number:

LEGEND: UIL: 4945.04-04
B = scholarship
C = university
D = county/state
x dollars = amount

Dear

You asked for advance approval of your scholarship grant procedures under
Internal Revenue Code Section 4945(g). This approval is required because you are
a private foundation that is exempt from federal income tax. You requested
approval of your scholarship program to fund the education of certain qualifying
students.

Our determination

We approved your procedures for awarding scholarships. Based on the information
you submitted, and assuming you will conduct your program as proposed, we
determined that your procedures for awarding scholarships meet the requirements
of Code Section 4945(g)(1). As a result, expenditures you make under these
procedures won't be taxable.

Also, awards made under these procedures are scholarship or fellowship grants and are
not taxable to the recipients if they use them for qualified tuition and related expenses
(subject to the limitations provided in Code Section 117(b)).

Description of your request

You will operate a merit based scholarship program called B to enable recipients to
complete an undergraduate or graduate education in the field of their choice at select
colleges or graduate schools. The policies and procedures for B were approved by your
board of directors.

Recipients are selected on an objective and nondiscriminatory basis. The group from
which recipients are selected must be sufficiently broad so that giving scholarships to one
or more members of the group fulfills a charitable purpose; however, selection from such

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a group is not necessary if one or more recipients are selected on the basis of their
exceptional qualifications to carry out the purposes of B or it is otherwise evident that the
selection effectuates the charitable purpose of B rather than to benefit particular persons
or a particular class of persons.

You will award one or more scholarships per year, depending on the number of qualified
applicants, in amounts of up to x dollars. Your staff and designated members of your
Selection Committee will advertise the availability of B on the campus of C and
encourage potential recipients to submit applications. Applicants will be required to
submit application forms and supporting materials as you deem appropriate.

Recipients of B must be graduates of a D public high school and undergraduate students
at C pursuing studies that meet the requirements for an academic degree.

Criteria for selecting recipients of B are:

(1) Prior academic performance

(2) Prior athletic performance

(3) Prior leadership performance

(4) Additional biographical information regarding an applicant's career, academic, and
other relevant experiences

(5) The Selection Committee's conclusions as to the applicant's motivation, character,
ability, or potential.

B must be used for qualified educational expenses at C. Qualified educational expenses
are certain expenses incurred in attending an educational institution — tuition and fees for
enrollment and attendance.

You reserve the right to impose additional, minor reasonable restrictions and/or
requirements upon the awarding and administration of B. Any substantial or material
changes will be made only with approval of your board of directors.

Your Selection Committee may not be controlled by your donors. This means no
combination of donors, persons appointed or designated by donors, and persons (a term
that includes partnerships, corporations, and trusts as well as individuals) related to them
may constitute a majority of the committee, be given a veto power, be allowed to chair
the committee or otherwise be permitted to control the committee's decisions. If a
donor/advisor recommends a person for appointment to a Selection Committee based on
objective criteria related to the expertise of such person, such person will not be deemed
to be appointed or designated by the donor/advisor.

Every member of your Selection Committee must adhere to your relevant policies as they
may be adopted and amended from time to time, including without limitation, your conflict
of interest and confidentiality policy. Each member of any Selection Committee must
disclose any personal knowledge of and relationship with any potential grantee under
consideration and refrain from participation in the award process in a circumstance where

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they would derive, directly or indirectly, a private benefit if any potential grantee(s) are
selected over others.

B may not be awarded to any member of your board of directors, any substantial
contributor, any employee, or any other disqualified person. B may not be awarded to any
donor/advisor or substantial contributor to the fund making the award, to any member of
a Selection Committee for such award, or to any members of their families. Finally, B
may not be made for a purpose that is not charitable.

Your Selection Committee will forward recommendations to you in such form and on such
schedule as you shall establish. Your board of directors will approve each award.

Your Selection Committee is required by provision to have at least three members. If a
member of the Selection Committee dies or becomes incapacitated, or is otherwise
unable to act or continue to act in furtherance of the specified duties of the Selection
Committee, the remaining members of the Selection Committee have the right and duty
to name an agreed-upon successor. The selection of any new member of the Selection
Committee will include a detailed evaluation of the background, qualifications, possible
disqualifications and conflicts, and willingness to perform the required duties of a
proposed member of the Selection Committee. The official selection of a new member of
the Selection Committee shall be in written form and signed by the remaining members of
the Selection Committee.

B will ordinarily be awarded for a one-year period. You may consider renewing B on a
case by case basis according to the status of the recipient's project.

Unless otherwise provided in the fund agreement, B will be used only for qualified
educational expenses. An additional condition is that no part of B be used as payment
for teaching, research, or other services by the recipient.

You will pay B directly to C for the recipient to defray qualified educational expenses. C
has agreed in writing to use B to defray expenses only if the recipient is enrolled and in
good standing consistent with the purposes and condition of B.

You will conduct proper follow-up to determine whether recipient(s) have performed the
activities B is intended to finance and have not diverted any funds away from the original
purposes of B. You will do so through periodic progress reports made annually. If these
progress reports are not made or there are other indications that B is not being used as
intended, you will investigate and take corrective action.

You will keep records relating to B including:
(1) Information obtained to evaluate potential recipients
(2) Identification of recipients including any relationship to you that makes them a
disqualified person
(3) Amount and purpose of each scholarship

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(4) Follow-up information, including required annual reports and investigation of
jeopardized funds.

Where the reports submitted or other information (including the failure to submit reports)
indicate B is not being used for its intended purpose, you will investigate. While
conducting your investigation, you will withhold further payments to the extent possible
until any delinquent reports required under these procedures have been submitted. You
will also take reasonable and appropriate steps to recover misused funds and/or ensure
restoration of the diverted funds to the purposes of B. However, if the recipient has not
previously diverted funds, you may elect to continue further payments if you receive
assurance future diversions will not occur, that the recipient has restored the missing
funds, and the recipient will take extraordinary precautions prescribed by you to prevent
future diversions from occurring. If a further diversion takes place, you will take steps to
recover funds.

The phrase "all reasonable and appropriate steps" includes legal action where
appropriate, but may not include legal action if such action would in all probability not
result in the satisfaction of execution on a judgment.

Information pertaining to unsuccessful applicants for B shall be kept along with
information on successful applicants for no less than three years after the filing of your
annual tax return for the period in which the last installment of B was paid.

Basis for our determination

The law imposes certain excise taxes on the taxable expenditures of private foundations
(Code Section 4945). A taxable expenditure is any amount a private foundation pays as a
grant to an individual for travel, study, or other similar purposes. However, a grant that
meets all of the following requirements of Code Section 4945(g) is not a taxable
expenditure.

• The foundation awards the grant on an objective and nondiscriminatory basis.

• The IRS approves in advance the procedure for awarding the grant.

• The grant is a scholarship or fellowship subject to the provisions of Code Section
  117(a).

• The grant is to be used for study at an educational organization described in Code
  Section 170(b)(1)(A)(ii).

Other conditions that apply to this determination

• This determination only covers the grant program described above. This approval
  will apply to succeeding grant programs only if their standards and procedures
  don't differ significantly from those described in your original request.

• This determination applies only to you. It may not be cited as a precedent.

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• You cannot rely on the conclusions in this letter if the facts you provided have
  changed substantially. You must report any significant changes to your program to
  the Cincinnati Office of Exempt Organizations at:

Internal Revenue Service
Exempt Organizations Determinations
P.O. Box 2508
Cincinnati, OH 45201

• You cannot award grants to your creators, officers, directors, trustees, foundation
  managers, or members of selection committees or their relatives.

• All funds distributed to individuals must be made on a charitable basis and further
  the purposes of your organization. You cannot award grants for a purpose that is
  inconsistent with Code Section 170(c)(2)(B).

• You should keep adequate records and case histories so that you can substantiate
  your grant distributions with the IRS if necessary.

Please keep a copy of this letter in your records.
If you have questions, please contact the person listed at the top of this letter.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

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