From the Magazine

How Not to Fail at Employer-Related Scholarships

Corporate foundations need to follow specific rules when implementing a successful employee scholarship program.

Corporate foundations often wish to award scholarships to further their charitable missions and by doing so, help to brand their parent companies. This ability is one of the unique advantages conferred by a private foundation, and can benefit the corporation in multiple ways. For example, the foundation of a technology company might award scholarships to winners of a juried science fair, generating positive publicity and goodwill in the community while associating the parent company’s brand with innovation and achievement.

In addition to giving scholarships to students outside the company, the Internal Revenue Service allows corporate foundations to award scholarships to the parent company’s employees and their children. These employer-related scholarship programs are popular with corporate foundations because they contribute to employee morale and corporate culture, and they also count toward the foundation’s annual 5 percent minimum distribution requirement.

A corporate foundation’s scholarship program is considered employer-related if it:

• Treats the employees (and/or their children) of a particular company as a group to which the scholarships may be given;
• Limits the potential recipients for some or all of the foundation’s scholarships to employees (or their children) of a particular employer; or
• Otherwise gives such individuals preference or priority over other applicants.

Because the beneficiaries of these awards are the company’s own employees, employer-related scholarship programs are strictly regulated to prevent abuse, and IRS approval for these programs is harder to obtain. Foundations are granted tax-exempt status, after all, because their endowments are irrevocably dedicated to charitable purposes.

To ensure they don’t violate their charitable purposes, the benefits that foundations confer to their parent companies should be indirect (e.g., visibility, branding and community goodwill). Regulations around employer-related scholarships are therefore intended to ensure scholarships are not the functional equivalent of extra pay, an employment incentive, or an employee benefit. They cannot be used as a tax-free perk to recruit employees (or dissuade them from leaving), enrich corporate executives and shareholders, or as a reward for employee performance.

The use of a scholarship program for any of these purposes could result in a self-dealing violation, which could result in stiff penalties being imposed on the company. Therefore, before launching an employer-related scholarship program, a foundation needs to apply to the IRS for advance approval, and in so doing, describe the program’s structure, selection criteria and decision-making process.

Obtaining Approval for Your Employer-Related Scholarship Program

To qualify for IRS approval, employer-related scholarship programs must provide evidence scholarships are awarded to further the recipients’ education, rather than to compensate employees, and to ensure that recipients are truly deserving by objective standards. Thus, while employment with the company might be a threshold requirement, decisions about who receives aid, and how much, must be made without regard to an individual’s employment relationship. The specific evidence that the IRS requires for its analysis is outlined in the “facts and circumstances test” and the “percentage test.”

The facts and circumstances test assesses the following:
Inducement: The employer and the foundation may not use the program to recruit employees or to induce employees to continue their employment, or to compel employees to any other course.

Selection Committee: The committee reviewing the applications must be made up of independent individuals, preferably knowledgeable in the field of education. They may not be connected to the employer, former employees, the foundation, or its funders. The committee has the exclusive right to prioritize the awards and vary the amount of the scholarships. The foundation may reduce, but not increase, the number of scholarships. Only the foundation or committee may announce the awards publicly.

Eligibility Requirements: The foundation must exercise due diligence to ensure the recipient student is eligible to attend college and will be expected to attend once the scholarship is awarded. If a minimum period of employment is required for the employee (or employee’s child) to become eligible for this program, that period may not exceed three years. No other employment-related metric, such as job performance or rank, may be considered in the eligibility criteria.

Standards of Selection: Scholarship awards must be based solely on objective standards completely unrelated to employment of the recipients or their parents, and the employer’s line of business. Such standards include, but are not limited to, prior academic performance, performance on standardized tests, teacher recommendations, and financial need. Personal interviews attesting to motivation and character may also be considered.

Employment Status: The terms of the grant must not require an express or implied commitment of future employment from the recipient or the recipient’s parent. And, once awarded, a scholarship may not be terminated because a recipient or recipient’s parent leaves the company. In multi-year awards, renewals must be based solely on non-employment criteria, such as maintaining a minimum grade point average and remaining in good standing with the educational institution.

Study Objective: If a scholarship recipient has the opportunity to pursue multiple fields of study, the recipient alone must be free to make the choice among them. The foundation cannot limit the student’s scholarship award to study programs that benefit the employer or the foundation. Overall, the terms of the grant and course of study must allow recipients to obtain an education solely for their personal benefit.

The percentage test, the other important test of employer-related scholarship programs, effectively caps the number of possible awards relative to the size of the eligible applicant pool. This means that an employer-related scholarship program will always be highly competitive and that a majority of the candidates will not receive scholarship support, no matter how outstanding their credentials might be. When the scholarships are made to the employees’ children, rather than to employees themselves, the program satisfies the percentage test if the number of scholarships awarded to employees’ children under the program in any year does not exceed the greater of:

• 25 Percent Test: A quarter of eligible applications received and considered for that year.
Or,
• 10 Percent Test: A tenth of the total number of eligible candidates, regardless of whether they submitted applications.

Example: If there are 800 eligible children of employees, and 400 children actually applied for scholarships, the foundation may award 100 scholarships (25 percent x 400 eligible applicants = 100 awards). However, if only 200 children applied for scholarships, the foundation could award as many as 80 scholarships (10 percent x 800 eligible children = 80, which is greater than 25 percent x 200 eligible applicants = 50).

For scholarships to employees, the program satisfies the percentage test if the number of scholarships awarded annually does not exceed 10 percent of the total number of eligible applications received and considered for that year.

Where scholarships are awarded to employees and to employees’ children, the scholarships will be considered as having been awarded under two separate programs: one for the employees and one for their children. Accordingly, scholarships made under each program must meet the appropriate percentage test articulated above.

Finally, a foundation that makes more grants than allowed under the above percentage test may still be compliant if, when seeking advance approval, the foundation lets the IRS know that it might be relying on the facts and circumstances test in lieu of the percentage test.

John Oddy is senior philanthropic director with Foundation Source in Fairfield, CT