In a private letter ruling (PLR 201940013), issued in 2004 but released in 2019, the IRS ruled that a taxpayer's scholarship award grantmaking procedures complied with requirements of IRC Section 4945(g) and that the awards made would not constitute taxable expenditures under IRC Section 4945(d)(3) and would generally be excludable from the recipients' gross income.

Facts

The taxpayer was a nonexempt charitable trust (IRC Section 4947(a)(i)) that established a grantmaking program to pay the tuition of two or more students to attend the colleges of their choice. The program was structured as follows:

• Any student attending high school in the city could apply; the taxpayer mailed application forms to high school counselors.
• The selection committee, consisting of principals and high school counselors from all area high schools, chose the winners and alternates.
• Selection criteria equally weighed academic scholarship, ability, need, and other grants received by applicants.
• Another committee, consisting of the school superintendent and the president of the taxpayer's trustee, would give final approval to the recipients chosen by the selection committee.
• The trustee supervised the grants by paying the scholarship funds directly to the educational institutions, which would execute a letter agreement promising to use the funds only for the named scholarship recipients.
• If a recipient failed to matriculate, the trustee would recover any unspent funds and apply them to the next year's awards.
• The trustee retained permanent records regarding the scholarship recipients, their parents, and their college, and the selection committee retained all records relating to the application and selection process.

Applicable law

Excise taxes are generally imposed (IRC Section 4945(a) and (b)) on taxable expenditures (IRC Section 4945(d)(3)) made by private foundations. IRC Section 4945(g), however, provides that IRS Section 4945(d)(3) does not apply to individual grants awarded on an objective, nondiscriminatory basis under a procedure approved in advance if the taxpayer can show the grant:

• Is a scholarship or fellowship grant subject to the provisions of IRC Section 117(a) and will be used to study at an IRC Section 170(b)(1)(A)(ii) educational organization
• Is a prize or award subject to IRC Section 74(b), if the recipient is a member of the general public

or

• Is intended to achieve a specific objective, produce a report or similar product, or improve or enhance the grantee's literary, artistic, musical, scientific, teaching or other similar capacity, skills or talents

To obtain advance approval (Treas. Reg. Section 53.4945-4(c)(1)), a private foundation must show that (1) its grant procedures include an objective, nondiscriminatory selection process and are reasonably calculated to result in grantees that perform the objectives of the grants (e.g., being successful college students); and (2) the foundation plans to obtain reports to determine whether the grantees performed the activities intended by the grants.

Ruling

The IRS concluded (in 2004) that, based on the information the private foundation submitted and assuming the award program continued to "be conducted as proposed with a view to provide objectivity and nondiscrimination in making the awards," the taxpayer's grant procedures would not result in adverse tax consequences because they comply with IRC Section 4945(g). Further, the awards would not constitute taxable expenditures under IRC Section 4945(d)(3) and would be excludable from the recipients' gross income, subject to IRC Section 117 limitations.

The taxpayer had also asked the Service, under IRC Section 4962, not to assess any initial taxes under IRC Section 4945 for any of its grantmaking expenditures made according to the approved procedures that preceded the effective date of the PLR. The IRS concluded that the taxpayer had done everything required to have this request granted — except for obtaining advance approval of its grantmaking procedures. Citing Treas. Reg. Section 53.4945-1(d)(3), the IRS concluded the taxpayer had provided sufficient information to show its grantmaking procedures (1) do not permit the diversion of grant funds and had not been substantially changed in prior years; (2) met all IRC Section 4945(g) requirements in all subsequent respects for all prior years except for failure to obtain advance approval; and (3) subsequently requested IRS approval. As a result, the IRS concluded that, according to IRC Section 4962, the taxpayer was not subject to initial taxes under IRC Section 4945 for any expenditure from its grantmaking program covered by the determination letter that preceded the effective date of the private letter ruling.

Implications

The release of this 15-year-old private letter ruling by the IRS serves to both reaffirm the necessary criteria that a private foundation must meet to ensure the foundation's scholarship grants will be nontaxable under IRC Section 4945 and to support the fact that abatement of the first-tier tax imposed under IRC Section 4945 may be available to private foundations that have historically awarded such scholarship grants without obtaining pre-approval from the IRS.

Although private letter rulings only apply to the recipient and cannot be cited as precedent, PLR 201940013 does outline the factors the IRS will consider when requested to abate any penalty imposed under IRC Section 4945. Thus, private foundations that have not obtained preapproval of their scholarship program should thoroughly review this private letter ruling to see if the facts are similar to their own; if so, they should consider requesting formal, IRS approval for their scholarship program and relief from the first-tier IRC Section 4945 excise tax on program expenditures that precede the effective date of an IRS determination.

Please contact your Ernst & Young LLP professional for further information.

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