To take advantage of Internal Revenue Service regulations regarding scholarships, an organization needs to apply for advance approval, before awarding grant monies. Establishing scholarships under IRS rules involves setting up compliant scholarship selection procedures, supplying all requested information and filing paperwork with the federal tax agency.
Instructions and regulations in IRS official publications that provide guidelines on properly establishing scholarships refer repeatedly to grants. The IRS definition of "grant" includes scholarships. In the agency's directives to businesses, organizations and individuals to apply for advance approval for grants, this also means fellowships and internships, among other expenditures.
If a grant is made to an individual to finance education or travel before gaining IRS approval of the organization's grant procedures, the grant monies are treated as a taxable expenditure under IRS regulations.
Scholarships must be awarded on a nondiscriminatory basis to grantees, and the objective procedures used in the process must be confirmed to gain IRS approval. The IRS also requires the organization to choose grantees who are most likely to succeed at the funded activity and to supervise the scholarship recipients to determine if obligations have been met. The IRS stipulates that no prototype exist for the methodology an organization chooses to meet these guidelines: Each organization can develop its own procedures in establishing and awarding scholarship funds as long as the final results adhere to federal regulations.
Scholarship programs created by businesses to grant awards to employees or relatives of employees are treated somewhat differently under IRS rules. To establish a scholarship program of this type, the company also needs to seek advance approval. Besides meeting the IRS' requirements governing all grant programs, the company must abide by additional regulations. These include adhering to principles of basing awards on educational advancement for the recipients and not as added compensation for select employees. An independent committee must choose recipients, and the scholarships cannot be used as part of employees' benefit packages.
Organizations seeking tax-exempt advance approval for a grant program can file IRS Form 8940 -- Request for Miscellaneous Determination. Once an organization gains IRS advance approval of an awards system, the entity is then free to apply the same standards and procedures to additional grant programs without seeking prior approval from the IRS.