Question:
Prospective clients asked me to review their income tax situation for 2003 and their income tax return from 2002. In reviewing the 2002 return, I came across an interesting situation. Situation: The wife works as an RN for a hospital in a "rural" setting. She finished her schooling in approximately 1993. Over a year ago, she applied for and received a grant under the Nursing Education Loan Repayment Program through the U.S. Department of Health and Human Services. This grant was to pay for 60% of her student loans from her nursing schooling. Her original student loan balance was around $50,000 (rounded numbers), so the grant award was for approximatley $30,000 (60% of $50,000). The $30,000 is to be paid out to her over a 24 month period, which begain late in 2002 and will conclude in 2004. The award letter/contract states that this income will be reported to the IRS and is subject to income tax.

She is also required to work for a qualified health care facility that is located in a rural area for 2 years, which she should have little trouble complying with. Dept of HHS issued a 1099-MISC to her for the year 2002. The payments she received in 2002 were entered in box 7--Nonemployee compensation. Therefore, when the tax preparer completed the return, they entered it on a Schedule C and she paid SE tax on this money in 2002 (approximatley $500). I have reviewed Pub. 520 Scholarships and Fellowships. It makes mention of reporting on a Schedule C: "amounts you receive under a grant that represent pay for your services as an independent contractor are included in determining net earnings from self-employment." My problem with this is that I don't believe she performed any services as an independent contractor.

She received pay and a W-2 from the hospital where she is employed. I then reviewed the instructions for the 1099-MISC form and it states specifically "Scholarships. Do not use Form 1099-MISC to report scholarship or fellowship grants. Scholarship or fellowship grants that are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant are considered wages and must be reported on Form W-2." My ultimate questions in this situation are these: 1. What services did she perform (or is continuing to perform) as an independent contractor to make this income subject to SE tax? Dept of HHS is not subsidizing her pay from the hospital from what I can see and she is not performing any services for Dept of HHS as an independent contractor from my viewpoint. 2. If this is truly not subject to SE tax, how can this get corrected? I doubt I can talk to anyone at Dept of HHS that will be able to answer any questions I have nor will they be able to correct the situation very easily. In 2003, she stands to get nailed with about $2,500 of SE tax. Client doesn't have an issue paying the income tax that is due on this money, but they are questioning the SE tax as am I.

Answer:
This apparently is a program set up by the Clinton Administration due to the fact that his mother was a nurse. If the recipients have to pay income tax and SE tax on the 60% awarded to them, the grant should have been for 100% of the loan balance. Then, by the time the receipient got done paying the SE tax and income tax, they still would have had about 60% left to apply to their student loan balance! As it is right now, instead of having 60% to apply to the student loan balance, the recipients will only have about 30-35% of the award to apply to the student loan balance.

The problem is getting a refund of SE tax after the tax return has been filed. If you try to amend and get a refund, it's a big chance that the IRS will send you an SS-8 and request an employment status determination. (Pain in the neck). (This is what has happened to me.) (However, I suppose it wouldn't hurt to try, given your citations.) NOW, going forward I think you either make this money not subject to SE?FICA at all OR report it on Form 4137 and self-ess FICA only. In either event, you would repor the number on Sched C and then "back it off" using other expenses with a comment "See Line 7 Form 1040" I do several retired professors whose previous college/employer now pays $1440 a year towards Medicare. 1099 MIsc. I complained to the college and they won't do anything. So - it goes on page 1, misc income and I DO NOT apply SE tax. The LA area IRS seems to know what it's doing with this and leaves it alone. Point is - some payers don't know what they are doing and we simply need to be prepared to argue.