Counterintuitive Thoughts on Legal Scholarship and Secured ...
Legal Lowdown: Fundamentals for Scholarship...
Transcript of Legal Lowdown: Fundamentals for Scholarship...
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© 2015 Leaffer Law Group
Legal Lowdown: Fundamentals
for Scholarship Providers
Karen Leaffer National Scholarship Providers Association October 12, 2015
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Legal Context
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You’re All Unique …
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And the IRS Agrees!
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Types of Scholarship Providers:
Scholarship
Recipient
Nonprofit
Providers
For-Profit Providers
Govern- mental
Providers
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Types of Nonprofit Providers:
Nonprofit Providers
501(c)(3) Private Foundations
501(c)(3) Public Charities
Other Nonprofits
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Types of Nonprofit Providers:
More public involvement
= less IRS oversight
501(c)(3) limitations
Examples:
Private colleges
University foundations
Community foundations
Other organizations that
rely on many donors
Less public involvement
= greater IRS oversight
501(c)(3) limitations
+ private foundation rules
Examples:
Endowed foundations
Family foundations
Company foundations
(e.g., employer-related plans)
Public Charities Private Foundations
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Types of Nonprofit Providers:
Other Nonprofits
Less tax benefits = less IRS oversight
Some limitations based on tax-exemption category
Examples:
501(c)(4) providers (social welfare/civic organizations)
501(c)(5) providers (agricultural/horticultural organizations)
501(c)(6) providers (chambers of commerce and trade associations)
501(c)(7) providers (social clubs)
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Types of Scholarship Providers:
Question:
What type of scholarship provider are you?
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Agenda
1. Donor Participation in Selection
2. Scholarship Plans
3. Record Collection & Retention
4. Tax Treatment of Scholarships
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Donor Participation in Selection
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Donor-Driven Scholarship Funds
Nonprofit Providers
501(c)(3) Private Foundations
501(c)(3) Public Charities
Fund
Fund
Fund
Fund
Other Nonprofits
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Donor-Driven Scholarship Funds
Mechanics:
Donor(s) establishes separate fund or account with charity
Donor(s) “advises” charity in selection process
Examples – Funds Established By:
Individual donors or families
Companies and their employees
University alumni and faculty
Professional associations and their members
Civic/service organizations and their members
Members of faith based organizations
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Donor-Driven Scholarship Funds
Benefits to Donor:
Current tax deduction
Avoid cost and complexity of
separate scholarship entity
Receive administrative/
back-office support
Avoid private foundation rules (for the most part)
Participate in (but not control)
selection process
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Donor-Established Scholarship Funds
Historical Abuses:
De facto donor control
over selection process
Convert personal gift
to charitable donation
Impermissible private benefit
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Watch Your Step!
Since 2006,
Donor Advised Funds (DAFs)
have been prohibited
from making scholarships unless
they are structured to meet
stringent criteria of a Qualified Scholarship Fund!
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Scholarship Prohibition
Penalties for Violation:
20 percent of scholarship against sponsoring charity
+ correction
5 percent of scholarship against fund managers
for knowing violation
Rules can snag well-meaning
donors and sponsoring charities!
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Only Two Ways Around Prohibition:
1. Structure fund to avoid being considered a DAF.
2. Structure fund to qualify as Qualified Scholarship Fund.
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Donor Advised Fund: Three Elements
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Donor/advisor has or expects advisory privileges as to distributions
because of donor status
+
+
= Fund is
separately identified by reference to contributions of donor(s)
Fund is
owned or controlled
by a sponsoring organization
Donor Advised Fund
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Donor-Advised Fund: Three Elements
• Covered:
• 501(c)(3) public charities
• War veteran organizations
• Fraternal organizations
• Not Covered:
• 501(c)(3) private foundations
• Non-501(c)(3) entities
• Governmental entities (including non-501(c)(3) schools)
• Custodial funds
1. Fund is owned or controlled by a sponsoring organization
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Donor-Advised Fund: Three Elements
• Covered:
• Fund bears name of donor/advisor
• Fund tracks contributions of specific donor(s)
• Not Covered:
• General fund *
• Field of interest fund *
2. Fund is separately identified by reference to contributions of donor(s)
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* Funds with multiple donors, contributions pooled
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Donor-Advised Fund: Three Elements
• Other “multiple donor” funds?
• IRS looks at substance over form
2. Fund is separately identified by reference to contributions of donor(s)
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Donor-Advised Fund: Three Elements
• Covered: Advisory privileges (i.e. donor/advisor makes recommendations; sponsor considers them)
• Not Covered: Gift restrictions (e.g. donor restricts purpose of fund to scholarships; or establishes eligibility or selection criteria)
3. Donor/advisor * has or expects advisory privileges as to distributions because of donor status
22 * Includes related persons
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Donor-Advised Fund: Three Elements
• Covered: Donor/advisor participates in selection process because of donor’s status as a donor
• Not Covered: Donor/advisor participates in selection process because he/she holds certain position (e.g. officer, director, faculty)
3. Donor/advisor has or expects advisory privileges as to distributions because of donor status
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Donor-Advised Fund: Three Elements
• Covered: Recommendation of scholarship recipients (note: advisory privileges can also extend to investment)
• Not Covered: Recommendation of selection committee, if based on objective criteria related to expertise (e.g. department heads, high school principal, etc.)
3. Donor/advisor has or expects advisory privileges as to distributions because of donor status
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Donor-Advised Fund: Three Elements
• Covered:
• Privilege arises under written agreement
• Privilege arises by course of conduct
• Privilege exists even if not exercised
• Privilege arises later
• Not Covered:
• No mutual expectation of donor/advisor and sponsor
3. Donor/advisor has or expects advisory privileges as to distributions because of donor status
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Donor-Advised Fund: Three Elements
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Donor/advisor has or expects advisory privileges as to distributions
because of donor status
+
+
= Fund is
separately identified by reference to contributions of donor(s)
Fund is
owned or controlled
by a sponsoring organization
Donor-Advised Fund
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Only Two Ways Around Prohibition:
1. Structure fund to avoid being considered a DAF.
2. Structure fund to qualify as Qualified Scholarship
Fund.
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Qualified Scholarship Fund: Four Requirements
1. Donor/advisor * has advisory privileges
in process only as member of advisory committee
2. Entire advisory committee is appointed
by sponsoring charity
3. Donor/advisor* does not directly or indirectly
control advisory committee
4. Scholarships are awarded pursuant to
pre-approved scholarship plan (more on this later)
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* Includes related persons
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Donor Participation - Summary
Donor-driven funds fill an important, unique space
in the scholarship world
Done well, they represent a win, win, win proposition
Good for students, good for donors, good for sponsors
Done poorly, they create risk and result in penalties
Remember, always structure to avoid being a DAF,
or to qualify as a Qualified Scholarship Fund! 29
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Agenda
1. Donor Participation in Selection
2. Scholarship Plans
3. Record Collection & Retention
4. Tax Treatment of Scholarships
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Scholarship Plans
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Two Questions:
1. Who must have a scholarship plan,
who should have one,
and who must
approve it?
2. What must a
scholarship plan
include?
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1. Who Must Have a Scholarship Plan?
Private Foundations
Scholarships are prohibited unless awarded pursuant to
plan pre-approved by IRS
Qualified Scholarship Funds (just discussed)
Scholarships are prohibited unless awarded pursuant to
plan pre-approved by sponsor’s governing board
Public Charities and Other Nonprofit Providers
No requirement, but should have board-approved plan
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2. What Must the Plan Include?
Scholarship plan must address …
Objective and non-discriminatory selection process
Process for supervising scholarships
Process for handling jeopardized scholarships
Record collection and retention
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2. What Must the Plan Include?
Objective and Non-discriminatory Selection Process:
Eligibility Criteria:
potential applicant pool = charitable class (broad or indefinite)
Selection Criteria:
related to purposes of scholarship
(e.g., grades, test scores, references, need, interviews)
Selection Committee:
not be in position to benefit privately from selection
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2. What Must the Plan Include?
Process for Supervising Scholarships:
If Funds are Paid to School:
School agrees to: (1) use funds to defray student’s expenses,
or (2) pay funds to student only if enrolled and standing is
consistent with purposes of scholarship
If Funds are Paid to Student:
Provider obtains, at least annually, a school-verified transcript
of courses taken and grades received for each academic
period
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2. What Must the Plan Include?
Process for Handling Problem Scholarships:
If Funds are Paid to School:
No additional requirements
Funds Paid to Student:
Provider must investigate and withhold further payments if
concerned about proper use of funds or if reports are
delinquent; plus take “reasonable and appropriate steps”
to recover misused funds
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2. What Must the Plan Include?
Record Collection and Retention:
Stay tuned ….
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Scholarship Plan - Summary
All providers should have a scholarship plan
Private Foundations and Qualified Scholarship Funds
must have a pre-approved plan
Several required elements, but central is inclusion of
objective and non-discriminatory selection process
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Agenda
1. Donor Participation in Selection
2. Scholarship Plans
3. Record Collection & Retention
4. Tax Treatment of Scholarships
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Record Collection & Retention
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Two Questions:
1. What information should
a provider collect to meet
its tax obligations?
2. How long should it keep
that information?
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Different Session, Highly Recommend:
“Legal Issues in Collection and Retention of Student Data”
Required disclosures when collecting information
Using and sharing information
Storage of information (including data security requirements)
Data destruction requirements
Data breach planning and response
Immediately following this session!
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1. What Information Should be Collected?
501(c)(3) Polestar:
Remember, scholarships must be awarded
on an objective and nondiscriminatory basis …
So maintain records that support your compliance
with this requirement!
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1. What Information Should be Collected?
Private Foundations / Qualified Scholarship Funds
Must collect and keep:
• All information related to evaluation of applicants
• Identity of awardees
• Amount and purpose of each scholarship
• Any follow-up information obtained in supervising awards
Other Nonprofit Providers
Should collect and keep the same records
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1. What Information Should be Collected?
Private 501(c)(3) Schools
Must adopt a racial nondiscrimination policy
Must collect and keep for three years:
• Records showing racial composition -- student body, faculty
and staff -- for each academic year
• Records showing awards were made on a racially
nondiscriminatory basis
• Copies of brochures and similar items addressing aid
• Copies of materials used to solicit contributions
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2. How Long Should They be Retained?
Our recommendation:
Minimum of four years, preferably six years, after
close of calendar year in which studies funded
by scholarship are completed
Example: four-year scholarship
• Student selected for scholarship during 2014/2015
• Student begins college in Fall 2015
• Student graduates from college in May 2019
• Keep records until December 31, 2025
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Record Collection & Retention - Summary
Record collection and retention requirements
are fairly minimal under the tax laws
Specific requirements for Private Foundations and
Qualified Scholarship Funds provide good guidance
for all providers
Don’t forget, many other federal and state laws
cover data privacy and security!
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Agenda
1. Donor Participation in Selection
2. Scholarship Plans
3. Record Collection & Retention
4. Tax Treatment of Scholarships
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Tax Treatment of Scholarships
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1. Is the Scholarship subject to income tax?
2. Does the Provider have to report the Scholarship
to the IRS or withhold taxes?
Two Questions:
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Remember … you’re in this together.
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1. Is the Scholarship Subject to Tax?
Scholarships are tax-free only if:
Funds are used for qualified education expenses,
Student is a candidate for a degree,
Student studies at an educational institution, and
Award is non-compensatory
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1. Is the Scholarship Subject to Tax?
Qualified Education Expenses:
Tuition and fees required for enrollment or attendance
Fees, books, supplies and equipment required for course work
× Room and board
× Travel expenses
× Optional equipment (e.g., laptop, tablet)
× Family allowance
× Anything else!
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1. Is the Scholarship Subject to Tax?
Candidate for Degree:
Pursues degree at college or university
Attends primary or secondary school
Attends a non-degree school in program that counts
for full credit toward bachelor’s degree or higher
Attends vocational school
Note: the last two schools must be nationally accredited,
and authorized by law to offer the program
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1. Is the Scholarship Subject to Tax?
Educational Institution:
Primary function is presentation of formal instruction,
Normally maintains a regular faculty and curriculum, and
Normally has a regularly enrolled body of students
in attendance at the place where it conducts
its educational activities
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1. Is the Scholarship Subject to Tax?
Non-Compensatory:
Scholarship cannot be conditioned on
performance of teaching, research or other services
(past, present or future)
Limited exceptions:
• National Health Service Corps Scholarship Program
• Armed Forces Health Professions Scholarship and Financial
Assistance Program
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1. Is the Scholarship Subject to Tax?
Non-Compensatory (cont.):
Relevant Factors for Research Services
• Extent of faculty supervision over work schedule
• Student’s ability to direct course of research work
• Right of student to retain copyrights or patents
• Extent of reporting requirements
(but reporting requirement alone is not determinative)
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1. Is the Scholarship Subject to Tax?
Non-Compensatory (cont.):
What about graduate students who teach or conduct
research for the provider?
• Example 1: Graduate student at USC is required to teach
intro level chemistry class to undergraduates. Compensatory?
• Example 2: Graduate student at SCS is required to conduct
chemistry research. Compensatory?
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1. Is the Scholarship Subject to Tax?
Non-Compensatory (cont.):
What if the services are performed for someone else?
• Example 1: Student is awarded scholarship to Clemson by
private foundation, who requires student to teach in
South Carolina for three years after graduation. Compensatory?
• Example 2: Student at Charleston Law School is awarded
scholarship, which requires her to practice public interest law
for three years after graduation. Compensatory?
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1. Is the Scholarship Subject to Tax?
Recap -- scholarships are tax-free only if:
Funds are used for qualified education expenses,
Student is a candidate for a degree,
Student studies an educational institution, and
Award is non-compensatory
Otherwise, they are taxable!
-- See IRS Publication 970
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Two Questions:
1. Is the Scholarship subject to income tax?
2. Does the Provider have to report the Scholarship
to the IRS or withhold taxes?
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2. Reporting & Withholding Obligations?
Provider’s obligation to report and withhold taxes
depends on …
Whether student is U.S. or foreign
Whether scholarship is compensatory or non-compensatory
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Reporting & Withholding Obligations
U.S. Students:
Non-Compensatory Scholarship:
no tax reporting or withholding required, even if some or all of
scholarship is taxable
-- But IRS recommends alerting students
of potential taxation
(see IRS Notice 87-31)
Compensatory Scholarship:
tax reporting required, plus withholding for employees
-- Form W-2 (student = employee) or Form 1099 MISC
(student = independent contractor)
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Reporting & Withholding Obligations
Foreign Students:
Non-Compensatory Scholarship:
• If tax free, no reporting or withholding required
• If taxable, both reporting and back-up withholding required
-- Form 1099/1042-S; withholding rate is generally 14 percent
Compensatory Scholarship:
• Reporting and withholding required
-- Form W-2 (student = employee) or Form 1099/1042-S
(student = independent contractor); different withholding
rates apply depending on classification
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Reporting & Withholding Obligations
What about undocumented students?
U.S. taxpayer v. non-U.S. Taxpayer
• Citizen – born or naturalized in U.S.
• Permanent resident – greencard
• Substantial presence test
DACA v. non-DACA
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Taxation of Scholarships - Summary
Not all scholarships are tax-free!
Tax reporting and withholding obligations depends
on nature of award and identity of recipient
Tax treaty may change things with foreign students
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Karen Leaffer, Esq. 303.781.6899
1899 Wynkoop Street | Suite 275 | Denver, CO 80202
LeafferLaw.com
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