In a recent private letter ruling (PLR), the IRS held that stipends paid to research fellows under non-NRSA grants are included in wages subject to employment tax including Social Security/Medicare (FICA). (PLR 201705001.)

In response to its query, a research institution (the taxpayer) received PLR 200607017 (dated March 7, 2005) wherein the IRS held that stipends paid to fellows using grants other than, but similar to, those authorized under the Ruth L. Kirschstein National Research Service Award (NRSA) program did not constitute "wages" for employment tax purposes and were not subject to FICA under IRC Section 3101, IRC Section 3111 and IRC Section 3121(a).

In contrast, private letter rulings published in 2009 (PLR 200944027) and again in 2011 (PLR 201117026) came to the opposite conclusion and stated respectively that:

— Amounts paid to post-doctoral fellows under the non-NRSA grants reviewed are subject to FICA

— Stipends awarded by non-NRSA programs do amount to wages

The IRS extensively reviewed the facts and circumstances in both cases and reasoned in both PLRs that the compensation was provided for services and, thus, was wages.

The 2017 PLR was issued to the same taxpayer as the 2005 PLR. The IRS concluded it was revoking the 2005 PLR but that the effect would be prospective with respect to the taxpayer who was a party to both the 2005 and 2017 rulings. The IRS revoked the 2005 PLR, explaining it had recently determined that the 2005 ruling was not in accord with its current view.

The IRS stated that in its current view, amounts paid to research fellows under non-NRSA grants are compensatory in nature, constitute payment for services, and are wages subject to FICA taxation and income tax withholding. The IRS limited the applicability of its revocation to the specific taxpayer who had received and relied on the revoked 2005 PLR.

IRS published guidelines on grants and scholarships

In Tax Topic 421, the IRS explains that a scholarship, fellowship grant, or other grant is excluded from gross income under the following conditions:

— The individual is a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.

— The amounts received are used to pay for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies, and equipment required for courses at the educational institution.

By comparison, such grants are included in gross income (but not subject to FICA taxation) if the amounts are:

— Used for incidental expenses, such as room and board, travel, and optional equipment

— Received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant, except that amounts are excluded from gross income if received for services that are required by the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.

A fellowship grant is not required to be reported on an information return (e.g., Form 1099-MISC) to the grantee; however, the grantee is required to include the fellowship amount in taxable income to the extent the fellowship grant was not used for qualified tuition and books.

Final regulations were issued in 2004 setting forth the conditions under which students are exempt from FICA tax. (T.D. 9167.)

Ernst & Young LLP insights

The limitation of prospective applicability stated in the recent 2017 PLR should not be relied upon generally. While PLRs provide an indication of what the IRS is thinking on a particular subject, they are not to be relied on and should not be cited as precedent. Moreover, the IRS provided its position on the subject in its extensive discussions within the intervening private letter rulings in 2009 and 2011.

Thus, individual taxpayers receiving non-NRSA grants are at risk for understated Form W-2 wages and underpaid FICA taxes for calendar years 2014 through 2016 and research institutions are at risk for failure to properly report non-NRSA grants as wages and properly remit income tax withholding and FICA taxes if they followed the reasoning of the 2005 PLR.

The information return penalties for failure to provide and report correct Forms W-2 have also increased significantly these past few years as follows:

— $100 for each failure to report in 2014 with a cap of $1,500,000

— $250 for each failure to report in 2015 with a cap of $3,178,000

— $260 for each information return if it is not issued by August 1, 2017 ($100 between May 1 and August 1, 2017) with a cap of $3,193,000

It is important for research institutions and other organizations to recognize the distinction between grants that are treated as taxable compensation for services and those that are excludible scholarships, fellowships or other type of grants.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.

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