Paul L. Caron

Wednesday, July 29, 2020

Is Law School's 1L Scholarship A Forgivable Loan For Tax Purposes?

Kyle McEntee (Law School Transparency), Scholarship Or Loan In Disguise? Law School Policy Has Experts Asking Questions:

Cal Western (2017)For the upcoming school year, Cal Western will award the “Admissions Scholarship” to students as an apparent alternative to conditional scholarships. ... According to the award letter, the Admissions Scholarship is a one-year award that covers a percentage of tuition. The student will receive an additional award in the second and/or third year commensurate with the student’s class standing. However, if the student transfers from Cal Western at any time, the student must repay “the total value of the scholarship awarded up to that point . . . in full within 30 days.”

Rank of eligible students based on only first year or second year GPA Scholarship award for only second year or third year, as applicable
Top 10.00% 100% tuition coverage
Top 10.01%-20.00% 70% tuition coverage
Top 20.01%-30.00% 40% tuition coverage
Top 30.01%-40.00% 10% tuition coverage

Jerry Organ, Bakken Professor of Law at the University of St. Thomas School of Law (Minnesota), has studied law school scholarships extensively. He could not find any references to similar policies. “I do recall either reading about or having a conversation with someone a few years back about the possibility of this approach to discouraging transfers. I remember at the time thinking it was problematic, so I am surprised to see it being utilized.”

A student who receives an award for 100% of tuition for the upcoming academic year would pay the school an additional $56,080 more or less immediately if they decide to transfer after the first year under the terms of the award. ...

While Cal Western calls their award a scholarship, it may be a misclassified loan that the school will forgive if the student does not transfer. According to Jennifer Bird-Pollan, the Robert G. Lawson Professor of Law at University of Kentucky J. David Rosenberg College of Law, “if it were a forgivable loan, there would be tax liability associated with the forgiveness.” Canceled debt under the Internal Revenue Code triggers an income event.

The initial question is whether it is actually a scholarship or a loan disguised as a scholarship. ...

Professor Bird-Pollan [says] that the award looks more like a loan than a scholarship from the start. “I think if the government wanted to make the argument, they would have a very compelling case. But given that there are government programs that have similar features, my guess is they’re not going to make that argument.”

She added if she were a judge hearing the argument that this was a loan, she’d say, “Wow, that sounds pretty convincing.” But as a practical matter, “the government doesn’t pursue every tax law that we know ought to be enforced.” She gave the example of “politicking from the pulpit” as a tax law that the “government is totally not interested in enforcing.”

According to Professor Bird-Pollan, the best legal argument for the school is that scholarship money is used to repay the loan. Under this framing, the student would have received a loan, declined to transfer, and subsequently received a scholarship to extinguish the loan. The scholarship would not be subject to income tax under Section 117 of the IRC and the debt would not have been canceled. This may alleviate student fears about taxable income from the award.

Still, Professor Bird-Pollan does not feel good about the program. “It’s kind of skeezy. [The transfer stipulation] feels very underhanded. But does that change the tax analysis?” She didn’t think it changed the outcome, but did say it may change the analysis, in part because it’s coercive. ...

On August 1, 2020, Sean M. Scott will begin her term as president and dean of the law school. According to Ms. Jordan, the school’s spokesperson, the incoming dean “has begun a review of existing policies and prefers we not comment until after she has had a chance to complete her review.”

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If the scholarship is to repay the loan, then it is probably not a qualified scholarship under §117(b). Perhaps a stronger argument would be that the repayment requirement is more akin to a penalty for noncompliance with the terms of the grant. Usually these limitations apply to behavior that qualifies as moral turpitude or similar, so the argument might not succeed.

Posted by: David Hasen | Jul 29, 2020 10:10:58 AM

Not surprising. With lawyers, you need to examine their language carefully. During the Google book settlement debate, Google had an online FAQ that journalists treated as unerring. It made a reference to "copyright interests" that some 99.9% of them breezed past, there minds even more dense than usual. What it actually meant was that, should the settlement go through, every copyright on the planet would become null and void within the U.S. "Copyright interest" meant legally enforceable copyright.

Just in the U.S. mind you. The settlement was a grotesque abuse of class action law. The pretense was that the small Authors Guild was representing all authors in the world and that the settlement, which allowed Google and only Google to post their books online, would settle that debate in the U.S. I'm not sure there has ever been a more devious bit of legal action.

For the record, I was one of seven authors who challenged that settlement and managed to delay it long enough for the real facts to get out.

In the case of this law school, it appears that Cal Western will be playing similar games with their incoming students. Those "scholarships" won't really be scholarships.

Posted by: Mike Perry | Jul 29, 2020 6:14:45 AM