Changes Needed in the Tax Laws Governing the Exclusion for Scholarships and Fellowships and the Deduction of Job-Related Educational Expenses

Section 117 of the Internal Revenue Code allows tax exemptions for amounts received as a scholarship or fellowship grant at an educational institution, and Treasury Regulations, section 1.162-5, allow the deduction of educational expenses if they qualify as ordinary and necessary business expenses.

These provisions have created tax controversies because they are often confusing. It has been difficult for the Internal Revenue Service (IRS) and the courts to apply tax computation rules of these provisions in an even-handed manner because determinations depend upon facts which are unrelated to the ability to pay. An example is the treatment of degree versus nondegree students. Treasury Regulations for deduction of job-related educational expenses allow deduction if education is to maintain existing earning capacity but not if it is to enhance existing earning capacity or to create new earning capacity. Section 117 controversies involved mostly resident physicians and graduate teaching fellows seeking income exclusion for compensation received for caring for hospitalized patients, for teaching undergraduate students, or for research which benefited the grantor. Regulations section 1.162-5 controversies concerned persons employed as teachers or in business or government seeking to deduct expenses incurred for graduate-level education related to their jobs.

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