Question: May we establish a scholarship fund through our corporation or our company foundation that will award scholarships to children of employees?
Answer: Yes, both are possible but each has very different characteristics. The IRS has developed specific guidelines for scholarships awarded through a company private foundation.
Corporate giving: A scholarship program for children of employees administered directly by the corporation is generally considered an employee benefit and not a charitable activity. Your corporation cannot take a charitable deduction when making grants directly to individuals. Because the focus of such a program is generally employee benefit instead of charity, it is typically run through another department (such as human resources) rather than the corporate giving program and the scholarship may be characterized as taxable compensation to the employee. The advantage of awarding scholarships directly from the company and not a charitable program is that the number that can be awarded is not limited.
Private company foundation: A program that awards scholarships to employees of children may also be administered by the company private foundation. However, the program must serve a charitable purpose and not be designed primarily to benefit the company as an employee recruitment, retention, or compensation tool. To ensure this balance, the IRS provides guidance on such programs, including specifying limits on how many awards may be granted each year.
Below is a brief overview of IRS guidance to private foundations that award scholarships to company employees.
- The grantee pool must constitute a charitable class. This partly means that the class of potential recipients must be large enough or open and ongoing so that an indefinite number of individuals may benefit. The issue of charitable class may present a significant challenge for smaller companies.
- The scholarship program may not be used to recruit or retain employees or induce employees to follow a particular course of action.
- The selection committee must be completely independent of the employer and the company foundation. This selection committee must be solely responsible for determining the amount and number of grants and choosing the grantees.
- Selection of grantees must be based on objective criteria, generally unrelated to employment. The one permissible employment-related requirement is a minimum period of employment, as long as the period is no longer than three years. Once a recipient has been awarded a scholarship, the grant may not be terminated based on the employee’s departure from the company.
- There is a percentage limitation on the number of employee children who can receive scholarships. Overly generalizing, the rules ensure that scholarships may not be awarded to every eligible child. You can satisfy this test if scholarships are awarded to no more than 25 percent of the eligible applicants or to no more than 10 percent of the eligible children, regardless of whether such children applied. This second option may be useful if there is a large potential applicant pool but only a small group of actual applicants. Finally, if the number of scholarships awarded in a particular year is both more than 25 percent of applicants and more than 10 percent of the eligible applicant pool, you can comply with IRS rules by demonstrating facts and circumstances that prove the scholarship is designed to educate the awardees and not provide additional compensation or incentives to employees.
In addition to these guidelines, a company foundation planning a scholarship program for company employees must comply with the more generally applicable rules for awarding scholarships. Among these rules is the requirement that a private foundation obtain pre-approval of the scholarship program from the IRS.
We suggest that a private foundation work with experienced counsel when designing a company foundation scholarship program that will exclusively serve or give preference to company employees or their children. For additional information, consult the Council publication Grants to Individuals by Private Foundations or our legal services department.