Kollel Pay Article_Hamodia

HAMODIAC6 7 TISHREI 5771 Community SEPTEMBER 15, 2010

Special Feature / Judah I. Kupfer, Esq.

IntroductionMoshe is a member of a new

Choshen Mishpat kollel. As a mem-ber, he is required to attend at settimes for learning with hischavrusa at a specific beismedrash, study a specific curricu-lum, be present at an in-depthlecture given by the Rosh Kolleltwice a week, and score high onoccasional written exams thattest his knowledge of the intri-cate subject matter. At times, thekollel also requires Moshe to tutoryoung children with theirChumash studies, provide occa-sional shiurim to students of anoutreach kiruv program that thekollel supports, and, twice a year,spend Shabbos in an out-of-towncommunity to present a lectureon a topic of halachah. Moshe isprovided with a monthly pay-check of $600. Moshe uses thismoney to pay for his family’s per-sonal living expenses. Also, priorto each Sukkos and Pesach, thekollel provides Moshe with anadditional $400 to help defray thecosts of his added holiday expens-es. How does Moshe report hisincome? Is any or all of it tax-able?

As our generation has seen asurge of Torah learning, manynow find themselves in Moshe’ssituation and are unsure of thetax ramifications of their kollelpay. With the increase of govern-ment scrutiny and the penaltiesfor infractions being so high, it isincumbent on each kollel and stu-dent alike to get it right.

The taxability of paymentsprovided by a kollel to its mem-bers/students (which we willrefer to simply as “Kollel Pay”)has generated much confusionand varying views.The reason forthe confusion is chiefly due to themistaken assumption that all kol-lelim are the same. In reality,though, different kollelim operatein different manners and the tax-ability of Kollel Pay can thus varybroadly, depending on the partic-ular circumstances of the kollel.In assessing the taxability ofKollel Pay, it is therefore neces-sary to analyze each kollel inde-pendently, in light of its customs,requirements, rules and regula-tions.

Outlined below are four broadclassifications of how to catego-rize Kollel Pay. As each kollel’sobligations are diverse and fact-specific, the reader is cautionedto seek specific guidance from atax professional in applying theprinciples articulated below. Therules outlined below only applyto kollel members who are U.S.citizens — different rules applyto international students.

It is also important to note atthe outset that should Kollel Paybe provided for segregated tasks,assignments, projects or services,it is possible for different por-tions of Kollel Pay to fit withindifferent categories, resulting inpart taxable and part non-taxableeven when being paid to thesame student. Later, we’ll revisitMoshe’s situation and seek to

apply these principles to his cir-cumstances.

Non-Taxable FellowshipThe first category is a non-tax-

able fellowship. However, such aclassification will likely not applyto most kollelim. This categorywould include payments to thestudent used only for tuition andrequired fees, books, supplies, orequipment. Non-taxable fellow-ships are not taxable income tothe student, are not subject toFICA (also known as “payrolltaxes,” which are made up oftaxes for Social Security andMedicare equal to 15.3% of thetaxpayer’s salary — generally, theemployer is required to pay half,i.e. 7.65%, and the employee paysthe other half), and there is norequirement for the kollel to with-hold or report these payments toeither the student or the InternalRevenue Service (IRS).

A fellowship is tax free only ifthe student is a “candidate for adegree” at an “eligible educa-tional institution,” (each definedbelow) and if the student uses thefellowship to pay “qualified edu-cation expenses” such asrequired fees, books, supplies orequipment. Payments used tocover room, board, travel or anyother living expenses would notbe included. To the extent that afellowship does not fit withinthese rules, it is considered a tax-able fellowship.

A student is a “candidate for adegree” if (a) he attends a pri-mary or secondary school or ispursuing a degree at a college oruniversity, or (b) he attends anaccredited (by a national recog-nized accreditation agency) edu-cational institution that is author-ized to provide (i) a program thatis acceptable for full credittoward a bachelor’s or higherdegree, or (ii) a program of train-ing to prepare students for gain-ful employment in a recognizedoccupation.

An “eligible educational insti-tution” is one that maintains aregular faculty and curriculumand normally has a regularlyenrolled body of students inattendance at the place where itcarries on its educational activi-ties.

Since Kollel Pay is most oftenused for personal living expenses,it will generally not fall withinthis category. Additionally, whilesome kollelim may qualify as “eli-gible educational institutions,”most kollel students are not “can-didates for a degree.”

Taxable FellowshipThe next category is a taxable

fellowship. This category, typical-ly known as a stipend and used asa living allowance, includes pay-ments to the student other thanthose defined as non-taxable fel-lowships.There is no requirementthat the recipient perform anyservices for the benefit of the kol-lel as a condition of receiving thepayment and these payments areoften made as an incentive for

students to attend the kollel. It isimportant to emphasize that ifthe student is being paid for serv-ices, such payment is not a fel-lowship at all but rather a taxablecompensation for services, thethird category below.

A fellowship recipient is anindividual who receives a taxableand/or non-taxable fellowship,and whose activities may include:Engaging in research programs orparticipating in training to fur-ther his individual educationaldevelopment; conducting inde-pendent research and determin-ing what research activities hewill be conducting; or providinghelp to a Rosh Kollel, providedthat the activities are principally

related to the recipient’s progressrather than to the needs of thekollel.

To the extent, however, that aprogram requires teaching orresearch activities to be per-formed by the recipient andthese activities are performed forthe benefit of the kollel, or if therecipient is performing otherservices for the kollel in exchangefor a payment, the paymentshould be characterized as a pay-ment involving services (the thirdcategory, below) and is not a fel-lowship.

Although taxable fellowshipsare taxable income to the stu-dent, the kollel is not required toreport them to the student or theIRS, nor is the kollel required towithhold tax on them. Thesefunds are also not subject toFICA. Students are responsiblefor reporting these payments andremitting any tax due, which caninclude estimated tax filings. It isimportant, however, to keep inmind that low income earnersmay not have an obligation to payany federal income taxes. Giventhe total taxable amount earnedby the student (and if married,the student’s spouse as well), stu-dents must determine with theirtax advisor whether they have afederal income tax obligationand, if so, whether it should bepaid quarterly (as estimatedtaxes) to the IRS or with the fil-ing of their personal income taxreturn.

Taxable Payments InvolvingServices

The third category involvestaxable payments for services.This category is defined as pay-ments made with respect toteaching, research and/or otheractivities performed for the bene-fit of the kollel, including activi-ties for the kollel that may beassociated with the student’s

course of study and educationalexperience. This would include astudent’s teaching responsibili-ties, tutoring and other activitieswhere the primary purpose is tobenefit the kollel or an objectiveof the kollel. If, however, as part oftheir program of training, all kol-lel students are required to per-form part-time teaching with theprimary purpose to benefit thestudent, such responsibilitiesshould not be deemed part-timeemployment for which they arereceiving taxable compensation.

Compensation is taxable tothe recipients, and the kollel isrequired to withhold federal andstate taxes and report such pay-ments to the IRS (the kollelshould issue a form W-2 to the stu-dent). The kollel is also requiredto contribute to half of the stu-dent’s FICA obligation and with-hold the other half from the stu-dent’s pay.

Please note, the student maybe able to qualify to have a por-tion (or all) of his taxable com-pensation (i.e. any Kollel Pay thatis taxable compensation for serv-ices) pre-designated as a parson-age housing allowance that wouldbe exempt from federal incometax (and, in most states, state andlocal income tax as well).The pre-designated amount would have toactually be used that year for thestudent’s “housing expenses.”The student would still berequired to pay Social Securityand Medicare taxes (both parts ofhis FICA obligation, see nextparagraph) on the entire part ofhis Kollel Pay that fits within thiscategory (both the parsonage andnon-parsonage amounts).To qual-ify for parsonage, the studentmust be classified as a “minister”whose job it is to conduct “minis-terial services.”

By being classified as a minis-ter, the student would also besubject to certain other rulesapplicable to ministers withrespect to their ministerial servic-es, including: (a) an exemptionfrom FICA — thus, the kollelwould not be required to with-hold nor pay into FICA on behalfof the student; however, the stu-dent would be required to payboth parts of the FICA obligationon his own (also known as“SECA” or “self-employmenttaxes”) in quarterly estimatedpayments; (b) the kollel would beexempt from federal income taxwithholding on the non-parson-age amount, yet the studentwould be required to report andpay estimated federal income taxon his own on the non-parsonageamount.

As an aside, since parsonage isonly available as payment for“ministerial services,” Kollel Payclassified as a fellowship wouldlikely not be eligible to be pre-designated as a parsonage hous-ing allowance since a fellowship,by definition, does not constitutepayment for services. If only partof a student’s Kollel Pay is pay-ment for ministerial services,while another part is provided as

a fellowship, only the portion ofpay categorized as payment forservices may be eligible to beallocated as parsonage, assumingall the other requirements forreceiving parsonage are met andthat such service is ministerial innature.

Those interested in designat-ing part of their kollel pay as par-sonage should seek specific guid-ance to ensure the proper appli-cation of the parsonage rules.

Charitable Grant to a “Needy”Individual

In very limited circumstances,Kollel Pay may be classified ascharitable grants to needy indi-viduals — essentially, a charita-ble tax-free gift. The IRS definesa needy person as someone wholacks the basic necessities of life— food, clothing, shelter, medicalhelp or transportation —becauseof poverty or temporary distress.A person may have short-termneeds in one or more of theseareas even if he or she hasresources (such as insurance orinheritances) that will be avail-able in the long run.

If a kollel student fits withinthe definition of “needy,” he maybe eligible to receive a charitablegift. Such funds would be tax freeto the recipient. The kollel wouldnot be required to report suchgifts to the student or issue forms1099 or W-2, but would berequired to maintain adequaterecords and case histories to

show: (i) The name and address ofeach recipient of aid; (ii) Theamount distributed to each; (iii)The purpose for which the aidwas given; (iv) The manner inwhich the recipient was selected;and (v) The relationship, if any,between the recipient and (a)members, officers, or trustees ofthe kollel, or (b) a grantor or sub-stantial contributor to the kollelor a member of the family ofeither. Before making such distri-butions, the kollel should alsoensure that it is authorized tomake such grants to needy indi-viduals in its organizational docu-ments. Should the kollel file ayear-end form 990, such informa-tion must also be disclosed on itwithin Schedule I.

Some tax experts are doubtfulabout the availability of this cate-gory to kollel students if the kollelstudents are required to performany kind of service in order toreceive the funds. Even if a kollelsimply requires its students to bein attendance, such a require-ment may be problematic to thisclassification. Additionally, if thefunds are provided on a regularbasis (e.g. weekly, monthly), thereis a concern that the distributions

The Taxability of Kollel Pay: Tax and Withholding Obligations of a Kollel and Its Members

It should be notedthat it is possible fordifferent portions ofKollel Pay to fit withindifferent categories

The IRS defines aneedy person as onewho lacks the basicnecessities of life

HAMODIA C77 TISHREI 5771 Community SEPTEMBER 15, 2010

look like compensation (which istaxable) as opposed to a scenariowhere funds are provided only atcertain times of the year, e.g.,before a Yom Tov, which wouldseem more akin to a non-taxablecharitable gift. Furthermore, ifany part of the Kollel Pay provid-ed to a particular student isdeemed compensation, anemployer/employee relationshipis thereby created between thekollel and the student. When thatoccurs, there is a presumptionthat any and all economic benefitprovided by the employer to theemployee is compensation andmay not be considered a tax-freegift.

Tying It All TogetherWith a background of the law

in hand, we can now return toMoshe’s scenario. At the outset,we can probably rule out any partof Moshe’s pay being classified asa non-taxable fellowship becausethe pay is being used for his per-sonal living expenses — not fortuition or other required fees orequipment. Additionally,although the kollel may be consid-ered an educational institution(we don’t know enough about thekollel to say for certain), Moshe islikely not a candidate for adegree. So, we now need to takeeach of Moshe’s responsibilitiesand examine them one by one.

First, Moshe is required to bein attendance at designatedtimes, at a designated place, tostudy a set curriculum and attendbi-weekly shiurim given by theRosh Kollel. These activities areconsistent with taxable fellow-ship functions as Moshe is notacting to benefit the kollel in anyway or performing any services.Thus, part of Moshe’s Kollel Paymay be designated as a fellow-ship to assist him in his learningactivities. For that portion of pay,the kollel would not be requiredto withhold federal income tax orFICA, but Moshe on his ownwould be required to pay federal,state and local income tax on thisamount.

Second, the kollel requiresMoshe to tutor children and lec-ture occasionally at the kollel-sup-ported kiruv program. Theseactivities represent services forwhich Moshe is being compensat-ed. Thus, the part of his monthlypay representative of these serv-ices must be considered as tax-able compensation. For this partof his income, the kollel isrequired to withhold federalincome tax and FICA.

Should Moshe qualify as a“minister” (e.g. he has semichahor a certificate from his yeshivahdetailing his qualifications toteach limudei kodesh), to theextent that his services qualify as“ministerial” in nature (e.g.learning Chumash with childrenand providing Torah lectures at akiruv program), the kollel maypre-designate by “official action”as a housing allowance the part ofMoshe’s salary being paid to himin exchange for performing min-isterial service. In such aninstance, the kollel would not berequired to withhold on this por-tion of Kollel Pay but Moshewould have to pay quarterly esti-mated SECA payments. To theextent that the pre-designatedamount is actually used that yearfor housing expenses, it wouldnot be subject to federal income

tax and in most cases, state andlocal income tax as well.

Third, Moshe is required tospend Shabbos at an out-of-towncommunity and present a shiurwhile there. As all members ofMoshe’s kollel possess this respon-sibility and it would appear thatthe objective is to provide the kol-lel students with practical hands-on training to teach and act in arabbinic capacity, such teachingresponsibility would likely fallwithin the taxable fellowship cat-egory. Readers should be cau-tioned that the distinctionbetween whether part-time serv-ices should be considered taxablecompensation or a fellowship isoften nuanced and dependent onthe specific circumstances; a taxprofessional should be consultedin making that decision.

Last, Moshe is paid a sum of$400 at certain times of the yearto help defray holiday expenses.If Moshe were a “needy” individ-ual (we don’t know whether hehas other sources of income, sav-ings or investments to saywhether he is indeed needy) whowas not receiving any taxablecompensation for services fromthe kollel, he may be able to clas-sify these payments as a tax-freegift. However, since Moshe isreceiving taxable compensationin exchange for services rendered(i.e. the part-time teaching), theIRS would consider any “gift”given from employer (the kollel)to employee (Moshe) as taxable.

This example should makeclear that different kinds of activ-ities will trigger different tax andwithholding obligations — evenwhen provided to the same kollelstudent.

When does Kollel Pay qualify asincome for the Earned IncomeCredit and Child Tax Credit?

Should a student receiveKollel Pay as part of taxable pay-ment involving services, such payshould be considered “earnedincome” for purposes of theearned income and child taxcredits, so long as it is reported ona form W-2 and taxes are paid, asrequired. If a parsonage housingallowance is allocated, suchamount would be considered“earned income” for purposes ofthe earned income credit, assum-ing self-employment tax is paid(as required), since earnedincome includes “the amount ofthe taxpayer’s net earnings fromself-employment.” However, pay-ments designated as parsonagewould not be considered “taxableincome” to qualify for the childtax credit.

Kollel Pay classified as a fel-lowship, whether taxable or non-taxable, is not considered earnedincome for purposes of theearned income and child taxcredits and the receipt of a tax-able fellowship may also nega-tively affect one’s eligibility forthese credits (consult youraccountant for further details).Similarly, a tax-free gift is notconsidered earned income forpurposes of these credits.

Kollel Pay classified as pay-ment for services (even if parson-age is designated) or as a fellow-ship (taxable or non-taxable)should likely be declared as asource of income for purposes ofother government programs/ben-efits, but the specific details ofprograms vary and must be con-

sidered individually in each state.

Reporting FellowshipsWhether you must report your

fellowship depends on whetheryou must file a return andwhether any part of your fellow-ship is taxable.

If your only income is a com-pletely tax-free fellowship (andassuming you and your spousedon’t have any other taxablesources of income), you do nothave to file a tax return and noreporting is necessary. If all orpart of your fellowship is taxableor if you or your spouse earnsother taxable income, you arerequired to file a tax return andreport the taxable amount,whether or not you received aform W-2.

For information on whetheryou must file a return, see IRSPublication 501, Exemptions,Standard Deduction, and FilingInformation, or your income taxform instructions. For additionalinformation regarding reporting,see IRS Publication 970.

ConclusionThe taxability of Kollel Pay is

dependent on the specifics ofeach kollel’s customs and prac-tices. It may fall within one offour broad categories outlined inthis article. However, professionalguidance should be sought toensure the proper application ofthese principles to the specificsof your kollel and particular cir-cumstances.

* * *This note is provided for gen-

eral information and educa-tional purposes. Neither its dis-tribution to any party nor anystatement or information itcontains is intended to or shallbe construed as establishing anattorney-client relationship orto constitute legal advice.Readers also are cautionedthat the information in thisnote may not apply to all situa-tions. Consequently, readersmust not rely upon this note orinformation it contains as asubstitute for competent indi-vidualized legal advice aboutthe specific circumstances ofthe readers. Attorney advertis-ing, prior results do not guaran-tee a similar outcome.

IRS Circular 230 Disclosure:To ensure compliance withrequirements imposed by theIRS, we inform you that anyU.S. federal tax advice con-tained in this document is notintended or written to be used,and cannot be used, for thepurpose of (i) avoiding penal-ties under the InternalRevenue Code, or (ii) promot-ing, marketing, or recommend-ing to another party any trans-action or matter that is con-tained in this document.

Judah I. Kupfer, Esq. is a staff coun-sel at Agudath Israel of America. Hepreviously practiced as an associateat the law firm of Allen & OveryLLP in New York. Mr. Kupfer is asumma cum laude graduate ofTouro College, a magna cum laudegraduate of Brooklyn Law Schooland an LL.M. taxation candidate atNew York University School of Law.To contact the author, please emailykupfer@agudathisrae l .org .Questions and comments are wel-come.