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.