Tax Treaty Benefits For Scholarships And Fellowships
Scholarship and
fellowship payments that are not for qualified items are taxable to the
recipient. Qualified items include tuition and fees required for
enrollment, and fees, books, supplies, and equipment required for a course
of study received by a candidate for a degree at a qualifying educational
institution.
Scholarships and
fellowships for nonqualified items such as room and board or research are
taxable and, in the case of nonresident alien recipients, subject to NRA
withholding at a 30 percent rate or a lower 14 percent rate for certain
recipients in F, J, M, or Q status. For more details on these rules, see
the articles about scholarships, fellowships, and stipends in the September/October, 2008, November/December, 2008, and
March/April 2009 editions of the
Crow’s Nest.
US Tax Treaty
Policy
It is not the policy of the United States to provide
tax treaty benefits for taxable scholarships and fellowships, as
illustrated by Article 20 of the 2006 US Model Treaty. Article 20 grants
benefits on payments received by a student, apprentice, or business
trainee who is present in the United States for his or her full-time study
at an accredited educational institution or for his or her full-time
training provided that such payments arise outside the United
States and are for the purpose of his or her maintenance, education, or
training. (Article 20 limits payments for apprentices and
business trainees to two years.) A similar provision was included in the
1996 U.S. Model Treaty.
As a result of this
policy, the majority of tax treaties in effect provide a benefit only for
foreign-source scholarship and fellowship grants. New treaties that have
come into effect since 2006 replacing existing tax treaties (e.g., the
treaties with Belgium and Iceland) have eliminated benefits for
U.S.-source taxable scholarships and fellowships that were in the prior
treaties. Treaties with new treaty partners such as Bulgaria also include
the U.S. Model Treaty provision.
Since nonresident
alien recipients of foreign-source scholarships and fellowships are not
subject to tax on foreign-source income, this treaty benefit is of no
utility for the majority of grant recipients who are nonresident aliens.
It is important for the minority of recipients of foreign-source
scholarships and fellowships who become resident aliens subject to U.S.
income tax on their worldwide income, including their grants from foreign
organizations and governments. However, these grant recipients may not
understand that their foreign grants are subject to U.S. tax, either
because such grants may not be taxable by the treaty country or because
there is no specific line for reporting taxable grants on Form 1040
(grants are recorded on the wages line with “SCH” on the dotted line), or
both.
Tax Treaties
with Benefits
Many older tax treaties include in the
Student/Trainee Article benefits for “a grant, allowance, or award.” The
treaties with Kazakhstan, Russia, and Ukraine use the wording “grant,
allowance, or other similar payments.” The IRS interprets this wording to
apply to taxable scholarship and fellowship grants, both U.S.- and
foreign-source. (Awards as defined by Section 74 might be covered by the
Other Income Article.) These benefits apply to both U.S.- and
foreign-source grants.
Article 21 of the
treaty with South Korea is typical. It provides benefits for an individual
from South Korea who is temporarily present in the United States for the
primary purpose of:
- Studying at a university or other recognized [i.e., accredited]
educational institution,
- Securing training required to qualify for a profession or
professional specialty, or
- Studying or doing research as the recipient of a grant, allowance,
or award from a governmental, religious, charitable, scientific,
literary, or educational organization.
Under treaties that
follow this model, benefits are available for researchers as well as for
students and trainees. (For more details, see “Tax Treaty Benefits for
Research,” in the July/August 2008 edition of the Crow’s
Nest.)
Benefits are typically
available for five taxable years from the date of arrival for the purpose
of the treaty. A few treaties allow benefits for a slightly longer period
by providing benefits for five years from date of arrival instead of
limiting the benefit period to tax years.
Grant
Recipient
In order for students, trainees, and researchers to
be eligible for a treaty benefit on a scholarship or fellowship grant, the
grant must be made by the grantor to the individual. (See, for example,
the Treasury Explanation for Article 21(1)(a) of the treaty with France
and for Article 20(3) of the treaty with Germany.) The fact that an
individual is paid a salary that is funded by a grant is not sufficient to
support treaty benefits although they may be eligible for a compensation
benefit provided by the treaty, if any. Because the treaty with Russia
does not include a compensation benefit for engaging in research, post
docs from Russia working for institutions that use grant monies to pay
their salaries frequently try to claim eligibility for treaty benefits
because their salaries are funded by grants. At least two such researchers
have taken their claims to court. In 2005, the U.S. Court of Federal
Claims in Sarkisov v. the United States held for the IRS ruling
that to be eligible for a treaty benefit, the grant must be made directly
to the individual by the grantor. In its ruling, the Court held that a
contingency based on funding included in contracts by the employer to
protect itself from a shortfall of funds for research “in no manner
converted Mr. Sarkisov’s salary into a grant.” More recently, on March 30,
2009, the U.S. Tax Court reached the same result in Ratnikov v.
Commissioner on very similar facts. The Tax Court stated that “if the
modern funding environment has shifted to providing grants to universities
instead of to individuals, we agree with the Court of Federal Claims that
the contracting states have the responsibility to modify their treaty
terms if they choose, not the judiciary.
©Copyright 2009 by Windstar Technologies, Inc. Windstar reserves all rights to this electronic material. Information contained in this publication is based on the best information available at the time of publication. While believing the information in this publication to be accurate, Windstar accepts no legal responsibility for its accuracy
About The Author
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.
The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.
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