Professional Dance Business Tax Tips
Part VI: Tax-Free Grants
by Ma*Shuqa Mira Murjan
This series on Professional Business Tax Tips has covered various aspects of business operations relevant to running a professional dance business and abiding by the federal government Internal Revenue tax rules. This last article in the series reviews a very important source of funds for the support of professional dance activities: scholarship and fellowship grants for the study and pursuit of research on dance. This article will interest those students pursuing graduate studies or postgraduate research in dance. If you have an organized nonprofit dance group that has been incorporated with a nonprofit taxable status as a charitable organization, then you will not be concerned with this information as you are responsible for other financial reporting requirements as a non-profit charitable organization.
The 1986 Tax Reform Act changed the tax treatment of scholarship and fellowship grants. There are now two sets of rules, the old rules and the new rules. The old rules apply to grants awarded before August 17, 1986 (even if extending into 1993 or later years). The new rules apply to grants awarded on or after August 17, 1986.
The old rules generally allowed degree-candidate students to exempt the full amount of their grants from taxation. Non-degree candidates came under a $300 per month limitation for a lifetime maximum of 36 months on the amounts exempted from income tax. However, non-degree candidates, as well as degree candidates, received a total exemption from social security tax on the full amount of their scholarships or fellowships, with no $300 per month or 36 month limitation.
The new rules for grants awarded on or after August 17, 1986 are much more severe. Degree-candidate students are only able to exempt from tax amounts used for tuition and related instructional expenses such as fees, books, supplies, and equipment. Amounts that are used for room, board, or other living expenses are subject to income tax. Non-degree candidates get no income tax exemption at all under the new rules.
A scholarship generally means an amount paid to enable a student to pursue her studies at an educational institution.
A fellowship generally means an amount paid to aid an individual in the pursuit of study or research.
Limits on tax exemptions
The only grant money that is tax exempt is that which is used by degree candidates for tuition and related instructional expenses. In addition, if a grant meets either of the following 2 conditions, it will generally not be considered a scholarship and will be taxable income:
1) The grant is paid as compensation for past, present, or future services;
2) The grant is paid to enable you to pursue studies or research primarily for the benefit of the grantor.
The exclusion from income tax does not apply to any portion of amounts received as a scholarship or fellowship grant representing payment for teaching, research, or other services required as a condition for receiving the grant. Such portions are included in taxable income, even if used for tuition or course-related expenses. This is so because teaching is always considered to be a service primarily for the benefit of the grantor. And research is also to be considered for the benefit of the grantor if there is a specific project on which the grantor wants the researcher to work.
Individuals who are not candidates for a degree do not get any income tax exemption. Amounts received from grants awarded are fully taxable. However, there is an exemption from social security taxes as long as the grant satisfies the requirements of being a scholarship or fellowship that applies under the tax law.
Difference between a Gift and a Grant
The terms scholarship or fellowship do not include money which is given by a friend or relative, motivated by philanthropic or family considerations. Such a payment, however, will probably qualify as a gift, which is entirely tax-free. Although gifts which you receive are better than grants because the latter are subject to the limitations described, you can’t simply call a grant a gift. To be regarded as a gift, you must show that the donor was motivated by family or philanthropic reasons that were directed solely to the recipient. In other words, unless a grant you receive is given by a relative or a charity, you will not be able to treat it as a gift.
Prizes and Awards
Prior to 1987, certain prizes and awards made in recognition of past achievements were exempt from tax entirely. However, starting in 1987, this exemption was eliminated, except where the recipient assigns the prize or award to a governmental unit or tax-exempt charitable organization.
It is up to the student to keep records of scholarships or fellowship amounts used for qualified tuition, fees, and required supplies and equipment. These amounts are tax-free; the remainder is taxable income.
The one piece of good news is that scholarship and fellowship grants, to the extent they are taxable, are considered to be earned income rather than unearned income. As discussed previously, tax is due if there is unearned income which exceeds $600. But an individual receiving only earned income up to $3,700 (the amount of the standard deduction for singles) need not even file a tax return.
Where to Report a Tax-Free Grant on a Tax Return
Report on line 7 of Form 1040 all income which is shown as wages or other taxable compensation on W-2 Forms you receive from your employer(s). Then, subtract any amounts that should be tax-free by entering a negative entry on line 22, Other Income. This method of handling tax-free income showing up on a W-2 Form is not spelled out in any official IRS instructions but has been recommended by the IRS in other similar situations.
Withholding from Grants
Under the current rules, a scholarship or fellowship grant awarded to a student might be partly tax-exempt and partly taxable. However, making this partition is the duty of the recipient. Neither the grantor nor the school is required to file a form with the IRS reporting on the taxable portion of the grant. And, since such grants are not considered wages, there should be no withholding of income tax or social security on any payments under the grant. Essentially, students are being placed on the honor system with regard to reporting taxable amounts of scholarships or fellowships.
An exception to this rule occurs to the extent amounts received under the grant represent payment for teaching, research, or other services by the student required as a condition for receiving the scholarship or tuition remission. In such a case, the school is required to make the allocation between the taxable and tax- free amounts and issue an appropriate W-2 Form reporting the amount regarded as wages.
Exception — Revenue Ruling 75-280
If teaching, research, or other equivalent services are required of all candidates for a particular degree (whether or not recipients of scholarship or fellowship grants), then money received for such services may still be considered a tax-free scholarship or fellowship. According to an IRS ruling, a grant will be considered to have been for the primary purpose of benefiting the recipient and hence excludable from gross income if the following conditions are satisfied:
1. The student was a candidate for a degree at an educational institution.
2. The student performed research, teaching, or other services for the institution that satisfied specifically stated requirements for the degree;
3. Equivalent services were required of all candidates for the same degree;
4. The work required is reasonable and appropriate to the degree.
However, the above conditions will not be sufficient to establish that the grant is excludable from gross income if:
A. The student performed services for a party other than the educational institution;
B. The grant is made because of past services or conditioned upon future services or other requirements.
If a student performs services in excess of those necessary to satisfy the degree requirements, then amounts received for these excess services are subjected to tax. The remainder is tax-free, provided that the student is not required to perform the excess services as a condition of receiving amounts for the regular services required of all candidates for the degree.
Note that Restriction A above only refers to work performed directly for an outside agency. If, for example, a university contracted with an outside agency to provide funds for a research project, and then hired a student to assist in the project, Restriction A would not apply.
How to obtain Tax-Free Treatment for a Grant
There are no rigid rules to apply which will determine whether or not a grant is deductible. Even the Court has admitted that the tax status of a grant must be decided “on a case by case basis by considering the facts and circumstances” in the given situation. You can improve your chances of obtaining tax-free status for a grant if, the study aspect of the research is stressed, as opposed to the result aspect. Funds for study tend to be regarded as benefiting the recipient, while funds to obtain specific results tend to be regarded as benefiting the grantor.
Non-profit, Charitable Organizations and Fundraising to Support Dance Activities
This article has reviewed the tax implications of funds received as scholarships and fellowships for the specific purpose of attaining a degree, probably in dance history, teaching and ethnography, and is of interest to dancers pursuing their love of Orientale dance through traditional university degree programs. The term scholarship or fellowship does not include money which is given by a friend or relative, motivated by philanthropic or family considerations. Such a payment, however, will probably qualify to be a tax-free gift.
As by definition, non-profit charitable organizations are legal entities incorporated and organized for a charitable purpose; they are deemed tax-free operations by the Internal Revenue Service and state tax boards and pay no taxes. Hence, since this series has dealt with professional business tax tips, fund raising and reporting requirements for these charitable institutions are outside the bounds of the topic addressed here.
Questions about professionalism in dance?
As a management consultant for nonprofit organizations, I am available to the dance world for consultations on any questions you may have related to dance activity, research, and fundraising. If dancers have other questions about professionalism in dance, I would welcome the opportunity to discuss your issues, concerns and questions. My purpose in writing this series on Professional Business Tax Tips has been to provide basic information on definitions, tax rules, deductible expenses, and information on reporting on tax forms.
Having completed her MBA, Ma*Shuqa Mira Murjan now divides her time between her career as a university professor of business, her work as a business consultant, and her performing, teaching and continued study of Oriental dance. She is currently pursuing a Ph.D. in Educational Administration. www.mashuqa.com