Rev. Rul. 73-218

Advice has been requested whether, under the circumstances described below, amounts received by students are excludable from their gross incomes as scholarships or fellowship grants under the provisions of section 117(a) of the Internal Revenue Code of 1954.

The students are candidates for a Bachelor of Science Degree, and as a condition to receiving the degree are required to participate in a university designated work period for ten weeks each year. The university assists the students in securing work period positions by advising them in their efforts and by inquiring of various prospective employers whether employment positions are available. The work periods are not supervised by the university, but the students do submit reports on their work periods to the university, and the employers are requested to complete a questionnaire supplied by the university for each student. Each student is required to complete his designated work assignment as a condition to receiving his degree.

A student's work activities during this period are determined by his employer, and are based on the particular needs and activities of the employer during the work-term period. The students have regular job titles, and their wages are the same as those received by other employees with the same background and experience and doing similar work.

Subject to certain qualifications and limitations, section 117(a) of the Internal Revenue Code of 1954 provides that gross income of an individual does not include an amount received as a scholarship at an educational institution or as a fellowship grant. Section 117(b)(1) of the Code provides that in the case of an individual who is a candidate for a degree at an educational institution the exclusion provision of subsection (a) shall not apply to that portion of any amount received which represents payment for teaching, research, or other services in the nature of part-time employment required as a condition to receiving the scholarship or fellowship grant. However, if teaching, research, or other services are required of all candidates for a particular degree as a condition to receiving the degree, such teaching, research, or other services shall not be regarded as part-time employment within the meaning of this paragraph.

Section 1.117-4 of the Income Tax Regulations provides, in pertinent part, that amounts paid or allowed to or on behalf of an individual to enable him to pursue studies or research are considered to be amounts received as a scholarship or fellowship grant for the purpose of section 117 of the Code if the primary purpose of this study or research is to further the education and training of the recipient in his individual capacity, and if the amount provided by the grantor for such purpose does not represent compensation or payment for services. However, any amount or amounts paid or allowed to or on behalf of an individual to enable him to pursue studies or research shall not be considered to be an amount received as a scholarship or fellowship grant for the purpose of section 117 of the Code if such amount represents compensation for past, present, or future employment services, if such amount represents payment for services which are subject to the direction or supervision of the grantor, or if such studies or research are primarily for the benefit of the grantor.

In Elmer L. Reese, Jr., 45 T.C. 407 (1966), aff'd per curiam, 373 F. 2d 742 (1967), the Tax Court of the United States rejected the petitioner's contention that in enacting section 117(b)(1) of the Code Congress effectively established a mechanical test which, without regard to the primary purpose test, automatically excludes amounts received for required part-time services. The court concluded that before the provisions of section 117(b)(1) of the Code become operative there must be an initial determination that the payment sought to be excluded has the normal characteristics associated with the term "scholarship," that is, that the primary purpose of the payment is to further the education and training of the recipient rather than to compensate him for services rendered or to be rendered for the benefit of the grantor.

In the instant case, while completion of the work-term period satisfies a degree requirement imposed by the university at which the students are candidates for degrees, and in this sense is in furtherance of the education and training of the recipient, nevertheless, the payments do not satisfy the requirements of section 1.117-4 of the regulations. The students are paid for working under the supervision and the direction of their employers, and the students' activities are of benefit to the employer. The amounts received by the students are the same as those received by other employees with the same background and experience doing similar work. Thus, the entire amounts paid are compensation for present employment services within the meaning of section 1.117-4 of the regulations.

Accordingly, under the circumstances described above, the amounts received by the students from their employers for whom they perform services, are not excludable from their gross incomes under the provisions of section 117 of the Code, but represent compensation for services rendered and are wages subject to income tax withholding under section 3402(a) of the Code.