By Karen E. Klein Q: I would like to offer a small educational scholarship to my employees' children. Are there any special tax issues to consider? -- L.S.T., St. Louis
A: Yes, there certainly are. Most employers setting up scholarship programs prefer to do so by first establishing a tax-exempt scholarship foundation that can accept contributions. That way, the employer donates the scholarship funds to the foundation and secures a tax deduction for the corresponding amount. Then, the foundation grants the funding to the students for educational purposes.
While you do not have to funnel the money through a charitable organization, it's a neater format for accounting purposes, and offers added benefits for you and your company if you do, experts say.
Next, you'll want to insure the scholarship benefits are tax-exempt for the recipients and their parents. To do so, you should hire a tax adviser familiar with Internal Revenue Service guidelines that insure the scholarship benefits are not, in reality, compensation for past, present, or future services rendered by the recipient, or the recipient's parent.
MUST-HAVES. IRS Revenue Procedure #76-47 lays out eight requirements that employer scholarship programs should meet in order to gain tax-exempt status, says Eugene Younger, a CPA with Fiducial Support Systems in Montrose, Calif.
The scholarship program must not be used by the employer to recruit or retain employees.
Selection of grant recipients must be made by a committee that is totally independent of the employer.
The scholarship program must impose identifiable minimum requirements for grant eligibility, and all candidates must meet the minimum educational requirements for the institution for which the grants are available. If the requirements include a minimum period of employment for the parent of the candidate, that period cannot exceed three years.
Selection of grant recipients must be based on substantial objective factors that are completely unrelated to the employment of the recipients or their parents, and to the employer's line of business. The factors for granting scholarships might include prior academic performance, performance on standardized tests, recommendations from instructors, and financial need.
A grant may not be terminated because the recipient or the recipient's parent terminates his employment.
The courses of study for which grants are available must not be limited to those courses that would be of a particular benefit to the employer.
The grant must be for qualified tuition, books, and fees. The grant may not impose a requirement that the recipient provide services as a condition of receiving the grant.
The law imposes a limit on the number of grants that may be awarded to the children of employees, Younger says. It is based on either a mathematical formula provided under the law, or some other objective criteria. Your CPA should be able to specify what limits will apply to your company. Have a question about running your business? Ask our small-business experts. Send us an e-mail at firstname.lastname@example.org, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.