Are Scholarships Tax Deductible for Companies? IRS Rules and Tests

Scholarships are generally tax deductible for companies, but which deduction applies, and whether it survives IRS scrutiny, depends on who receives the money. Payments to a public scholarship fund with no ties to your business are treated as ordinary charitable contributions. Scholarships tied to a real business purpose can be deducted as business expenses. Education paid for your own employees runs through a separate provision with its own cap. And scholarships awarded to employees’ children or family members face the strictest rules of all, with the IRS starting from the presumption that the payment is disguised compensation.

Donations to a Public Scholarship Fund

The simplest deduction is a charitable contribution to a qualified 501(c)(3) organization or educational institution that runs its own scholarship program. If the recipients have no connection to your company or its employees, the payment is treated like any other charitable gift, and the selection is the charity’s problem, not yours.¹

For C corporations, the annual charitable deduction has long been capped at 10% of taxable income, with a five-year carryforward for excess contributions. Starting with tax years beginning in 2026, the One Big Beautiful Bill Act adds a 1% floor. Only the portion of charitable contributions exceeding 1% of taxable income is deductible, and the 10% ceiling still applies on top. A C corporation with $1 million in taxable income gets no deduction on the first $10,000 of giving. Amounts below the 1% floor can be carried forward, but only to years when total contributions exceed the 10% ceiling.

The 10% corporate cap applies only to C corporations. If your business is an S corporation, partnership, or LLC taxed as a pass-through, charitable deductions flow through to the owners and are governed by their personal AGI-based limits, which are generally more generous. Entity choice matters as much as program design.

Deducting Scholarships as an Ordinary Business Expense

Scholarship payments can sometimes be deducted as an ordinary and necessary business expense instead of a charitable contribution. This route fits when the program is explicitly tied to a business purpose such as marketing, community relations, or building a workforce pipeline in your industry. A construction firm funding engineering scholarships to develop future hires has a stronger case than a company funding unrelated liberal arts awards and calling it branding.

The upside is no percentage-of-income cap. The downside is that the IRS can challenge whether the expense is truly ordinary and necessary. If the connection between the scholarship and your operations is thin, the deduction is exposed. Document the business rationale in writing before the first award goes out.

Section 127 Educational Assistance for Employees

To fund education for people already on the payroll, there’s a cleaner path. Section 127 lets an employer pay up to $5,250 per employee per year for educational assistance, with the employee excluding that amount from gross income entirely.² The employer deducts the payment as a compensation expense. It covers tuition, fees, books, supplies, and equipment, and it doesn’t have to relate to the employee’s current job.

The program must be a separate written plan for the exclusive benefit of employees, and it can’t discriminate in favor of highly compensated employees, officers, or owners. No more than 5% of total benefits in a year can go to individuals who own more than 5% of the company.² Employees also can’t be offered a choice between the benefit and other taxable compensation.

One caveat on timing: Section 127’s provision covering employer-paid student loan repayments expired on January 1, 2026, and has not been extended. If your plan still includes loan payments, those amounts are now taxable wages to the employee. Amounts above $5,250 in a year may still be excludable under working-condition fringe benefit rules if the education qualifies, but the automatic exclusion stops at the cap.³

Scholarships for Employees’ Children or Family Members

This is where companies get into trouble. When a company wants to award scholarships to employees’ children or other family members, the IRS presumes the payments are disguised compensation unless the company proves otherwise. The typical fix is a company-created private foundation that administers the program independently. Even then, the grants are treated as “taxable expenditures” subject to excise taxes unless the foundation gets advance IRS approval of its procedures and meets specific nondiscrimination requirements.¹

The penalties are severe. A foundation that makes scholarship grants without advance approval, or whose program fails the structural requirements, owes an initial excise tax of 20% on the full amount of each grant. If the problem isn’t corrected in the taxable period, an additional 100% tax applies.⁴ If the IRS decides the program is compensatory in substance, the foundation can lose its tax-exempt status.¹ Advance approval is requested on Form 8940 with Schedule C.⁵

The Percentage Tests Under Revenue Procedure 76-47

Revenue Procedure 76-47 sets the numerical caps the IRS uses to distinguish a genuine scholarship from a paycheck routed through a foundation.⁶

For scholarships to employees’ children, the program passes if the number of grants to employees’ children in a year doesn’t exceed either:

25% of the employees’ children who were eligible, applied, and were considered by the selection committee that year, or
10% of the employees’ children who can be shown to be eligible, whether or not they applied.

Meeting either threshold is enough. The 10% test counts every eligible child; the 25% test counts only actual applicants.⁶

For scholarships awarded to employees themselves, the test is stricter: grants can’t exceed 10% of the employees who were eligible, applied, and were considered. There’s no broader-pool alternative the way there is for children.⁶

Renewals of prior-year grants don’t count toward the current year’s numbers, and grants to employees and grants to their children are treated as separate programs for testing purposes even when administered together.

Program Structure the IRS Will Accept

Passing the percentage tests isn’t enough. Revenue Procedure 76-47 also requires an administrative structure that keeps the employer out of the selection process.

An Independent Selection Committee

The committee must consist entirely of people independent of the foundation, its organizer, and the sponsoring employer. Former employees of either the foundation or the company don’t qualify. The IRS prefers members with education backgrounds who can actually evaluate applicants.⁶

The company or foundation can reduce the number of grants below what the committee recommends but can never increase them or change the committee’s ranking. Only the committee can adjust individual award amounts. The foundation may confirm the committee followed the rules, but public announcements have to come from the committee or the foundation, not the employer.⁶

Objective, Employment-Neutral Criteria

Selection criteria must be objective and completely unrelated to the recipient’s or the parent’s employment. Prior academic performance, standardized test scores, recommendations from instructors unrelated to the applicant, financial need, and interview impressions are all acceptable. A parent’s job title, salary level, or tenure will disqualify the program.⁶

What Happens When the Program Fails

If an employer-related scholarship program fails the Revenue Procedure 76-47 tests, the payments are reclassified as compensation. You still get a deduction, but as wages rather than as a charitable contribution, and you have to report the amounts on Form W-2 and withhold employment taxes. The employee owes income and payroll tax on the full amount.

By contrast, tax-free qualified scholarships to unrelated individuals generally trigger no Form 1099 or W-2 obligation for the company. Keep records showing the funds went to qualified expenses and that the program met the applicable requirements.

Why the Recipient’s Tax Treatment Matters to You

Whether the recipient owes tax on the money drives your reporting obligations, and in employee-related programs it determines whether the grant gets reclassified as wages in the first place. Under Section 117, a scholarship is excluded from the recipient’s gross income only if the recipient is a degree candidate at an eligible educational institution and the funds are used for qualified tuition and related expenses.⁷

Qualified expenses are limited to tuition, enrollment fees, and course-required books, supplies, and equipment. Amounts spent on room, board, travel, or optional equipment are taxable to the recipient.⁸ Any portion conditioned on the recipient performing services such as teaching or research is also taxable, with narrow exceptions for certain military and national service programs.⁹

One boundary worth flagging: scholarships to non-resident alien recipients trigger a separate set of withholding and reporting rules, including Forms 1042 and 1042-S and possible treaty relief with a valid Form W-8BEN.¹⁰ If you’re funding foreign students, treat that as its own compliance workstream rather than assuming domestic rules control.

1
Internal Revenue Service. Company Scholarship Programs
2
Office of the Law Revision Counsel. 26 USC 127 Educational Assistance Programs
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Internal Revenue Service. Frequently Asked Questions About Educational Assistance Programs
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Internal Revenue Service. Taxes on Taxable Expenditures – Private Foundations
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Internal Revenue Service. Instructions for Form 8940
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Internal Revenue Service. Revenue Procedure 76-47
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Office of the Law Revision Counsel. 26 USC 117 Qualified Scholarships
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Internal Revenue Service. Topic No. 421, Scholarships, Fellowship Grants, and Other Grants
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Internal Revenue Service. Publication 525 (2025), Taxable and Nontaxable Income
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Internal Revenue Service. Federal Income Tax Withholding and Reporting on Other Kinds of U.S. Source Income Paid to Nonresident Aliens