A scholarship fund is a dedicated pool of money, set up by an individual, family, company, community organization, or school, that pays for students’ education costs under legally binding rules about who can receive awards and how the money is managed. The fund’s founding document (a trust agreement or gift agreement) locks the money to that educational purpose, and administrators cannot redirect the dollars to general overhead or unrelated programs even if the organization’s priorities change.
Funds range from small annual awards to multibillion-dollar endowments. What they share is a legal structure that governs three things: how the money is invested, who qualifies for an award, and what tax treatment applies to the donor putting money in and the student taking money out.
How the Money Is Managed
The people running a scholarship fund carry a fiduciary duty to follow the donor’s instructions. A manager who invests too aggressively, awards money to ineligible students, or diverts dollars elsewhere can face personal legal liability. Nearly every state has adopted the Uniform Prudent Management of Institutional Funds Act, which requires managers to weigh the fund’s intended duration, expected investment returns, inflation, and the organization’s other resources before deciding how much to distribute each year.
Endowed Funds vs. Expendable Funds
Scholarship funds are built on one of two financial structures, and the choice determines how long the fund lasts and how big each award can be.
An endowed fund is designed to exist indefinitely. The original gift stays invested, and only a portion of the earnings is distributed each year. Most institutions target a spending rate of roughly 4% to 5% of market value. A $500,000 endowment at a 5% payout would generate about $25,000 per year in scholarships while preserving the principal for future students. Endowed funds require a larger upfront commitment and produce smaller annual awards relative to their total size.
An expendable fund, sometimes called a pass-through fund, distributes its entire balance over a set period. A donor might contribute $50,000 and direct the administrator to award $10,000 per year for five years. Once the money runs out, the fund closes unless someone adds more. Expendable funds deliver bigger immediate awards but leave no permanent legacy.
Who Qualifies for an Award
Every fund’s governing document sets the eligibility criteria. Founders typically build the rules around academic performance (a minimum GPA or test score), financial need (often measured through FAFSA data), a particular field of study, or geographic ties to a specific community. Selection committees follow these written standards so the process stays consistent and defensible.
Federal law places real limits on what criteria a fund can use. Institutions that receive federal financial assistance are subject to Title VI of the Civil Rights Act, which prohibits discrimination based on race, color, or national origin. Following the Supreme Court’s ruling in Students for Fair Admissions v. Harvard, the U.S. Department of Education’s Office for Civil Rights has stated that schools may not treat race as a factor when distributing scholarships, even as a “plus factor” in a competitive selection process. The only recognized exception is remedying specific, documented past discrimination by the institution itself. Funds can still target socioeconomic disadvantage, first-generation college students, or geographic regions without running into these rules, because those criteria are race-neutral.
What Scholarship Money Can Cover, and What Gets Taxed
For the student receiving an award, the most important thing to understand is that not all scholarship money is tax-free. The federal tax treatment depends entirely on what the money pays for.
Tax-Free Uses
Scholarship money used for tuition, enrollment fees, and required course materials (books, supplies, and equipment) is excluded from the student’s taxable income, as long as the student is pursuing a degree at an eligible institution.1Office of the Law Revision Counsel. 26 U.S. Code 117 – Qualified Scholarships The key word is “required.” A textbook listed on the syllabus and required for the course qualifies. A laptop bought for convenience does not qualify unless the school mandates it for enrollment.
Taxable Uses
Any scholarship money that covers room and board, travel, or other living expenses is taxable income to the student.2Internal Revenue Service. Publication 970 (2025), Tax Benefits for Education A full-ride scholarship that pays $60,000 per year might cover $45,000 in tuition and fees (tax-free) and $15,000 in housing (taxable). That $15,000 gets reported as income even though the student never touched the money. Students report taxable scholarship income on Schedule 1 of Form 1040.
How Schools Report It
Each January, schools send students Form 1098-T showing tuition payments in Box 1 and scholarships or grants in Box 5. If Box 5 exceeds Box 1, the student likely has taxable scholarship income.3Internal Revenue Service. Instructions for Forms 1098-E and 1098-T (2025) Schools that waive tuition entirely through scholarships may not issue a 1098-T at all, which can create confusion at tax time. Students in that situation still need to report the taxable portion of the award.
What the Fund Itself Has to Do
For a scholarship fund to offer tax advantages to donors, it must qualify as a tax-exempt organization under Section 501(c)(3) of the Internal Revenue Code. The IRS requires that the fund be organized and operated exclusively for charitable or educational purposes, and that no part of its earnings benefit any private individual.4Internal Revenue Service. Exemption Requirements – 501(c)(3) Organizations In plain terms, the fund must serve a broad enough group of potential recipients that it functions as a public benefit rather than a personal gift vehicle.
Tax-exempt organizations file an annual return with the IRS. Larger funds file Form 990, which discloses income, expenses, officer compensation, and how scholarship dollars were distributed. Small organizations with gross receipts normally at or below $50,000 can file the much simpler Form 990-N electronic postcard.5Internal Revenue Service. Annual Electronic Filing Requirement for Small Exempt Organizations – Form 990-N (e-Postcard) Missing these filings for three consecutive years results in automatic revocation of tax-exempt status, and reinstatement requires starting the application process over.
Funds organized as public charities must also demonstrate broad financial support. The most common test requires that at least one-third of the organization’s total support come from contributions by the general public, measured over a rolling five-year period.6Internal Revenue Service. Exempt Organizations Annual Reporting Requirements – Form 990, Schedules A and B: Public Charity Support Test Organizations that fail this test get reclassified as private foundations, which brings a much heavier regulatory burden, including advance IRS approval of grant-making procedures before any scholarships can be awarded.
Tax Benefits for Donors
Donors who contribute to a scholarship fund organized as a 501(c)(3) public charity can deduct those contributions on their federal income tax return if they itemize. For 2026, the standard deduction is $16,100 for single filers and $32,200 for married couples filing jointly, so the charitable deduction only helps donors whose total itemized deductions exceed those thresholds.7Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Cash donations to a public charity scholarship fund can be deducted up to 60% of the donor’s adjusted gross income. Anything above that cap can be carried forward for up to five additional tax years. Donations to a private foundation face a lower ceiling of 30% of AGI.
Donating appreciated stock or other securities held for more than one year produces a double benefit: the donor claims a deduction for the full current market value of the shares and avoids paying capital gains tax on the appreciation. The deduction limit for appreciated property is 30% of AGI, with the same five-year carryforward for any excess. For donors holding highly appreciated stock, this can deliver significantly more tax savings per dollar than writing a check.
How to Set One Up
There are three common paths to creating a scholarship fund, and the right choice depends on how much money is involved and how much administrative work the donor wants to handle.
- Partner with a school. The donor gives money to a college or university with a written agreement specifying the scholarship’s name, criteria, and whether the gift is endowed or expendable. The school handles investment, selection, and IRS compliance. Most universities require a minimum endowment gift, commonly $25,000 to $50,000, to establish a named fund.
- Work through a community foundation. Community foundations accept donor-designated gifts and manage them as component funds. The foundation provides 501(c)(3) status, investment management, and administrative support. Annual management fees typically run from about 0.20% to 1.00% of the fund balance. This option works well for donors who want a named scholarship without creating a separate legal entity.
- Create an independent organization. This path gives the donor the most control and requires the most work. The donor forms a nonprofit corporation, applies for 501(c)(3) status by filing Form 1023 (or Form 1023-EZ for smaller organizations) electronically through Pay.gov, and takes on ongoing compliance responsibilities including annual Form 990 filings. Organizations that plan to award scholarships to individuals must complete Schedule H of Form 1023, which requires a detailed description of the grant program and selection procedures.8Internal Revenue Service. Instructions for Form 1023 (Rev. December 2024)
Whichever path a donor picks, getting the founding documents right at the start prevents the most common problems later. Vague selection criteria, missing successor provisions, and endowment spending rules that conflict with state law are all fixable early and expensive to repair once the fund is running.