Stipend vs. Salary: IRS Rules and Tax Consequences

The distinction between a stipend and a salary is a frequent source of confusion. While the terms are sometimes used interchangeably, the Internal Revenue Service (IRS) applies specific criteria to differentiate between the two. This classification carries significant implications for tax obligations, as the nature of the relationship between the payer and recipient, along with the fundamental purpose of the payment, are the determining factors. An incorrect classification can lead to substantial tax complications for all parties involved.

The IRS View on Payments for Services vs. Support

The IRS’s main goal is to determine whether a worker is an employee. To do this, it looks at the degree of control the paying entity has over the worker. This evaluation falls into three categories:

• Behavioral Control: This considers whether the organization has the right to direct and control how the worker performs their tasks. If the organization provides extensive instruction, training, and evaluation, it suggests an employer-employee relationship.
• Financial Control: This examines who controls the economic aspects of the worker’s job. If the organization controls how the worker is paid, reimburses expenses, and provides the necessary tools and supplies, it points toward an employment relationship.
• Relationship of the Parties: This looks at how the worker and the organization perceive their relationship. The presence of written contracts or employee-type benefits, such as insurance or vacation pay, can be indicative of a salary arrangement.

If this analysis leads the IRS to classify the payments as wages, they are treated as a salary. If the payments are for the support and training of an individual who is not an employee, they may qualify as a stipend. For example, an intern performing administrative tasks that a company would otherwise pay an employee to do is likely earning a salary. In contrast, a graduate research fellow receiving funds to support their own dissertation work is more likely receiving a stipend.

Simply labeling a payment a “stipend” does not make it so in the eyes of the IRS. Separately, the Department of Labor uses a “primary benefit” test under the Fair Labor Standards Act (FLSA) to determine if an intern is a trainee or an employee. While the principles are similar, the IRS uses its own distinct criteria for tax purposes.

Tax Obligations for the Payer

The tax responsibilities for an organization making payments diverge depending on whether the payment is a salary or a stipend. For payments identified as salary, the payer must withhold federal and state income taxes from the employee’s pay. The employer must also withhold the employee’s share of Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare, and pay the corresponding employer’s share.

The employer is also responsible for paying both federal (FUTA) and state (SUTA) unemployment taxes. These funds provide income support to workers who lose their jobs. Annually, the payer must summarize these payments and withholdings for each employee on a Form W-2, Wage and Tax Statement, and file it with the Social Security Administration, providing a copy to the employee. This creates a clear record of compensation and taxes paid throughout the year.

When a payment is a legitimate stipend, the payer’s obligations are substantially different. For a true stipend—one not provided as compensation for services—there are no requirements to withhold income or FICA taxes. This significantly reduces the administrative and financial burden on the organization. If a payment, even if called a stipend, is for services rendered by a non-employee (an independent contractor), the payer must report it on Form 1099-NEC, Nonemployee Compensation.

Tax Obligations for the Recipient

The tax responsibilities for the individual receiving the payment depend heavily on the payment’s classification. When an individual receives a salary, their income and withheld taxes are reported on Form W-2. Because federal and state income taxes, as well as FICA taxes, are withheld from each paycheck, the recipient’s year-end tax liability is often simplified. The regular withholding helps to ensure that tax obligations are met on a pay-as-you-go basis.

The situation for a stipend recipient is markedly different. Most stipends are considered taxable income by the IRS, even if they are intended to cover living expenses. The most significant difference is the lack of tax withholding, which means the entire responsibility for calculating and paying income taxes falls on the recipient. To meet this obligation, individuals are required to make quarterly estimated tax payments to the IRS using Form 1040-ES, Estimated Tax for Individuals.

These payments cover projected income tax and, in some cases, self-employment taxes. Failure to make these quarterly payments can result in an underpayment penalty. Whether self-employment tax is due depends on the nature of the stipend.

If the stipend represents payment for services, it is subject to self-employment tax. If the payment is a pure scholarship or fellowship grant with no service requirement, the recipient does not owe self-employment tax on that income, even if it is incorrectly reported on a Form 1099-NEC.

Consequences of Misclassification

Incorrectly classifying payments that are effectively wages as a stipend can lead to consequences for both the paying entity and the individual recipient. If the IRS determines that workers have been misclassified, the organization can be held liable for all unpaid back payroll taxes. This includes the employer’s share of FICA and unemployment taxes and the employee’s share of FICA and income taxes that should have been withheld.

On top of the back taxes, the IRS can levy penalties and interest. A determination of misclassification can also trigger a broader audit, potentially leading the IRS to reclassify all workers in similar positions, compounding the financial liability.

For the recipient, the consequences of misclassification can be damaging. The most immediate problem is an unexpectedly large tax bill at the end of the year. Because no taxes were withheld, the individual is responsible for the full amount, plus potential underpayment penalties.

Misclassification means the individual was not earning credits toward Social Security and Medicare benefits. Because no unemployment taxes were paid, the individual would be ineligible to claim unemployment benefits if the position were terminated.