This is the unofficial website of the NSF AAPF program, run by the fellows themselves. For official information about the fellowship, please go to the NSF program announcement.
As all the sites I've listed here will say, this is not tax advice, you should consult your lawyer or CPA, I cannot be held accountable for the information listed here. No one who has contributed to this page is an accountant, nor plays one on TV.
However we are all in this together and having similar tax returns might decrease our chance of being audited so here's what I've found on the web, and how I've interpreted these documents. If you have input/objections or other sites, send them to me and I'll add them.
Since the document is getting long here's a list of what we're trying to answer:
Q: Do we have to pay income tax on our fellowships?
Q: Do we have to pay self-employment taxes?
Q: Do we have to pay income taxes on the travel/computer money?
Q: Do we have to pay income taxes on the interest on our travel/computer money?
Q: Where can I find estimated tax form information?
Q: Do I have to annualize my estimated taxes? What does that even mean?
Q: What advice does the NSF give us about all this?
Q: Any other thoughts or advice?
Yes, everyone is agreed, we owe the IRS income tax. We should pay it quarterly but might get away with not paying it quarterly for the first year. ("Getting away with it" means not paying big penalties in addition to the tax.)
DON'T FORGET you have to pay STATE income taxes quarterly as well!
IRS Publication 17 says you will not have to pay a penalty for 2001 if any of the following applies:
More in Chapter 4 of Publication 505.
The distinction here is between "compensation" and "non-compensation" grants -- if you consider an NSF Fellowship a "non-compensation" grant then
Advice to medical fellows says on a
"non-compensation type of grant, you pay no Social Security or Medicare tax on the grant and you can deduct the cost of books, tuition, supplies and required fees. The net amount is considered taxable income."
The Smithsonian did (after a disclaimer) provide tax advice for their fellows:
With respect to U.S. citizens and resident aliens, informal information received from the Internal Revenue Service advises that fellowship income is not considered to be income derived from a trade or business and is not, therefore, subject to self-employment (social security) tax.
TaxLinks.com provides all tax rulings from 1954 to the present.
Ruling 60-378 in 1960 says
"Such grants do not constitute income from a trade or business and, hence, are not subject to the tax on self-employment income imposed by section 1401 of the Code."
Later on:
"The terms `fellowship grant' and `trade or business' are inconsistent and mutually exclusive... The characterization of an award as a qualified `fellowship grant' extends to the whole of the grant, and the unexcluded portion may not be treated as the product of a trade or business for self-employment tax purposes, just as it may not be excluded as a gift, or prize or award."
See also Private Letter Rulings PLR 8208097 and PLR 8239111. Private Letter Rulings are responses to letters written to the IRS and are not precedent setting.
Vanderbilt University takes a conservative view that you probably should pay self-employment tax BUT they lay out reasons why you might not have to very clearly -- this is the best summary of why this is so confusing.
Basically they say that prior to 1986 you didn't have to pay EITHER income tax (up to a certain amount) or SELF-EMPLOYMENT tax on a fellowship. Then, with the Tax Reform Act of 1986 the tax liability changed -- fellowships were now subject to INCOME taxes. However nowhere did they say anything about changing the liability for SELF-EMPLOYMENT taxes.
Cornell University says
"Fellowship payments are exempt from social security taxes; they are not considered wages or self-employment income."
Bertrand M. Harding Jr. is an attorney that runs www.universitytax.com.
He wrote a page on the issue of Distinguishing Between Scholarship/Fellowship and Compensation Payments. He agrees with the above that fellowships owe income but not self-employment and cites a case decided in favor of the fellow Spiegelman vs. Commissioner, which occurred on March 8, 1994. He does note that while it's good that the court decided in favor of the fellow, it's distressing that they took him to court at all.
OK, we now have two competing sets of advice, both from CPA's.
| A: Yes, but only on the money we haven't spent | B: No |
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Advice from NRAO's CPA at Brookhaven (who has now retired): The taxable portion of the grant (gross revenue less expenses against the grant) should be reported as net grant income on the other income line of your 1040....I would report the net on the 1040 as described above, with a statement attached to the return explaining your situation. I would net the total cost of the computer against the grant gross. |
Advice from Kelsey Johnson's CPA: My husband and I hired a CPA this year, and his advice is in keeping with much of what we have already heard, and far less complicated than I had feared. The main points are the following: First, as we thought, he advised us NOT to pay personal employment tax because fellowships are exempt. He also advised us not to even mention the 10K in research allowance; in his opinion, we should be able to account for this after the three years of the fellowship if audited, and in fact, we don't even need to spend all of the 10K in any given year, rather we just have to spend 30K after three years (or claim it as income at that point). In his opinion, the 10K is like an operating budget for a business, and this is how it is treated in business. Also, in his opinion, writing a letter explaining the 10K was inviting an audit. Finally, as I'm sure you all know, we have to file both federal and state tax quarterly. |
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Strengths/Weaknesses: If you choose this option you will have deal with the fact that your fiscal year is not the same as the tax year. There are suggestions for dealing with this on the link above. |
Strengths/Weaknesses: The NSF income and travel money is not reported by the NSF to the IRS (if it was they would also have to send us form 1099). If you write the IRS a letter telling them about it that's the first they have ever heard of it. While I don't suggest using this to evade income tax (which the law is quite clear that we do owe), it means that they won't come knocking on your door asking why you reported your salary and not your travel/computer funds. Since funneled through ordinary university/observatory channels this money is normally not taxed as income, if you were audited you would have a pretty strong case if you could show that it was entirely used (over the period of the fellowship) for research needs. Either way you should keep complete records of how the money was spent (probably at the same level you would if you had to file for reimbursement at your institution). |
| NSF fellows using this method: 0 | NSF fellows using this method: 2 |
Kim Coble:
The part I'm slightly fuzzy on: I think we do need to pay tax on the travel/computing $$. However, we can deduct it as a business expense under itemized deductions. The bummer is if you were just going to take the standard deduction of $4400 (for a single person) instead of itemizing, you can no longer do that. i.e.. We can't subtract the standard $4400 from the salary part and we end up having to pay 0.28*4400 = $1232 more to the IRS than if travel/computing $$ went through our universities. If you were going to itemize anyway, you are not hosed by this.
I think it would be reasonable to pay tax owed because of the travel/computer $$ out of the travel/computer budget. Do others agree?
Kristy Dyer checked this out with the institution's CPA:
Dear Mr. Federmann,
Thanks for agreeing to look into this. In case it wasn't clear from the email Bob D'Angio forwarded to you, there are two of us at NRAO on NSF Astronomy fellowships. The NSF isn't willing to give us tax advice and it's a little unusual because our travel/computer budget is deposited to the same checking account our paychecks are.
(I moved mine immediately to a separate account but they are totally under our control.)
We've resolved some things to our satisfaction (although if you disagree, I'd be very interested). We do have to pay quarterly state and federal income tax on our salary. We do not have to pay self employment tax on our salary. However the travel/computer money is a problem. If we have to declare it as income and then claim business deductions then that leads to all kinds of problems:
The NSF Physics fellows probably have been dealing with this for years but most comparable moveable fellowships (Hubble, Chandra, etc) send travel money to the institution (which does or does not waive overhead) which avoids this difficulty. I don't know whether to agree that in essence this is the same as those fellowships and therefore not income, or that since the money is deposited like income it should be treated as such.
Anyway thanks for your help,
-- Kristy
Kristy:
Your research and conclusions are right on point. Your fellowship does not constitute business income and therefore is not subject to business expense deductions. The taxable portion of the grant (gross revenue less expenses against the grant) should be reported as net grant income on the other income line of your 1040. If the NSF intends to send you a 1099 ask them to net all expenses. They probably will not send you a 1099 nor accommodate a request for a netted 1099; therefore I would report the net on the 1040 as described above, with a statement attached to the return explaining your situation. I would net the total cost of the computer against the grant gross. Please call me if you have further questions.
Frank
If you start your fellowship in September your allowance is for September 1 2001 to September 1 2002. That means that in December you are likely to have 2/3 of your travel/computer allowance in a bank account at the end of the tax year.
Kelsey suggested that you behave as if the the travel/computer allowance is a monthly allowance rather than a yearly allowance. 10,000/12=833.33 per month and you could add to your tax liability only what you hadn't spent out of the monthly allowances.
i.e. You receive monthly allowances of 833.33 for September, October, November, December -- a total of 3333.32. You spend 1500 on a computer and 1700 on two trips. This leaves 133.32 left in the account which you add to your taxable income. (Clearly you could figure out how to avoid this by spending at least the monthly allowance before the end of the tax year.)
The other option is changing your tax year to reporting from September 1 - September 1 -- I have no idea how to do this.
I'll run this by the CPA and see what he thinks. (he's now retired....) if someone else wants to follow this up let me know.
Probably not if you spend the interest on travel/computing but since this is reported as income by your bank to the IRS I would include it as income and pay taxes on it in hopes of simply avoiding an audit. It's not that much money.
Kim Coble says: "We do need to pay tax on interest earned (seems fair actually)."
Josh Winn says: "As for the interest on the research budget, my opinion is that it is taxable and should be lumped in with other interest income."
You will soon find yourself familiar with the following publications:
| IRS Publication 970: Tax Benefits for Education | This form describes how to record taxable scholarship income, among other things. See Chapter 1. |
| Publication 520 Scholarships and Fellowships | This is now discontinued, but it was the best IRS publication directly commenting on our taxable scholarship income. |
| Topic 355 - Estimated Tax | These are the online version of teletax topics. |
| Publication 505: Tax Withholding and Estimated Tax | Information on paying estimated taxes |
| Form and Instructions: 1040-ES Estimated Tax for Individuals | This has both the instructions and the coupons you need to send in with your estimated tax payments. Don't forget that April 15 is the FIRST payment of the new year, not the last payment of the old year. If you mess up and owe the IRS money you will have to make up for that AND submit your new quarterly payment on April 15. |
| Form 2210: Underpayment of Estimated Tax by Individuals, Estates, and Trusts: | This is the form to use if your estimated tax payments differ during the year, or if you only started making estimated tax payments mid-year. |
| Withholding Calculator | This is an online worksheet (they claim they don't record any of your information) that is supposed to be slightly more accurate than the worksheet in 1040-ES. |
When you make estimated tax payments, the government requires that you do so promptly each quarter. If the amount varies each quarter, they don't necessarily know whether you paid correctly, or waited until the end of the year to pay your tax. This applies to state taxes (if applicable) as well as federal tax! If your payment amount varies during the year, or if you didn't make the first payment or three (as is often the case for first-year fellows), you need to "annualize" your payments, and report this with your year end taxes.
| State | Year-end: "1040" | Estimated Taxes: "1040ES" | Underpayment/Annualization: "2210" |
| AZ | Form 140 (2005) | Form 140-ES [instructions] (2006) | Form 221 (2005) |
| CA | Form 540 (2005) | Form 540ES [instructions] (2006) | Form 5805 (2005) |
| CO | Form 104 (2005) | Form 104-EP (2006) | Form 204 (2005) |
| CT | Form CT-1040 (2005) | Form CT-1040ES (2006) | Publication IP 2005(27)/Form CT-1040AES (2005) |
| IL | Form IL-1040 (2005) | Form IL-1040-ES (2006) | Form IL-2210 (2005) |
| MA | Form 1 (2005) | Form 1-ES [instructions] (2006) | Form M-2210 (2005) |
| NY | Form IT-201 (2005) | Form IT-2105-MN [instructions] (2006) | Form IT-2105.9 (2005) |
| OH | Form IT-1040 (2005) | Form IT-1040-ES (2006) | Form IT-2210 (2005) |
| TX | No State Income Tax | Zero | 0 - 0 = 0 |
| WI | Form 1 (2005) | Form 1-ES [instructions] (2006) | Schedule U (2005) |
Someone at the NSF who shall remain nameless sent out this email:
A couple of you have asked recently about taxes, so I thought I would send along what I can about that. Unfortunately, it isn't much. We at NSF are not permitted to give tax advice (you can probably guess why). Take a look at the IRS publication: IRS 520, "Scholarships and Fellowships" (http://www.irs.ustreas.gov/prod/forms_pubs/pubs/p52001.htm). It explains how to report fellowship income when no W-2 is issued. Naming the source doesn't appear to be required. (One puts down "SCH".) Remember that NSF is not the employer.
I don't know how the $10K research budget would be counted, perhaps this publication says more. In any case, you should not have to pay taxes on it, since it covers 'business expenses', and those can be deducted (see tax Schedule C, for example).
For those of you who have some of the institutional allowance remaining after benefits have been covered (by whatever means), it is pretty much up to the institution how these funds are used. But, if you run into administrative or departmental costs like for mailings, computer connections, computer services within the department or university, etc. it seems very reasonable to remind them that they have these funds and ask them to use them to offset these costs.
Beginning circa 2005, the IRS opened the "Electronic Federal Tax Payment System (EFTPS)" that allows individuals and businesses to make tax payments for any IRS tax form; this includes 1040ES (estimated taxes). It does not include state income taxes yet.
EFTPS allows you to make payments as often as you wish (quarterly, monthly, weekly) without having to pay a service fee for the transaction.
I (Kurtis) have been using this for 16 months now, and have not had any problems or any audits, though I am coming up on my first full calendar year now; hopefully the "no problem" status will remain.
I've been making monthly payments (100% of my annual estimated tax / 12) each time my fellowship payment arrives. It is possible to set up automatic payments, but I'm not that brave. But, given the (so far) trouble-free nature and a way to avoid having to save money for a quarterly payment, I'd heartily recommend using the service.
As with all of this advice, be sure to check for yourself that you are making the proper payments to the proper people on time.
To learn more and to register, go to: www.eftps.gov.