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Proper reading of 117 of the Internal Revenue Code of 1954 (26 USC 117), which excludes from a taxpayer's gross income amounts received as "scholarships" and "fellowships," requires that before the exclusion comes into play there must be a determination that the payment sought to be excluded has the normal characteristics associated with the term "scholarships."
Respondents, Johnson et al., who held engineering positions at a laboratory which the Westinghouse Electric Corp. operates under contract with the Atomic Energy Commission, participated in a two-phase Fellowship Program. In the first, or work-study phase, a participating employee holds a regular job and attends university classes’ part time, for which the tuition and other expenses are paid by the company. A qualified employee may then be granted an educational leave of absence, the second phase, to work on his doctoral dissertation based partly on general relevancy to work at the laboratory. He then devotes full time to the dissertation for a period of several months, during which he receives a stipend from his employer plus a family allowance, also retains seniority status and other employee benefits. Respondents filed refund claims for federal income taxes withheld by their employer from the amounts paid them while on leave, contending that these payments were scholarships and hence excludable under § 117 of the Internal Revenue Code of 1954. Respondent taxpayers brought suits against appellant Bingler, district director of internal revenue for refunds after they were taxed on amounts received from their employer for attending college. A jury, instructed by the judge using 26 C.F.R. § 1.117-4(c), found the amounts were taxable. The court of appeals reversed the judgment on the verdict, holding § 1.117 invalid, and district director appealed.
Did the court of appeals err in holding § 1.117 invalid?
Yes. The Court reversed the judgment of the court of appeals and reinstated the judgment of the district court.
The Court ruled that the definitions of scholarships and fellowships, in 26 C.F.R. § 1.117-4(c), as relatively disinterested, no-strings educational grants, with no requirement of any substantial quid pro quo from the recipients, were proper. Under § 1.117-4(c), as set out in the trial court's instructions, the jury properly found that the amounts received by respondents were taxable compensation. The Court noted that there was an employer-employee relationship, that there was a close relation between respondent taxpayers' prior salaries and the amount of their stipends, that employee benefits were continued, that topics studied were required to relate at least generally to the work of the employer, and that respondents were required to hold positions with the employer throughout the program and to return to employer to work for a substantial period of time after completion of their leave. Under these circumstances, the amounts paid to taxpayers were income, not excludable scholarships.