Does taxable scholarship money used for living expenses count as salary when applying Virginia's $15,000 state-employee salary subtraction limit?

Plain-English summary

A Commonwealth employee earned $10,000 in W-2 wages and received $17,500 in scholarship funds during 2017. Virginia initially denied the state-employee salary subtraction because her overall income exceeded $15,000.

The Department abated the assessment: only compensation that counted as salary applied to the $15,000 limit. The $16,000 taxable scholarship used for living expenses was not paid for services and therefore was not salary.

The $15,000 government-employee rule

Va. Code § 58.1-322.02(16) allows federal and state employees to subtract the first $15,000 of salary when their total annual salary from all employment is $15,000 or less.

The taxpayer was a verified state employee. The question was whether her scholarship money raised total salary above the ceiling.

How Virginia classified the three amounts

• $10,000 W-2 wages: Payment for teaching-assistant services. This was salary and counted toward the limit.
• $1,500 scholarship reported on Form 1099: Used for required tuition and fees. It qualified for exclusion from gross income under IRC § 117.
• $16,000 scholarship for room and board: Taxable because it paid incidental living expenses, but not compensation because the taxpayer did not receive it for teaching, research, or other required services.

Virginia has construed the salary ceiling to include income reported on Form W-2. Scholarship money may be taxable income without being salary. Since the taxpayer's salary was only $10,000, she stayed below the $15,000 limit.

What this means for you

• Taxable income and salary are not identical. A taxable scholarship for living expenses may still fall outside the government-employee salary limit.
• Services are the key distinction. Scholarship payments for required teaching, research, or other services can be wages; educational support without a service condition is different.
• Forms help identify character but do not decide everything. The Department examined what each payment was for.
• The ceiling uses salary from all employment. Other W-2 compensation could still disqualify an otherwise eligible government employee.

Common questions

Q: Did all $17,500 of scholarship money count as salary?

A: No. The tuition portion was excluded from income, and the room-and-board portion was taxable income but not compensation for services.

Q: Why did the $10,000 count?

A: It was W-2 compensation for the taxpayer's teaching-assistant services and therefore salary.

Q: What was the result?

A: Her total salary was $10,000, below the $15,000 ceiling, so Virginia allowed the subtraction and abated the assessment.

Citations and references

• Va. Code § 58.1-322.02(16) — government-employee salary subtraction
• IRC § 117(a), (b)(2) — qualified scholarships
• Treas. Reg. § 1.117-2(a) — scholarships and service compensation
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Law No. 82-0846 (Roanoke Cir. Ct. 10/27/1983)
• Related Virginia ruling cited: P.D. 09-17

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-81

Original ruling text

August 2, 2019

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the “Taxpayer”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayer filed a Virginia resident individual income tax return for the 2017 taxable year and subtracted the income she received as an employee of the Commonwealth of Virginia. The Department denied the subtraction on the basis that the Taxpayer received more than $15,000 in salary from all employment and issued an assessment. The Taxpayer appeals, contending she was entitled to claim the subtraction because she had less than $15,000 in income that should have been considered salary.

DETERMINATION

By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell’s Motor Freight, Inc. et al. v Virginia Dep’t of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

Virginia Code § 58.1-322.02 16 allows for a subtraction for:

The first $15,000 of salary for each federal and state employee whose total annual salary from all employment for the taxable year is $15,000 or less.

The statutory language first grants a subtraction (“the first $15,000 of salary for each federal and state employee”) then imposes a restriction (“whose total annual salary from all employment for the taxable year is $15,000 or less”). If the Taxpayer was a “federal or state employee”, then she is granted the subtraction, subject to the limiting condition imposed by the last clause.

The documentation provided verifies that the Taxpayer was a state employee. As such, the subtraction was available to the Taxpayer, subject to the $15,000 limitation. During the 2017 taxable year, the Taxpayer received $10,000 in wages from her employment with the Commonwealth, which was reported on a Form W-2. The Taxpayer also received $17,500 in scholarships. A $1,500 scholarship was reported on a Form 1099. The Taxpayer also had $16,000 in scholarship income that was not reported on either a Form W-2 or a Form 1099.

The Department has construed the subtraction limitation to include all income reported on a W-2 for the taxable year. See Public Document (P.D.) 09-17 (2/4/2009). The Internal Revenue Code (IRC) § 117 addresses the taxability of scholarships and grants. Amounts received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization are not included in gross income. See IRC § 117 a. A qualified scholarship means any amount received as a scholarship to the extent the individual establishes that such amount was used for tuition and fees requested for enrollment, or fees, books, supplies and equipment required for courses. See IRC § 117 b 2. Amounts received as scholarship funds and used for incidental expenses, such as room and board, travel and optional equipment are includable in gross income. However, such amounts are not considered wages unless they are received as payments for teaching, research or other services required as a condition for receiving the scholarship. See Treas. Reg. § 1.117-2 a.

Based on information provided by the Taxpayer, the income reported on the Form W-2 were payments received for her services as a teaching assistant. The $1,500 scholarship reported on the Form 1099 was used to pay tuition and fees required for her enrollment, which was appropriately excluded from her gross income. The $16,000 scholarship was used to pay incidental expenses, such as room and board, but was not received in payment of services performed. While these scholarship funds were includable in the Taxpayer’s gross income, such income merely helped fund her education by covering her living expenses. Because the funds were not compensation for services reported on Form W-2, the Department does not consider it to have been income earned as salary.

The Taxpayer received $10,000 in wages, which did not exceed the $15,000 limitation. The Taxpayer was, therefore, eligible to claim the subtraction, and the assessment will be abated.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1886.A

Related Documents

09-17