A good education can be a springboard to a better life, providing access to a rewarding career, greater lifetime earnings and even better lifetime health.

When your clients support even one college scholarship, they can change the life of a recipient, helping him or her break the cycle of poverty and thus change the trajectories of siblings, friends and communities. There are few other gifts that return such profound rewards.

Private foundations play an important role in this regard, funding students’ study, research or travel, or improving their literary, artistic, musical or scientific capacities.

There’s no rule that says scholarships must be reserved exclusively for straight-A students, yet most academic scholarships ironically go to the students already well-equipped to go to college on their own—those with top grades, a wide range of activities and, more often than not, a support network for their pursuits. So what happens to the B-average student who lives in a dangerous area, for whom just getting to high school every day is a challenge? What about the single mother learning job skills following her transition from a domestic violence shelter?

The efforts of these people might not be reflected in their GPA, but they are just as worthy of support.

Nontraditional scholarships go beyond funding typical high achievers by creating opportunities for these other hard-working students—people striving diligently to lift themselves up to a better life.

Take some other examples of nontraditional scholars:

• The born leader: someone who inspires others as a positive role model, bringing constructive change to the life of his or her community. 

• The kid who has fallen through the cracks: a promising student confronting overwhelming odds, such as life in a foster home or a homeless shelter. 

• The middle-class exemplar: an excellent student from a relatively “comfortable” home who, because of his or her parents’ hard work, is unable to qualify for federal loans and is thus unable to afford college.

Private foundations are in good stead to reach these kinds of students, because they not only fund scholarships, but also select recipients. That means they can recognize people with a special spark and determination no standardized test could reveal.

The Right Channels
But choosing those worthy scholarship candidates means getting IRS approval and going through a process that ensures the selection is fair. The Internal Revenue Service has rigorous requirements for scholarship funding, which means foundations must be meticulous about their processes to avoid running afoul of the tax code, risking penalties and fines.

If a foundation funds an existing scholarship program in a public charity, such as a nonprofit college or university—and does not involve itself in selecting the recipients—advance approval from the IRS is not required. However, if a foundation board wishes to take an active role in selecting scholarship recipients, it must obtain advance approval from the agency for any program. In fact, it is a foundation’s very act of choosing a scholarship recipient that triggers the need for IRS advance approval, regardless of whether the funds are paid directly to the recipient or to a college or university.

In issuing advance approval, the IRS looks for the following:

• A selection process that is objective and nondiscriminatory.

• Selection criteria that align directly with the purpose of the scholarship program.

• Evidence that the foundation has systems in place to verify that the recipients fulfill any requirements that are a condition of the scholarship. (For example, the production of a book or research report.)

In applying for advance IRS approval, foundation clients can expect to have to provide the following information:

• The IRS requires that grant recipients be selected from an open-ended group of individuals known as a “charitable class.” This group must be large or indefinite enough to ensure that the number of members within it is not fixed (it could consist, for example, of all the individuals located in a city, county or state). Foundations must provide a description of the charitable class their recipient belongs to. This way it is showing it serves a broad public interest rather than a private one. 

• Foundations must also provide a list of the qualifying criteria it will use to select recipients.

• Foundations must offer the qualifications of those who will select the recipients from the applicant pool and their relationship to the foundation. (The people who select the grant recipient should not be in a position to receive private benefit if certain grantees are selected over others.)

• The foundation must provide an explanation of how the scholarship program will be publicized to all potential candidates to make them aware of the opportunity.

• The foundation will need a description of the process used to ensure that recipients satisfy the requirements of the program and that the funds are committed to the program’s stated purpose. 

• And the foundation must explain the procedures it will follow if funds are misused.

Once advance IRS approval is obtained, donors can have direct, hands-on involvement in choosing the recipients, developing relationships with them and seeing firsthand the impact of their giving. These foundation boards may review scholarship applications and essays, and interview applicants, taking a direct role in choosing whom they support.

IRS rules say that the foundation can proceed to make awards if it has not been notified within 45 days that the agency has rejected its procedures. But if the IRS later rejects the process, any awards made after the agency’s communication would be taxable.

Considering the uncertain nature of making scholarship awards during the waiting period, we recommend that foundations wait until the IRS has formally approved a scholarship program, so as to limit a foundation’s exposure and avoid potentially awkward situations in which the foundation would be unable to fulfill a commitment it has already made.

Avoiding Unintended Consequences
One of the great advantages of having a private foundation is that it enables a donor to fund the educational aspirations of deserving individuals—whether through a school or through the foundation’s own scholarship program. However, under certain circumstances, a scholarship grant made by a private foundation may have the unintended consequence of reducing the amount of actual financial assistance awarded to a student.

When schools offer financial aid packages to students, a portion of the package is comprised of institutional award dollars that students need not repay, and another portion is “self-help” dollars, such as need-based student loans and work-study programs. Students are responsible for paying back the self-help portion of the financial aid package eventually, often with appreciable interest. 

Federal law requires universities to reduce the financial aid package of private foundation scholarship recipients by the amount of the foundation scholarship grant, whether the scholarship grant is sent directly to the university or to the student. Often, universities will reduce the award dollars of their financial aid package first and leave the student loan portion of the aid package to the student. This practice obviously helps the university more than the student. There are techniques, however, for designing your foundation’s scholarship program to maximize the benefit to your recipient, rather than to his or her university.

For example, let’s suppose that John’s tuition is $40,000 and University X had already promised $15,000 of scholarship aid from their own endowment, as well as an additional $15,000 in “self-help” loans. The foundation then sends University X a $10,000 scholarship check to be applied toward John’s tuition. The university might simply reduce its own scholarship commitment from $15,000 to $5,000 on account of the foundation’s scholarship. To avoid this outcome, the foundation should consider including language in its scholarship grant letter to the effect of:

“The Grant is made under the condition that it will first reduce the Student’s self-help aid dollars (loans and work study); specifically, the Grant should not be used to reduce the Student’s in-kind awards or financial assistance of any type with the exception of self-help aid dollars (loans and work study).”

Such language assures that the university, while remaining in complete accordance with federal law, is not penalizing the student by reducing his or her award.

In conclusion, scholarships are not only a powerful way of directly impacting lives through giving, but they help your clients create a legacy that aligns giving with their values and goals. Even small foundations can powerfully impact lives through scholarship funding. And by choosing nontraditional candidates, donors might be creating a stronger impact than they knew they were capable of.

But knowing the rules is an important first step if you want to make sure you don’t run afoul of the laws and end up hindering the student instead.
 

Page Snow is chief philanthropic officer at Foundation Source.