To set up a scholarship fund, you pick a legal structure to hold the money, write eligibility criteria that meet IRS charitable-purpose rules, build an independent process for choosing recipients, sign a fund agreement, and transfer the initial contribution. Almost every donor takes one of three paths: forming a private foundation, opening a donor-advised fund at a community foundation, or giving directly to a college or university. The structure you pick shapes the cost, the paperwork, and how much control you keep.
Pick a Structure First
This is the decision everything else follows from. Choose before you draft criteria or talk to an attorney about paperwork.
Private Foundation
A private foundation is your own nonprofit entity, with your own board and bylaws. You get maximum control over investments, criteria, and awards. You also take on real overhead: you have to apply for tax-exempt status by filing Form 1023 with the IRS, which carries a $600 user fee,1Internal Revenue Service. Form 1023 and 1023-EZ Amount of User Fee file Form 990-PF every year, and pay an annual 1.39% excise tax on net investment income.2Internal Revenue Service. Tax on Net Investment Income Missing the 990-PF for three consecutive years costs you the tax-exempt status automatically.3Internal Revenue Service. Instructions for Form 990-PF (2025) Because of legal setup costs, accounting, and annual filings, a private foundation typically only makes sense when the initial endowment is large enough to absorb those expenses without eating into the awards themselves.
Donor-Advised Fund at a Community Foundation
A donor-advised fund is a separately identified account at a sponsoring 501(c)(3) where you have advisory privileges over grants but the sponsor retains legal control of the assets.4Office of the Law Revision Counsel. 26 USC 4966 Taxes on Taxable Distributions You skip the IRS application entirely because the sponsor already has tax-exempt status. Some community foundations open accounts with as little as $5,000 to $10,000, though minimums vary. Annual administrative fees generally run between 1% and 2% of the fund’s market value. The trade-off is control: your grant recommendations are advisory, not binding, and the sponsor handles compliance and investments.
Fund at a College or University
Gifting to a school’s development office is the simplest path. The university runs the endowment, applies your criteria to its own students, and handles every piece of compliance. You cannot award outside that institution, but you inherit its financial aid infrastructure. This fits when your goal is tied to a specific campus or program.
Write Eligibility Rules That the IRS Will Accept
Criteria decide who can apply, and they also decide whether the IRS treats your fund as genuinely charitable. The IRS recognizes “advancement of education” as a charitable purpose under Section 501(c)(3), so your criteria should tie clearly to educational goals.5Internal Revenue Service. Exempt Purposes Internal Revenue Code Section 501c3 The applicant pool also has to be broad enough that selecting winners benefits the public rather than a handful of pre-identified people.
Common criteria include a minimum GPA (often 3.0 or 3.5 on a 4.0 scale), demonstrated financial need verified through the FAFSA or income documentation, enrollment in a specific field of study, or residence in a particular geographic area. Combining several is normal. A scholarship for nursing students from a particular county who maintain a 3.0 GPA is specific enough to have purpose but broad enough to avoid the appearance of benefiting predetermined individuals.
Two limits apply. Federal nondiscrimination law governs your criteria, and Title VI of the Civil Rights Act prohibits discrimination based on race, color, or national origin in federally assisted programs; courts apply heightened scrutiny to scholarship criteria that consider race or ethnicity.6U.S. Department of Education. Education and Title VI Second, decide upfront whether the award is one-time or renewable. Renewable awards that require students to maintain academic standards add administrative work but reward sustained performance.
Set Up an Independent Selection Process
The IRS pays close attention to how a private foundation chooses recipients. Federal regulations require that scholarship grants be made under a procedure approved in advance by the IRS; otherwise the grants can be classified as taxable expenditures.7eCFR. 26 CFR 53.4945-4 Grants to Individuals Advance approval is one of the most overlooked steps in setting up a private foundation scholarship, and skipping it can turn every grant into a taxable event.
The selection committee matters just as much as the criteria. IRS guidance states that committee members should be entirely independent from the foundation, its organizers, and any related employer, and that they cannot be in a position to derive a private benefit from the selection, such as picking their own relatives.8Internal Revenue Service. Instructions for Guide Sheet for Advance Approval of Individual Grant Procedures This is where family foundations get into trouble. If you and your spouse want a scholarship in your child’s name, neither of you should control or dominate the committee that picks winners.
Give the committee a written scoring rubric tied directly to the published criteria. Record scores for academics, financial need, essays, and any other factor, and keep the files. That documentation protects the tax-exempt status if the IRS ever audits how grants were made.
Paperwork You Need
The exact documents depend on the structure you picked.
- Fund or scholarship agreement. The contract between you and the administering entity names the fund, incorporates the eligibility criteria, and sets the spending policy. A typical spending policy limits annual awards to about 4% to 5% of the fund’s market value to preserve purchasing power over time.
- Selection committee description. Identifies each member, their qualifications, their independence from the donor, and the scoring methodology. Essential for private foundations seeking Section 4945 advance approval.
- Application form. Collects contact information, transcripts, financial documentation, and essay responses. Clear instructions cut down on incomplete submissions.
- IRS Form 1023, private foundations only. Filed with the $600 user fee to obtain recognition of tax-exempt status as a new nonprofit entity.
If you work through a community foundation or a university, most of this is simplified. The sponsoring organization supplies template agreements and handles IRS-facing compliance. Your job is to finalize the criteria, fund the account, and approve the process.
Protecting Applicant Data
Applications collect sensitive information: Social Security numbers, income records, transcripts, family finances. If your fund coordinates with a school to pull student records, the Family Educational Rights and Privacy Act governs how that data can be shared. FERPA defines education records as records directly related to a student and maintained by an educational institution, and it limits disclosure of personally identifiable information without the student’s consent.9U.S. Department of Education. Protecting Student Privacy FERPA
In practice, ask applicants to submit their own transcripts and financial documents directly, rather than having the fund pull records from schools. Store everything securely, limit access to committee members, and set a retention policy for destroying files after the cycle ends.
Launching and Funding the Account
Once the structure, criteria, and documents are in place, launch follows a predictable sequence. Send the scholarship agreement and committee description to your administrative partner. Community foundations and universities generally review and approve within a few weeks.
A new private foundation takes longer. File Form 1023, wait for the IRS determination letter, and file any annual returns that fall due while the application is pending.10Internal Revenue Service. Life Cycle of a Private Foundation Applying to the IRS Submit your scholarship grant procedures for advance approval under Section 4945 before making any awards.
After the legal paperwork clears, transfer the initial endowment to the custodial account. Then post the scholarship on public databases, school financial aid offices, and community bulletin boards. Set a realistic application deadline and tell applicants when they will be notified.
Tax Deductions for the Donor
Your charitable deduction depends on what you give and where. Cash contributions to a public charity or to a community foundation’s donor-advised fund are deductible up to 60% of your adjusted gross income. Cash contributions to a private foundation are capped at 30% of AGI. Appreciated securities face lower limits: generally 30% of AGI for public charities and donor-advised funds, and 20% for private foundations. Amounts over these limits carry forward for up to five years.
To claim a deduction for a donor-advised fund contribution, the sponsor must be a qualifying 501(c)(3), and you need a written acknowledgment confirming the organization has exclusive legal control over the assets.11Office of the Law Revision Counsel. 26 USC 170 Charitable Etc Contributions and Gifts Contributions to a university-based fund follow the public charity limits because colleges qualify as 501(c)(3) organizations. Private foundations also pay the 1.39% annual excise tax on net investment income regardless of how much they distribute, which is another reason smaller endowments favor the other two structures.
What Recipients Owe in Tax
Recipients pay no income tax on scholarship money used for tuition, enrollment fees, and course-related expenses like required books and supplies.12Internal Revenue Service. Publication 970 (2025) Tax Benefits for Education The tax-free treatment ends there. Money spent on room and board, travel, or optional equipment is taxable income and belongs on the student’s return.13Internal Revenue Service. Topic No 421 Scholarships Fellowship Grants and Other Grants
Scholarship providers are not required to issue a Form 1099 or other tax document. Students track their own scholarship income and qualified expenses. If your fund awards amounts that could go toward living expenses, a short note in the award letter warning that the non-tuition portion may be taxable saves recipients confusion later.
Keeping the Fund Compliant Each Year
Private foundations must distribute at least 5% of the fair market value of their non-charitable-use assets each year.14Office of the Law Revision Counsel. 26 USC 4942 Taxes on Failure to Distribute Income Falling short brings a 30% excise tax on the undistributed amount for each year the shortfall remains uncorrected, and an additional 100% tax if the foundation still has not made up the difference within 90 days of IRS notification.15Internal Revenue Service. Taxes on Failure to Distribute Income Private Foundations Donor-advised funds and university-held funds have no federally mandated minimum payout, though some community foundations set their own spending expectations.
Every private foundation scholarship grant has to follow the procedures submitted for advance IRS approval. Grants outside those procedures are taxable expenditures, triggering a 20% excise tax on the foundation and a 5% tax on any manager who knowingly approved the grant. If the problem is not corrected in the taxable period, an additional 100% tax on the amount applies.16Office of the Law Revision Counsel. 26 USC 4945 Taxes on Taxable Expenditures The penalties escalate fast enough that a single careless grant can hurt a small foundation.
Form 990-PF is due on the 15th day of the fifth month after the fiscal year ends. A six-month extension is available by filing Form 8868 before the deadline.17Internal Revenue Service. Exempt Organization Annual Filing Requirements Overview Late or incomplete returns bring penalties of $25 per day, up to $13,000 per return for smaller organizations.3Internal Revenue Service. Instructions for Form 990-PF (2025) If you chose a community foundation or university, the sponsoring organization handles all of this on your behalf.