GOP Raises Taxes on Graduate Students … Or Does It?

Patrick W. Thomas
Professor of the Practice, Notre Dame Law School

We’ve all been poring over the GOP tax bill, released last week. On my initial read, I mainly looked at those provisions that affect my own practice in a Low Income Taxpayer Clinic: the expansion/restriction of the Child Tax Credit; the elimination of the dependency exemption; and the lack of any expansion in the Earned Income Tax Credit (paging Paul Ryan…). Selfishly, I also calculated the bill’s effect on my own taxes: a nearly 3% tax cut that I do not need!

Or so I thought. You see, my wife is a Ph.D. student in computer science who, like most students at the University of Notre Dame, receives a full tuition waiver, in addition to a stipend from the university. As I returned home on Friday, ready to put the tax bill out of mind for a couple hours, I saw a tweet from Claus Wilke, professor of integrative biology at the University of Texas:

Uh oh. Back to tax policy on a Friday night, it seems. And, perhaps, so long to that tax cut.

Most non-professional graduate students (i.e., students not studying law, business, medicine, and certain other professional fields at the graduate level) pay no tuition for their course of study. This includes those in the vaunted STEM fields, as well as the humanities and social sciences. While universities “charge” tuition, all of the tuition is ordinarily waived. Additionally, most graduate students and nearly all Ph.D. students receive an additional stipend for work as either a teaching or research assistant. These stipends are taxable under current law, whereas under IRC § 117(d)(5), the tuition waivers are not. (Prior to the 1986 tax reform, not only were tuition waivers tax-free, but so were graduate student stipends! See Russell v. Comm’r, T.C. Memo. 1987-216.)

According to Dr. Wilke, the GOP tax bill now requires those tuition waivers to be included in income. After studying the bill and the current statute, this appeared to be true. So, I ran the numbers for a typical graduate student at my institution. You can read my in-depth calculation in the Twitter thread. But essentially, of the $23,000 stipend that a single Notre Dame student receives, he or she would need to pay approximately $13,350 in federal and state income tax, compared with about $2,500 under current law. That makes a graduate education effectively unaffordable.

Perhaps I’m naïve, but I have trouble believing that the GOP really intends to take away such a large, important benefit from a huge number of students, whose work is critically important to the betterment of this country. Could the GOP have meant only to target the other provisions in section 117(d), which exclude undergraduate tuition waivers from taxation for employees of a university? Are there remaining provisions in the Code that could save the tuition waiver’s tax-free nature? Let’s take a closer look at the proposal.

Section 1204(a)(3) of the bill wreaks the havoc here, stating: “Subchapter B of chapter 1 is amended . . . by striking subsection (d) of section 117.” IRC § 117(d) provides for exclusion from gross income for a “qualified tuition reduction”, defined as “any reduction in tuition provided to an employee of an organization described in section 170(b)(1)(A)(ii) [an educational organization] for the education (below the graduate level) at such organization (or another organization described in section 170(b)(1)(A)(ii)) of (A) such employee, or (B) any person treated as an employee . . . under the rules of section 132(h).” Under IRC § 132(h), that’s retired/disabled employees, spouses, and dependent children.

So, mainly, this exclusion targets a smaller set of benefits that universities give as part of their standard employee benefit packages: tuition waivers for current employees taking a few credit hours, or (often larger) waivers for the employee’s dependents. While I know a number of people who would balk at taxing such a benefit, that ultimately places those folks on the same playing field as those not employed in academia.

But critically, under IRC § 117(d)(5), for someone “engaged in teaching or research activities for such organization”, the “below the graduate level” proviso doesn’t apply. Thus, graduate teaching and research assistants may receive the full benefit of a qualified tuition reduction under section 117(d). None of their tuition waiver is included in gross income.

The GOP bill does away with all of section 117(d), which would seem to cause the inclusion in income of tuition waivers for graduate students in research or teaching assistant roles. But could graduate students still qualify for other exclusions for their tuition waivers? Section 127, which provides exclusion up to $5,250 for employer-provided tuition assistance (and upon which some universities (see, e.g., Minnesota, Texas A&M) rely for non-teaching or research graduate assistants), is also repealed under section 1204(a)(2) of the bill. So that’s no help.

What about qualified scholarships under section 117(a)? The bill does not touch this provision. Let’s go through the statute. “Gross income does not include any amount received as a qualified scholarship by an individual who is a candidate for a degree at an educational organization described in section 170(b)(1)(A)(ii).” A qualified scholarship, is “any amount received by an individual as a scholarship or fellowship grant to the extent that, in accordance with the conditions of the grant, such amount was used for qualified tuition and related expenses.”

Are tuition waivers an “amount received . . . as a scholarship or fellowship grant”? Yes. Proposed Regulation 1.117-6(c)(3)(i) includes tuition reductions as a “scholarship or fellowship.” (FYI, the proposed regulations are difficult to find online, given that they were proposed in 1988 and don’t appear in the online Federal Register. You’ll need to find them on Lexis, Westlaw, or Bloomberg.) And, given that a tuition waiver, per its name, is solely used for payment of tuition, it’s for “qualified tuition and related expenses”. All graduate students that I’ve met are “individuals”, and though Ph.D. students are not technically Ph.D. “candidates” until passing their qualifications, the proposed regulations count any tuition paid for coursework leading to a degree.  See Prop. Reg. § 1.117-6(c)(4)(ii).

But to achieve exclusion, the graduate student must contend with IRC § 117(c) and prior caselaw, which generally includes benefits in income where the grantor of the scholarship is also the student’s employer; i.e., the relationship that essentially all graduate students have with their universities. In 1969, the Supreme Court held in Bingler v. Johnson that where cash payments represent only a “quid” for the “quo” of services, they constitute taxable income. Similarly, Regulation section 1.117-4(c)(1) includes a payment or tuition reduction in income if it “represents either compensation for past, present, or future employment services or represents payment for services which are subject to the direction or supervision of the grantor.” And finally, section 117(c) specifically includes in gross income “any amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship or qualified tuition reduction.” Essentially, if the payment or tuition reduction the graduate student receives is given on account of the services provided, it’s included in gross income.

Given that IRC § 117(c) applies to both qualified scholarships and qualified tuition reductions under current law, why aren’t tuition waivers already subject to tax under current law? Aren’t they “payments for teaching [or] research . . . services by the student required as a condition of receiving the . . . qualified tuition reduction”?

Section 1.117-6(d)(3), Example 6, of the proposed regulations answers this question. In situations where a graduate student is receiving a substantial stipend (as most do), that cash compensation represents reasonable remuneration for services provided. In essence, it’s what the university would pay to someone other than a graduate student for work performed. So, while that amount must be included in income, anything else counts as a “qualified tuition reduction”; the waiver is seen, under the regulations, as something other than payment for services performed.

While Example 6 provides an example for a qualified tuition waiver under section 117(d), Example 5 provides a similar example for a qualified scholarship under section 117(a). There, the student (1) receives a scholarship of $6,000 and (2) performs services as a researcher, where such services are valued at $2,000. The regulations contemplate that, while $2,000 must be included in income because it represents reasonable compensation, $4,000 can be excluded if spent on qualified tuition or related expenses.

Doesn’t Example 5 in the proposed regulations have potentially the same economic effect as Example 6, albeit with another name? Could a university, even with section 117(d) repealed, grant a scholarship of, say, $70,000, where $20,000 is allocated as reasonable compensation and $50,000 as a qualified scholarship? I don’t immediately see a problem with this, but I invite other thoughts.

Given the economic effects on graduate students that I detailed in my tweets, the reaction of those affected is understandable. At the very least, the GOP could stem a growing tide of fear, consternation, and frustration through adding a specific provision in section 117, clarifying that the tax-free nature of tuition waivers will remain. But if the GOP does intend to prevent thousands of current and aspiring graduate students from an affordable education, they should come out and say so directly.

 

8 thoughts on “GOP Raises Taxes on Graduate Students … Or Does It?

  1. Application of the proposed reg is really interesting. However, I doubt the GOP intended to retain grad students’ tuition waivers. I would think that, if the bill passes with this provision in it, Treasury might well revise or withdraw that reg.

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  2. Interesting points. If anything, this really just highlights the disincentives for secondary income earners. An unmarried graduate student’s stipend is not nearly big enough to trigger taxation, especially if the standard deduction is enlarged to $12k. However, with income stacking onto a working spouse’s salary, yes, much of a graduate student’s stipend goes to taxes.

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  3. In the absence of 117d or 127, is it possible that tuition waivers for “student employees” (RAs and TAs) could qualify as working condition fringe benefits under 26 USC 132(a)3? I am a PhD student now, but when I worked for a large industrial company, the company covered our education expenses tax-free as long as they were related to our immediate job.

    Under 132(a)3, educational assistance qualifies as a non-taxable fringe if it would otherwise be deductible if the employee paid for it him/herself, ie. if the education “(1) maintains or improves skills required by an individual in his employment, trade or business” or “(2) meets the express requirements of the individual’s employer”.
    I think RAs and TAs could meet this definition, as they already meet the minimum level of education required to do the job of “research” in their field, and they are not attempting to change fields, but merely improving skill.

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    1. Yes, you’re onto something.

      Here’s a 1990 IRS private letter ruling:

      “Under section 132 of the Code, a fringe benefit that qualifies as a no-additional-cost service, a qualified employee discount, a working condition fringe, or a de minimis fringe is excludable from gross income. However, section 132(j) [now section 132(l)] prevents the exclusion under section 132…from applying to fringe benefits of a type for which the tax treatment is expressly provided elsewhere in the Code. Because section 117(d) provides for the tax treatment of tuition reductions, the exclusions under section 132 generally do not apply to free or discounted tuition provided by an educational institution to its employee, whether the tuition is for study at or below the graduate level.”

      The IRS then says in Field Service Advice 2002 (March 13):

      “Tuition reduction is the type of benefit provided for under Code § 117; thus, Code § 132(l) precludes application of § 132 to exclude tuition reduction amounts from gross income, other than as a de minimis fringe benefit. In addition, the regulations seem to clearly distinguish between tuition reduction under Code § 117 and amounts paid by an employer for an employee’s education under Code § 127.”

      “Moreover, Congress considered the relationship between the working condition fringe benefit and educational assistance in enacting OBRA ‘89, and found it necessary to amend Code § 132 (then Code § 132(h)(9)) to provide that educational assistance that is not excludable under Code § 127 may be excludable under Code § 132. This suggests that Congress believes that educational assistance would not be otherwise excludable because Congress is presumed not to enact statutes that are superfluous. Thus, Congress’ failure to include Code §117 in this amendment provides further support that tuition reductions are not excludable under Code § 132(d).”

      Disregarding whether the IRS’s argument about the Congress’s infallibility is sensible, the IRS’s current interpretation would imply that a repeal of Code § 117(d) in fact open up *all* types of employer-provided tuition reductions to be excludable under Code § 132. Whether the GOP congressmen intended for this or not (probably not), the effect of the repeal of 117d would be a massive expansion of educational tax credits toward university employees, including non-degree-enrolled employees.

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  4. Typically the GRA / TA position gets the tuition waiver IN EXCHANGE for providing some service. Presumably some might push back on that not being considered income if schools were to attempt to skirt the new laws by calling it a scholarship rather than a tuition waiver.

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  5. I think this part is in error.

    >Essentially, if the payment or tuition reduction the graduate student receives is given on account of the services provided, it’s included in gross income.

    >Given that IRC § 117(c) applies to both qualified scholarships and qualified tuition reductions under current law, why aren’t tuition waivers already subject to tax under current law? Aren’t they “payments for teaching [or] research . . . services by the student required as a condition of receiving the . . . qualified tuition reduction”?

    They aren’t. Most tuition waivers are offered as part of a degree program (virtually the case for all PhDs). The waivers are not conditional on working as an RA/TA position, even though those RA/TA positions might also be offered/guaranteed as part of the same contract. As far as I can tell, IRS doesn’t consider this quid pro quo, and I think their interpretation is correct.

    If you want to pursue this further, I suggest asking a graduate department in Notre Dame (e.g. in the sciences) for a copy of their graduate student offer.

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    1. I’m not proficient in the goings-on of graduate programs at other universities, but our program offers only extend tuition waivers to graduate students who are taking an assistantship of some sort; the waiver is conditional on the assistantship. I have not yet met a graduate student whose tuition was waived without some additional type of service the student was required to perform. I have a copy of my own offer letter, and the waiver is in exchange for work expected through the assistantship. I have a screen shot but no clue how I could upload it.

      And during years where funding for the specific department was low (i.e. virtually no one was graduating), there would be grad students who took the program acceptance without funding, paid the tuition, and just crossed their fingers for the next year.

      This was an enlightening and helpful read. I still cannot locate any stated reasoning behind this reform either, but perhaps there is a loophole or provision…somewhere. Either that or the GOP really is trying to through a wrench into graduate programs in general, which sounds like something a conspiracy theorist would say. But why go after an already financially struggling (and when it comes to how much we’re paid and the constraints most programs place on obtaining jobs to supplement tiny stipends, virtually powerless) group? That’s what I’ve been searching for this week to no avail.

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