Scholarship criteria that meet IRS rules start with a private foundation getting written advance approval of its selection procedures, drawing recipients from a group large enough to count as a charitable class, and awarding grants on an objective, nondiscriminatory basis. Miss any of those three, and every grant becomes a taxable expenditure carrying a 20 percent excise tax on the foundation plus personal liability for the managers who signed off.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures The rest of the design work — GPA thresholds, financial-need measures, essay prompts, committee scoring — has to be built to satisfy those three anchors.
First, Confirm the Rules Actually Apply to You
The compliance burden depends almost entirely on the type of tax-exempt organization awarding the money. Private foundations sit under two layers of restriction that public charities do not: the taxable-expenditure rules of Section 4945 and the self-dealing rules of Section 4941. Community foundations, donor-advised fund sponsors, and university-based scholarship offices are public charities and are exempt from both sections.2Internal Revenue Service. Private Foundations – Incidental and Tenuous Exception to Self-Dealing Under Treas Reg 53.4941(d)-2(f)(2)
If a donor is running the scholarship through a community foundation or public charity, most of the machinery below is irrelevant. If it originates from a private foundation, every step applies, and skipping even one can trigger penalties. Everything that follows assumes a private-foundation program.
The Advance-Approval Rule and What Happens Without It
Section 4945 imposes a 20 percent excise tax on every taxable expenditure a private foundation makes. A grant to an individual counts as a taxable expenditure unless the foundation’s selection procedures have been approved in advance by the IRS and the awards are made on an objective, nondiscriminatory basis. Managers who knowingly authorize a taxable expenditure owe an additional 5 percent tax, capped at $10,000 per grant.1Office of the Law Revision Counsel. 26 USC 4945 – Taxes on Taxable Expenditures If the foundation fails to correct the problem, a second-tier tax of 100 percent of the expenditure hits the foundation itself.3eCFR. 26 CFR 53.4945-1 – Taxes on Taxable Expenditures
The most common failure mode is sequencing. A foundation drafts thoughtful eligibility rules, announces the scholarship, collects applications, and picks winners before anyone files the paperwork with the IRS. Every grant made before approval arrives is a taxable expenditure, regardless of how fair the process actually was.
Filing Form 8940 with Schedule C
Advance approval comes through Form 8940 (Request for Miscellaneous Determination), with the attached Schedule C describing the scholarship program.4Internal Revenue Service. Instructions for Form 8940 (Rev. December 2025) Schedule C asks for detailed answers on who is eligible, what criteria the committee uses, how the opportunity is publicized, and what safeguards prevent awards from going to disqualified persons. It also asks whether the foundation will collect annual progress reports and investigate any diversion of funds.
File before the first grant cycle, not after. Foundations whose awards fund tuition and fees at a degree-granting institution check the Section 4945(g)(1) box. Foundations whose awards fund research, artistic work, or similar independent projects check Section 4945(g)(3) instead. The determination letter covers the procedures as described, so a later change in eligibility requirements, scoring methods, or committee structure may require a fresh submission.
Drawing From a Broad Enough Charitable Class
The IRS requires that recipients come from a “charitable class” — a group large enough that the beneficiaries cannot be individually identified, or indefinite enough that the community as a whole benefits.5Internal Revenue Service. Disaster Relief – Meaning of Charitable Class All graduating seniors in a school district, all students enrolled at a named university, or all residents of a metropolitan area pursuing healthcare degrees are acceptable classes. A scholarship open only to a donor’s three nephews is not.
Reasonable restrictions are fine. A foundation may limit applicants by field, geography, or economic bracket, as long as the restricted pool remains large enough to qualify as a charitable class.6eCFR. 26 CFR Part 53 Subpart F – Taxes on Taxable Expenditures The regulations recognize a narrow exception when one or a few individuals are chosen because they are exceptionally qualified to carry out the grant’s purpose, but that exception rarely fits a traditional student scholarship.
Writing Objective Eligibility Criteria
Criteria should be precise enough that two reasonable reviewers reading the same application would reach the same conclusion about whether the applicant qualifies. Vague standards produce inconsistent decisions, and inconsistent decisions are what the IRS treats as failing the “objective and nondiscriminatory” test.
Academic Performance
Most programs set a minimum cumulative GPA on a 4.0 scale. Specify whether you are using the GPA on the applicant’s official transcript or recalculating with your own methodology. Schools vary in how they weight honors courses, assign plus/minus grades, and handle transfer credits, so a 3.5 at one institution is not necessarily equivalent to a 3.5 at another. If the scholarship targets a specific major, decide whether the threshold applies to the overall GPA or only to courses in that department, and put that in writing.
Field of Study
When eligibility is limited to a discipline, identify which programs qualify with enough precision that borderline cases are easy to resolve. One approach is to reference Classification of Instructional Programs (CIP) codes, the six-digit taxonomy the Department of Education uses to classify degree programs.7Study in the States. Classification of Instructional Programs (CIP) A scholarship for “engineering students” that lists specific CIP codes settles the question of whether engineering technology or biomedical engineering is included.
Financial Need
The most widely accepted measure is the Student Aid Index (SAI) from the applicant’s FAFSA Submission Summary. The SAI replaced the older Expected Family Contribution and is the number colleges use to build financial aid offers.8Federal Student Aid. FAFSA Submission Summary – What You Need To Know A foundation can set an SAI ceiling and require applicants to submit a copy of their Submission Summary. A negative SAI indicates the highest level of need. Decide in advance whether the SAI alone controls, or whether you will also consider outside factors like family size, medical expenses, or housing costs that the FAFSA may not fully capture.
Geographic Restrictions
Scholarships limited to a specific area need a clear boundary. ZIP code lists are the simplest approach. The Census Bureau publishes ZIP Code Tabulation Areas that can help map service areas when the target region does not align neatly with city or county lines.9United States Census Bureau. ZIP Code Tabulation Areas (ZCTAs) Require proof of residency, and specify which documents you accept so every applicant provides comparable evidence.
First-Generation Status
If the program targets first-generation students, define what that means. The most common definition is that neither parent nor legal guardian has completed a four-year degree. Some programs use a broader definition covering students whose parents have some college but no bachelor’s degree. Whatever you choose, state it in the application materials and specify verification, typically through a signed self-certification.
Community Service
Programs that value service should specify a minimum number of verified hours and what counts as qualifying activity. Verification letters from the supervising organization should include dates of service, total hours, the organization’s name and contact information, and a supervisor’s signature. Without those specifics, you end up comparing an applicant who logged 200 hours at a food bank against one who claims vague “volunteering” with no documentation.
Keeping Disqualified Persons Out of the Process
The self-dealing rules of Section 4941 constrain who can influence awards. A “disqualified person” includes substantial contributors, foundation managers, and their family members, defined as spouses, ancestors, lineal descendants, and spouses of lineal descendants.10eCFR. 26 CFR 53.4946-1 – Definitions and Special Rules Siblings are not in that statutory family definition.
Self-dealing occurs when a disqualified person receives a direct or indirect financial benefit from the foundation. The initial tax is 10 percent of the amount involved for each year the self-dealing continues, paid by the disqualified person, and foundation managers who knowingly participate face an additional 5 percent tax.11Office of the Law Revision Counsel. 26 USC 4941 – Taxes on Self-Dealing A scholarship awarded to the child or grandchild of a substantial contributor is almost certainly self-dealing.
Disqualified persons are not statutorily banned from sitting on a selection committee, but their presence creates risk. Form 8940 specifically asks what measures the foundation takes to keep awards away from disqualified persons, and an IRS reviewer who sees the donor’s spouse on the committee is going to have questions. The safest approach is to populate the committee with educators, community leaders, and professionals in the scholarship’s field who have no family or financial connection to the donor, managers, or substantial contributors. Assign a chair to run the process and a secretary to document the rationale for each decision.
Scoring on an Objective, Nondiscriminatory Basis
A formal scoring rubric is how criteria on paper become decisions the IRS will accept. Each criterion gets a defined point scale, commonly 0 to 4, where 0 means no relevant evidence and 4 means exceptional. Academic performance can map directly to GPA ranges: a 3.5–4.0 earns 4 points, a 3.0–3.49 earns 3, and so on.
The rubric should also specify relative weights. A need-based scholarship might weight financial need at 40 percent and academics at 20 percent; a merit-based program might reverse those. Putting the weights in writing before any applications arrive prevents the committee from quietly shifting priorities mid-cycle. Each reviewer scores independently, then the committee meets to discuss applicants whose scores diverge significantly. That structure is what the IRS means by “objective and nondiscriminatory basis”: not that every applicant is treated identically, but that every applicant is measured against the same published yardstick.6eCFR. 26 CFR Part 53 Subpart F – Taxes on Taxable Expenditures
The Non-Discrimination Layer
Civil rights law imposes its own rules on scholarship programs, separate from the tax code. Title VI of the Civil Rights Act of 1964 prohibits race and ethnic discrimination by any entity that receives federal funding. When a college or university helps administer a private scholarship, that involvement can bring the program under Title VI, even if the donor is a private party.
The IRS reinforces this through Revenue Procedure 75-50, which requires tax-exempt educational organizations to adopt and publicize a racially nondiscriminatory policy. The policy must appear in the organization’s governing documents and be communicated through brochures, catalogs, or advertising, confirming that scholarship and loan programs are offered without regard to race, color, or national origin.12Internal Revenue Service. Rev Proc 75-50, 1975-2 CB 587
Race-conscious criteria — a program restricted to applicants of a particular racial background, for example — face strict scrutiny under federal law and must serve a compelling interest and be narrowly tailored to achieve it. The legal landscape shifted after the Supreme Court’s 2023 decision on race-conscious admissions, and foundations considering race as a factor should get legal counsel before finalizing criteria. Criteria based on sex, disability, or religion involve different standards depending on the organization type and its funding sources.
Special Case: Employer-Related Scholarships
A common model awards grants to children of a company’s employees. The IRS subjects these programs to added scrutiny because the eligible pool is inherently limited by the employment relationship. To avoid taxable-expenditure treatment, the program must pass one of two percentage tests each year:13Internal Revenue Service. Taxable Expenditures by Private Foundations – Percentage Test – Employer-Related Educational Loans to Children of Employees
- The 25 percent test: recipients cannot exceed 25 percent of employees’ children who were eligible, applied, and were considered by the committee that year.
- The 10 percent test: recipients cannot exceed 10 percent of all employees’ children shown to be eligible, whether or not they applied.
Renewal awards from prior years do not count toward the current year’s totals. If the program offers both scholarships and educational loans to the same group, the tests apply to the combined recipient count. Employer-related programs still need advance approval through Form 8940, and the selection committee must remain independent of the sponsoring employer.
Keeping the Award Tax-Free for the Recipient
Section 117 excludes scholarship money from a student’s gross income only if it pays for tuition, required fees, books, supplies, and equipment needed for coursework at a degree-granting institution.14Office of the Law Revision Counsel. 26 USC 117 – Qualified Scholarships Anything outside those categories — room, board, travel, general living expenses — is taxable income to the recipient, even if the paperwork calls it a “grant.”
Your eligibility rules and award letter should specify which expenses the scholarship covers. If the award is limited to tuition and required fees, the whole amount stays tax-free. If you want to cover living expenses, tell recipients upfront that the portion used for non-qualified expenses will be taxable. Disbursement matters here too: paying scholarship funds directly to the institution’s financial aid office helps ensure the money is applied to qualifying charges first.
Documentation, Disbursement, and Reporting
The written procedures the IRS approves are what the foundation must actually follow. If the document says one thing and the committee does another, the IRS treats the actual practice as the operative procedure, which can invalidate advance approval. Have legal counsel review the draft against Section 4945(g), the self-dealing rules of Section 4941, and any applicable state charitable solicitation laws before it goes to the board for a formal vote recorded in the minutes. Publishing the full criteria on the scholarship’s website also cuts down on unqualified applications and demonstrates the openness the IRS expects. Exempt organizations must make their annual returns available for public inspection for three years, including schedules describing grant programs.15Internal Revenue Service. Public Disclosure and Availability of Exempt Organization Returns and Applications – Public Disclosure Overview
For multi-year scholarships, state renewal criteria in the original award letter — typically a minimum GPA each semester and continued full-time enrollment as a degree-seeking student. Specify when eligibility is reviewed and what happens if the student falls short. Collect annual progress reports covering academic standing, continued enrollment, and use of funds. If a recipient drops out or diverts funds, the foundation must investigate and take reasonable steps to recover the money, which is a condition of maintaining IRS advance approval.16Internal Revenue Service. IRC Section 4945(h) – Expenditure Responsibility
Private foundations report scholarship grants on Form 990-PF, listing each grant in Part XIV with the recipient’s name and address, the relationship (if any) to any disqualified person, and a description of the grant’s purpose that goes beyond generic labels like “educational.”17Internal Revenue Service. 2025 Instructions for Form 990-PF Individual recipients who received $1,000 or less during the year and are not disqualified persons may be reported without names and addresses; everyone else must be identified. Part VI-B specifically asks whether each grant to an individual was made under procedures approved in advance by the IRS. Answering “no” is essentially self-reporting a taxable expenditure.
Keep the full paper trail: applications received (including denials), committee scoring sheets, minutes documenting selection rationale, recipient progress reports, and disbursement records. That documentation is what turns an audit from an existential threat into a routine verification, because it shows the program operates the way the IRS approved it.