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Stipendsby Paula N. Singer, Esq.
“Stipend” is not a tax term. Stipends are payments typically given to individuals to help defray living or other costs, often under the assumption that they are not taxable. Frequently, stipends are not taxed, not because they are not subject to tax, but because they are not reported by payers to the recipient or the IRS on an information return or by the taxpayers on their tax returns. Under U.S. tax law, the substance of a transaction determines how a payment is taxed, not the name or form of a payment. Therefore, the first task of payers is to classify the income character of a stipend based on the tax rules. Character of
the Income Section 117 of the Internal Revenue Code (the
“Code”) provides rules for determining whether a stipend amount is a
compensatory or noncompensatory grant. Section 74 of the Code provides
rules for determining whether a stipend amount is a prize or award. IRS
Publication 970, Tax Benefits for Education, explains the tax
rules for determining 1) when a payment is a scholarship or fellowship
grant, 2) the various types of payments typically treated as
noncompensatory grants, and 3) when a noncompensatory grant can be
excluded from income. Payers making payments to foreign nationals can also use a recipient’s immigration documents to assist with determining the likely income character of a payment. For example, a recipient in H-1B immigration status is a “Temporary Worker in a Specialty Occupation” for whom the sponsoring organization has certified as to the job and “prevailing wage” in immigration filings and accompanying letters. (The immigration regulations for H-1Bs even address payroll taxes.) Therefore, payments to H-1B recipients are wages. A recipient who has an Employment Authorization Document (EAD), such as an F-1 Student engaged in Optional Practical Training, receives payments that can be either wages or self-employment income. (This is one of the few situations in which a foreign national is authorized to be an independent contractor.) 1. Scholarship
or Fellowship Grant IRS Publication 970 provides the following
definitions:
Section 117 of the Code provides rules for when a scholarship or fellowship is a “qualified” grant (and nontaxable) or a “nonqualified” grant (and taxable). For example, “Gross income does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization.” IRS Publication 970 provides a liberal definition of “candidate for a degree.” (Since post-docs are not candidates for a degree, their noncompensatory fellowships are taxable.) Qualified scholarships are amounts expended for “qualified tuition and related expenses” defined by Section 117(b)(2) to include:
Cash is nonqualified because of the lack of evidence of how the cash is expended. 2. Compensation for ServicesSection 117(c) specifically provides that “a scholarship or fellowship grant does not apply to that portion of the amount received that represents payment for teaching, research, or other services by the student as a condition of receiving the grant.” However, amounts received under the National Health Service Corps Scholarship Program and the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance (Armed Forces) Program are tax-free without regard to any requirement to perform services. If only a portion of a scholarship or fellowship grant relates to services, the payer must determine the amount of the grant allocable to the services. Generally, grants must be allocated to services based on the fair market value of the services. IRS Notice 87-31 explains how to allocate such grants between services and scholarship or fellowship grants. 3. Prizes and AwardsIRS regulations under Section 74 of the Code define “prizes and awards” as amounts intended to award or recognize special achievement, skill, knowledge, or renown in certain areas. A prize or award may also be won in a contest or paid to a figure of world renown for outstanding achievement in an area of research or politics. In these situations, grantors do not intend that the amount be used for any specific purpose. Recipients of prizes and awards may use the amounts as they see fit. Prizes and awards are generally taxable with exceptions being very narrowly defined by the Code. Stipend
Payments to Foreign Nationals Payers making payments to
foreign nationals have the additional task of determining if a stipend
recipient is a nonresident alien, in which case special tax withholding
and reporting rules apply depending upon the character of income and the
source of that income (as defined by the Code). The withholding and
reporting rules for payments to resident aliens are the same as those for
U.S. citizens. Although noncompensatory fellowships are not reportable to
U.S. citizens and residents, these recipients have an obligation to record
the taxable fellowship on their Form 1040 tax return. The character of
income of a payment is also important in determining whether a treaty
exemption from tax applies to a payment made to a foreign national,
since treaty benefits differ depending on income type.
Paula N. Singer, Esq. chairman of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer, Newton, MA, has over 25 years of experience providing advice and compliance services to employers on cross-border employment matters. She is also the editor of "US Tax Compliance For Immigrants And Employers: The Lawyer's Complete Guide". To learn more, see: http://www.ilw.com/books/tax.shtm. For more information, visit www.windstar.com. For additional information, call 1-800-259-6398 or email: info@windstar.com.
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