Yes, a 501(c)(3) organization can give scholarships, and awarding them fits within the educational purpose that supports tax-exempt status in the first place. What changes from one organization to the next is how much process the IRS demands up front. Public charities can design and run a scholarship program on their own authority as long as they keep the right records. Private foundations must get their grant procedures approved by the IRS before writing a single check.
Public Charity or Private Foundation Decides the Rulebook
Every 501(c)(3) is classified as one or the other, and the IRS treats scholarship programs differently based on that classification.
Public charities have flexibility. They must keep detailed records showing that their grants serve a charitable purpose, including recipient names and addresses, how recipients were selected, and any relationship between recipients and the organization’s officers, trustees, or donors. They do not need advance IRS approval of the program itself.
Private foundations carry a heavier load. Under federal tax law, any scholarship a private foundation awards to an individual counts as a “taxable expenditure” unless the foundation follows grant procedures that the IRS has approved in advance.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures A taxable expenditure triggers excise taxes on both the foundation and the managers who approved it.
How a Private Foundation Gets Advance Approval
Section 4945(g) of the Internal Revenue Code exempts a scholarship from taxable-expenditure treatment only if it is awarded on an objective and nondiscriminatory basis under a procedure the IRS has approved in advance.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures To get that approval, the foundation must show three things:
- Its selection criteria are objective and nondiscriminatory.
- Its procedure is reasonably designed to ensure recipients actually use the funds for the intended educational purpose.
- It plans to collect reports verifying that grantees are using the money as intended.2eCFR. 26 CFR 53.4945-4 – Grants to Individuals
The request goes on Form 8940 (Request for Miscellaneous Determination), completing Schedule C. Organizations that obtained 501(c)(3) status through the streamlined Form 1023-EZ must file Form 8940 separately if they want scholarship procedures approved.3Internal Revenue Service. Instructions for Form 8940 – Request for Miscellaneous Determination
Building a Program the IRS Will Accept
The mechanics look similar for both types of organization: written policies, objective criteria, an independent selection process, and good records.
Written Policies and Eligibility
Eligibility rules should be specific enough to apply consistently. “Academic merit” is too vague to defend; “minimum 3.0 GPA and enrollment in an accredited four-year institution” gives the selection committee something concrete to work with. The application should spell out what materials are required, such as transcripts, a personal statement, and recommendation letters. Standardizing the process protects the organization if the IRS later questions whether awards were made objectively.
An Independent Selection Committee
The people choosing recipients should not have a personal stake in the outcome. For private foundations, IRS regulations explicitly require a selection committee that is independent from the foundation, its organizers, and any related employer.4Internal Revenue Service. Company Scholarship Programs Public charities aren’t held to the same formal standard, but using an independent committee is the safer practice. When board members or donors hand-pick winners, auditors start asking about private benefit.
Records To Keep
Public charities must maintain a case history for every grant: names, addresses, purpose of the grant, how the recipient was selected, and any relationship between the recipient and the organization’s insiders.5Internal Revenue Service. Publication 4221-PC – Compliance Guide for 501(c)(3) Public Charities Private foundations keep the same records plus documentation showing compliance with their approved procedures. Retain applications, committee deliberations, and financial records for at least three years after the relevant return is filed.
Employer-Related Scholarships Have Extra Tests
Company-sponsored foundations that award scholarships to employees’ children face additional scrutiny, because the tie between the employer and the recipients raises an obvious private-benefit concern. Revenue Procedure 76-47 provides two percentage tests, and the program must satisfy one of them:
- The 25% test: scholarships awarded in a given year do not exceed 25% of eligible employees’ children who applied and were considered by the selection committee.
- The 10% test: scholarships awarded do not exceed 10% of all eligible employees’ children, whether or not they applied.6IRS.gov. Rev. Proc. 76-47
Exceed those caps and the IRS may treat the awards as compensation to the employees rather than charitable grants.
Who Cannot Receive an Award
A scholarship program cannot funnel benefits to organizational insiders. For private foundations, “disqualified persons” include substantial contributors, foundation managers, owners of more than 20% of any entity that is a substantial contributor, and family members of all of the above. Family covers spouses, ancestors, children, grandchildren, great-grandchildren, and their spouses.7Office of the Law Revision Counsel. 26 U.S. Code 4946 – Definitions and Special Rules
A grant to a disqualified person is not automatically prohibited, but it draws close scrutiny. The award must come out of the same objective process as every other award, and the recipient must qualify as part of the broader charitable class the program is designed to serve.
Public charities face a broader private-benefit doctrine rather than the disqualified-person rules. Same principle: the program must serve a public purpose, not channel money to people connected to the organization. A program whose criteria happen to fit the founder’s children is defensible when the criteria are genuinely objective. A program whose criteria seem designed so that only the founder’s children qualify is not.
What the Recipient Owes in Tax
How much of a scholarship is taxable depends on what the money pays for. Under Section 117 of the Internal Revenue Code, a “qualified scholarship” is excluded from the recipient’s gross income when the recipient is a degree candidate at an eligible educational institution and uses the funds for qualified tuition and related expenses.8Office of the Law Revision Counsel. 26 USC 117 – Qualified Scholarships
Qualified expenses cover tuition and fees required for enrollment, plus books, supplies, and equipment required for courses. Amounts used for room and board, travel, or other living expenses are taxable to the recipient, as is any portion that represents payment for teaching, research, or other required services.8Office of the Law Revision Counsel. 26 USC 117 – Qualified Scholarships Recipients report the taxable portion on their own return. An organization awarding scholarships for qualified educational expenses generally does not issue a tax form to the individual recipient.
How the Organization Reports Scholarships
Scholarship awards to individuals are reported on Schedule I of Form 990 (Grants and Other Assistance to Domestic Individuals). Part III of Schedule I is required if the organization reported more than $5,000 in total grants to individuals on Form 990, Part IX, line 2.9Internal Revenue Service. Instructions for Schedule I (Form 990)
Recipients are not listed by name. Instead, each type of assistance goes on its own line, such as “need-based scholarships” or “merit scholarships,” with the number of recipients and total dollars for each category.9Internal Revenue Service. Instructions for Schedule I (Form 990) If any grant went to someone with a relationship to an officer, trustee, or donor, that relationship must be documented and may need to be disclosed on Schedule L.10Internal Revenue Service. Exempt Organizations Annual Reporting Requirements – Form 990, Part VI and Schedule L: Scholarships
A 501(c)(3) that is not itself an eligible educational institution does not issue Form 1098-T to scholarship recipients. Only eligible educational institutions file that form.11Internal Revenue Service. About Form 1098-T, Tuition Statement
When scholarships go to nonresident aliens, the organization may have withholding and reporting obligations. Scholarship or fellowship income to a foreign student is reported on Form 1042-S using income code 16, unless the amount qualifies as a tax-free qualified scholarship under Section 117.12Internal Revenue Service. Instructions for Form 1042-S If a tax treaty reduces or eliminates withholding, the form still gets filed, with the treaty exemption reported in Box 5.
What Happens When It Goes Wrong
Private foundations that award scholarships without following IRS-approved procedures face steep excise taxes. The foundation owes an initial tax of 20% of the non-compliant grant. Any foundation manager who knowingly approved the expenditure owes 5% personally.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures
If the problem isn’t corrected within the allowed period, additional taxes apply: 100% of the expenditure on the foundation, and 50% on any manager who refused to participate in the correction.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures The exposure is meaningful at both the entity and the individual level.
Monitoring After the Award
Cutting the check isn’t the end of the job. Both public charities and private foundations should have a way to verify that scholarship funds are used for the intended purpose. Private foundations with approved procedures are typically required to collect annual progress reports from recipients and a final report when the scholarship period ends.
If the organization discovers that a recipient diverted funds to non-educational purposes, it must investigate, take reasonable steps to recover the money, and withhold future payments until the recipient shows that remaining funds will be used properly. Ignoring a known diversion can put the foundation’s advance approval at risk and expose it to the taxable-expenditure penalties above.