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3 Key Considerations for Charities and Foundations Offering Scholarships

3 Key Considerations for Charities and Foundations Offering Scholarships

Scholarships are an excellent opportunity to make a positive impact and support the objectives and mission of your nonprofit. This is particularly true if your organization’s mission is primarily educational in nature. But the benefits aren’t exclusive to educational nonprofits. And, there can be IRS compliance issues for your nonprofit if your program isn’t set up properly, so getting it right is vitally important.

Any Charitable Nonprofit Can Further Its Mission With Scholarships

Many people assume that scholarships are the exclusive domain of educationally-oriented nonprofits.  Nothing could be farther from the truth.  While it’s certainly true that many organizations offering scholarships do so as their main program, many others do so as a furtherance of their particular mission. 

The goal of this article isn’t necessarily to encourage you to adopt scholarships as part of your program plan.  That being said, scholarships are a great way to further just about any cause or mission you may have.  Think about these examples: 

  1. A nonprofit that focuses on endangered species and habitat protection funds a scholarship program for students seeking degrees in biology or conservation.
  2. A children’s literacy group offers money to students seeking degrees in early-childhood education. 
  3. A religious missions organization provides scholarships to seminary-degree students. 

This list could go on page after page.  In fact, contrary to what many might expect, the majority of scholarship-offering nonprofits are not exclusively educational in nature.

Key Considerations When Offering Scholarships

Establish the scholarship’s purpose in alignment with your organization’s goals. Starting with a clear alignment of purpose helps avoid eligibility and selection issues. If your nonprofits funds scholarships generally as a primary program, this activity supports your educational mission.  However, if your mission isn’t primarily educational, alignment is important.  The examples above give you some guidance about what we mean here. 

Define eligibility rules in compliance with IRS requirements. To start, eligibility criteria must be broad enough to serve a public interest. You can limit the eligible group to the people you wish to serve with your scholarships, such as residents of a city or state. To show that your program doesn’t create unfair advantages, you should also include a plan to publicize your scholarship to reach those who are eligible. 

Specify an objective selection process that follows specific guidelines. Recipient selection has a lot of potential for problems and may come under scrutiny. It’s imperative that you take measures to ensure that members of your organization cannot privately benefit from the selection process. Selection criteria need to be objective and non-discriminatory; however, you don’t have to limit the criteria to grades and test scores. You can and should define criteria that align with your purpose and mission, making sure that all criteria are compliant. Different regulations exist for public charities, for private foundations, and for funding scholarships connected to educational institutions and businesses. Non-compliance can result in financial and other penalties. 

One of the more important considerations here is making sure your potential universe of beneficiaries is sufficiently large enough.  This is highly subjective, and there isn’t a magic number that works for this.  It’s really more about making sure what you’re providing isn’t considered prohibited private benefit because the candidate pool only includes a handful of students, or worse, those somehow related to insiders of the nonprofit. 

Special Considerations for Private Foundations Offering Scholarships

Private foundations have another layer to consider if they are wishing to provide scholarships…namely, IRS regulations require advance approval by the IRS prior to commencing the activity.  Quoting directly from the IRS:

Grants to individuals must be made in accordance with procedures approved in advance by the Internal Revenue Service.  To secure such approval, a private foundation must demonstrate in its request for advance approval that:

No single procedure or set of procedures is required.  Procedures may vary depending upon such factors as the size of the foundation, the amount and purpose of the grants, and the number of recipients.

Approval is based on an evaluation of a foundation’s entire system of standards, procedures, and follow-up.  Hence, separate approval for each grant program is not required.  Once obtained, such approval applies to any subsequent grant program of the foundation if the procedures under which it is conducted do not differ materially from those described in the original request for approval.

Conclusion

Scholarships are a great way for any nonprofit to advance its mission, whether an educational or non-educational program, or whether public charity or private foundation.  The key is knowing best practices, as well as IRS expectations and restrictions.

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Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

This Post Has 4 Comments

  1. I have tried to ask the question in another blog but couldn’t. So here goes. We run a nonprofit organization for adults with Developmental Disabilities, and Most of our board members are family of the director or or old co-workers of his. He values no ones opinion of our employees or our executive directors opinions. He will not spend and of the money in the bank and it’s 6-figures, to buy nothing. No van, no up keep on the homes, no salary raises, nothing and he has all the board members in his hand because they are his family and or BFF’s. What should we do? We are in Georgia.

    1. This sounds like a tough and unfortunate situation. Assuming the organization is a public charity, it is required to have a majority of the board to be unrelated through blood, marriage, or business dealings. If you can’t convince them to make changes, in our experience, the best thing for you to do is likely to walk away from the situation.

      1. I, too, am closely tied to a nonprofit with a nepotistic board: a husband/wife, and a former staff member/her daughter. The community wants to do something to save this organization, but they will not listen to reason, and altered their bylaws to allow for such a small board. Can they change bylaws while in violation of them? What can be done short of calling the press or getting a watchdog organization to file suit?

        1. Sorry for the late response. To your question, as long as changes to the bylaws are made in accordance with the amendment procedures laid out in the bylaws, they can change them. While violation of other provisions is a serious matter, it doesn’t prevent them from acting lawfully in other ways. As for remedies, getting the press involved might put needed pressure on them, there’s no guarantee. And, lawsuits can only be filed by those with standing. This gets tricky with public charities. Some argue that as a charitable organization, the community at large (which might include a watchdog group) has standing, but case law is much less clear. Many, if not most, courts will argue that unless the plaintiff is directly impacted, they have no standing to litigate. It sounds like a mess. I hope it all turns out well.

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