Lives were changed during a 2019 commencement address at Morehouse College when self-made billionaire Robert F. Smith announced that he was paying the student debt for the entire class. Shortly afterward, those students, potential donors, and tax geeks like me began to wonder whether there would be any tax consequences as a result of the windfall (you can read my answer here). But wouldn’t it be better for graduates – and potential donors – if the tax questions were settled?
Congress may be working on some solutions. In March, Sen. Gary Peters (D-MI) introduced a bill that would exclude post-graduation scholarship grants from gross income in the same manner as scholarships are currently excluded. The bill, S. 676, Workforce Development Through Post-Graduation Scholarships Act of 2019, would exclude post-graduation scholarship grants from gross income if they are distributed through certain tax-exempt organizations. Recipients would be required to live and work in communities that meet certain requirements (typically those that are low income or have a lower graduation rate). The bill, which was introduced in the Senate on March 6, 2019, is co-sponsored by Sen. Shelley Moore Capito (R-WV). You can read the bill, which downloads as a PDF, here.
A similar bill was introduced in the House in 2018 by Rep. Darin LaHood (R-IL). H.R. 6486, Workforce Development Through Post-Graduation Scholarships Act of 2018, was referred to the House Ways and Means Committee where it currently sits. You can read the bill, which downloads as a PDF, here.
Under these bills, donors could make gifts to be used for scholarships to pay off acquired student debt – and qualified recipients wouldn’t have to worry about the potential tax consequences. That would be consistent with existing rules for students who have not yet graduated. The rule that currently excludes traditional (or pre-graduation) scholarships is found at section 117of the Internal Revenue Code, which begins:
(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).
The scholarship exception does not apply to amounts that are paid in exchange for teaching, research, or other services which are a condition for receiving the scholarship (or tuition reduction). If you have to work for the scholarship or grant, that income generally taxable, though some exceptions apply.
Fortunately, if a scholarship is federal income tax-free – and it’s the only income the student receives for the year – they’re off the hook: there’s generally no need to file a federal income tax return. However, any taxable portion of your scholarship or fellowship on your tax return should be reported on a federal income tax return even if there is no tax owed. And of course, under current law, there’s no double-dipping: students can’t exclude fellowships and scholarships from income and then deduct them as educational expenses. You can find out more about the taxation of scholarships and grants here.
As for those of you who are feeling charitable – even if not at Robert F. Smith levels? For now, if you’d like to make a difference in a student’s life AND you’re concerned about tax consequences, remember that you can always pay tuition for a current student directly to the educational institution – and the amount doesn’t count towards the annual exclusion amount (read: no gift tax consequences). If you’re looking to also capture a charitable donation, you can donate to a qualifying educational institution and earmark it for scholarship purposes for current students. If you’re looking for other ways to give, check with your tax professional.
