Changes Needed in the Tax Laws Governing the Exclusion for Scholarships and Fellowships and the Deduction of Job-Related Educational Expenses

GGD-78-72: Published: Oct 31, 1978. Publicly Released: Oct 27, 1983.

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Section 117 of the Internal Revenue Code allows tax exemptions for amounts received as a scholarship or fellowship grant at an educational institution, and Treasury Regulations, section 1.162-5, allow the deduction of educational expenses if they qualify as ordinary and necessary business expenses.

These provisions have created tax controversies because they are often confusing. It has been difficult for the Internal Revenue Service (IRS) and the courts to apply tax computation rules of these provisions in an even-handed manner because determinations depend upon facts which are unrelated to the ability to pay. An example is the treatment of degree versus nondegree students. Treasury Regulations for deduction of job-related educational expenses allow deduction if education is to maintain existing earning capacity but not if it is to enhance existing earning capacity or to create new earning capacity. Section 117 controversies involved mostly resident physicians and graduate teaching fellows seeking income exclusion for compensation received for caring for hospitalized patients, for teaching undergraduate students, or for research which benefited the grantor. Regulations section 1.162-5 controversies concerned persons employed as teachers or in business or government seeking to deduct expenses incurred for graduate-level education related to their jobs.

Recommendation for Executive Action

  1. Status: Closed

    Comments: Please call 202/512-6100 for additional information.

    Recommendation: Section 117 should be amended and a new educational expenses deduction section added. The amended section would: treat degree and nondegree students in the same way for tax purposes, include scholarship and fellowship grants in gross income unless the grant meets all statutory requirements for exclusion, set explicit statutory requirements which an excludable grant must meet, require grant funds to be used for study or research at a facultied school or university with an established curriculum and regularly enrolled student body, set explicit limits on the use of grant funds, provide for the selection process for grantees, remove educational grants from the compensation and gift categories, and set explicit statutory requirements with respect to the grantor's tax status. Regulations section 1.162-5 should be withdrawn and replaced by a new section and amendment which would: make a qualified educational expense a deduction from gross income to reach adjusted gross income, remove the distinction between job-related educational expenses which are capital or combined capital-personal and those which are ordinary, and allow a business expense deduction for ordinary and necessary job-related educational expenses whether as an employee or self-employed person.

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