Sizable Gift to Seminary Student

Question:

A church pays a monthly amount to a seminary student as support while he is school. He performs no services, and this money is truly a gift with no oversight of the use of the funds. The yearly amount exceeds $25,000. Is the student able to exclude this gift from taxable income? 

Answer:

The church leadership is wise to be careful in the situation described here. If the payments are compensation for services present or future they will result taxable income.

An example is given in IRS Publication 970, "You are a candidate for a degree at a medical school. You receive a scholarship for your medical education and training. The terms of your scholarship require you to perform future services. A substantial penalty applies if you don't comply. The entire amount of your grant is taxable as payment for services in the year it is received."

If a scholarship program is established with nondiscriminatory and non-compensatory parameters, then the disbursement represents a truly nontaxable scholarship. The recipient will be required to report taxable income to the extent that the scholarship and other nontaxable support exceed qualified education expenses. 

According to IRS Publication 970, "A scholarship or fellowship grant is tax free (excludable from gross income) only if you are a candidate for a degree at an eligible educational institution. A scholarship or fellowship grant is tax free only to the extent:

•  It doesn't exceed your qualified education expenses;
•  It isn't designated or earmarked for other purposes (such as room and board), and doesn't require (by its terms) that it can't be used for qualified education expenses; and 
• It doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship."

Qualified Education Expenses include (IRS Publication 970): 

• Tuition,
• Books, supplies, and equipment,
• Fees paid to the institution, and
• Student activity fees. 

Education Expenses that do not qualify:

• Room and Board,
• Insurance,
• Medical expenses (including student health fees),
• Transportation, and 
• Similar personal, living or family expenses.

We should also note here that non-taxable scholarships may reduce or eliminate the student's eligibility for federal tax credits.