Revenue Ruling 71-17 and Taxable Athletic Scholarships
An IRS ruling clarifies when an athletic scholarship is considered payment for services versus tax-free aid, based on the grant's underlying purpose.
Revenue Ruling 77-263 is an Internal Revenue Service (IRS) guideline that clarifies when an athletic scholarship crosses the line from non-taxable educational aid to taxable compensation. Its function is to distinguish between grants intended to support a student’s education and payments made in exchange for athletic services. The ruling provides a framework for analyzing the nature of the financial arrangement.
The Core Principle of the Ruling
The central test established by the ruling is the “primary purpose” test. The IRS examines whether the main reason for the grant is to help the student with their education or to pay them for playing a sport. If the primary purpose is educational, the scholarship is not taxable under the Internal Revenue Code’s exclusion for qualified scholarships. If the grant is primarily compensation for services, it becomes taxable income. The analysis hinges on the specific terms and conditions attached to the scholarship, which reveal the true intent behind the payment.
Applying the Test to Athletic Grants
The application of the primary purpose test involves looking at specific factors tied to the athletic grant. A grant is likely to be considered taxable compensation if the student is required to participate in the sport to receive the funds. Another indicator is if the scholarship would be canceled for reasons other than injury should the student decide to stop playing. These conditions create a direct link between the payment and athletic performance, resembling an employment relationship. A scholarship that continues even if a student voluntarily withdraws from the team is more likely to be seen as non-taxable educational aid.
Tax Reporting and Modern Relevance
If an athletic grant is classified as compensation, the educational institution must report it as wages on Form W-2. For other taxable portions of a scholarship, such as amounts used for non-qualified expenses like room and board, the student-athlete is responsible for reporting the income on their tax return. The principles of this ruling remain pertinent today with the advent of Name, Image, and Likeness (NIL) compensation. While Revenue Ruling 77-263 specifically addresses funds from educational institutions, its core concept of distinguishing between aid and payment for services provides a useful framework to analyze various payments a student-athlete might receive.