Opinion
Docket No. 4312-65.
1968-01-23
STEPHEN L. ZOLNAY AND ELIZABETH V. ZOLNAY, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
John A. Dunkel, for the petitioners. Richard M. Schwartz, for the respondent.
John A. Dunkel, for the petitioners. Richard M. Schwartz, for the respondent.
Petitioner was a candidate for a Ph.D. in electrical engineering at the Ohio State University in 1964. All candidates for such degree were required to do research. Petitioner did research work for the Electro-Science Laboratory of the university. His required work week was 40 hours and he was paid $9,600 during 1964. Held, the payments received by petitioner are taxable as compensation for services and are not excludable as a scholarship or fellowship within the meaning of sec. 117, I.R.C. 1954.
TANNENWALD, Judge:
Respondent disallowed certain expenses deducted by petitioners and determined a deficiency of $137 in petitioners' Federal income tax for the taxable year 1964. Petitioners have conceded the expense deduction issue but claim an overpayment of $1,100 on the ground that $9,600 received
in 1964 from the Ohio State University is properly excludable from income under section 117 of the Internal Revenue Code of 1954.
Petitioner actually received $9,768, of which $168 represented insurance premiums paid on petitioner's behalf, which premiums are excludable under sec. 106.
The question of excludability is the sole issue before us.
Unless otherwise stated, all references hereinafter shall be to the Internal Revenue Code of 1954.
FINDINGS OF FACT
Some facts have been stipulated and are incorporated herein by reference and found accordingly.
Petitioners Stephen L. and Elizabeth V. Zolnay, husband and wife, resided in Columbus, Ohio, at the time the petition herein was filed. For the taxable year 1964, they filed their joint Federal income tax return with the district director of internal revenue, Cincinnati, Ohio. Hereinafter, the term ‘petitioner’ will refer only to Stephen L. Zolnay, his wife being a party to this proceeding only by reason of having filed a joint return with him.
The primary objective of the Ohio State University's Department of Electrical Engineering is to train and educate its students. Research plays an integral part in achieving this objective, particularly with respect to graduate students.
The Electro-Science Laboratory of Ohio State University (hereinafter referred to as the lab) is a division of the university's department of electrical engineering. The purposes of the lab are stated as follows in a university bulletin dated May 1, 1963:
To provide graduate students in Electrical Engineering, Mathematics and Physics with programs and facilities with which they may complete modern theses and dissertations.
To finance costly graduate and postdoctoral study.
To encourage promising undergraduates to continue their education toward advanced degrees.
To help provide research facilities for members of the Electrical Engineering teaching staff.
To discover and disseminate technical information for the benefit of society particularly as it pertains to national defense and industrial growth.
In 1964, the lab had a staff of approximately 115 persons, consisting of a primary research staff— i.e., supervisors, research associates, research assistants— and a supporting staff of clerk-typists, machinists, technicians, editorial assistants, and a photographer. Approximately 35 were research assistants and associates.
Sponsored research projects are developed by either the Office of Research of the university or the Ohio State University Research Foundation (hereinafter referred to as the Research Foundation), the latter being a separate nonprofit educational institution closely connected with the university. In furtherance of the university's educational objectives, both of these agencies seek to encourage research and locate sources of financial support through contracts or grants for research projects. Part of the funds obtained by the foundation are retained to cover its administrative costs and the balance is used to pay stipends and research costs incurred by the lab in implementing research projects.
Specific research projects sponsored by outside parties— both governmental and private— as well as programs of general research utilizing university funds, are undertaken by the lab with the approval of the Department of Electrical Engineering Research Committee. In determining whether to undertake a specific project, a primary consideration is whether the project has educational value in the sense that it contains material for potential thesis or dissertation topics. Research projects are not undertaken unless they have thesis and/or dissertation possibilities. A project is also rejected if it would involve, for example, too many routine measurements relative to intensive investigation, or if such project would result in too much classified information. While lab personnel may at times have periodic conferences with technical representatives of the sponsor, it is within the sole discretion of the lab to decide upon the manner in which the grant or contract will be fulfilled. Except in isolated instances where the association of a particular professor is requested, the sponsor does not select the personnel who are to perform the research required by the specific contract or grant. The lab is generally required to furnish progress reports to the sponsor. When a project is completed, a final report is prepared and delivered to the Research Foundation, which in turn sends it to the sponsor.
A student who desires to do graduate work in the Department of Electrical Engineering must first apply to the university for admission to the graduate school. At the same time, application may be made for financial assistance. The available sources of such assistance are fellowships, administered by the graduate school, and departmental research assistantships and research associateships in the lab. Assistantships are awarded to graduate students pursuing a master's degree, while associateships are awarded to Ph.D. candidates. A student may simultaneously apply for both a research assistantship or associateship and a graduate fellowship. The application for either or both is made via a single set of application materials, the graduate school admissions office coordinating the application with the appropriate department. With regard to research assistantships and associateships, the department of electrical engineering requires that the applicant be admitted to the graduate school, have a good scholastic record, and that his research at the lab will coincide with his educational program toward an advanced degree in electrical engineering, physics, or allied sciences. With regard to graduate fellowships, those candidates with the highest academic qualifications are offered stipends, regardless of financial need.
Graduate school fellowship grants in the department of electrical engineering consist typically of an annual cash stipend ranging from $2,000 to $4,200 plus remission of tuition and other academic fees. The continuation of a fellowship grant is based upon the student's academic performance. There is no standard progression in the amount of a fellowship grant based on longevity, although modest yearly increases often occur. A fellowship grant does not require the rendition of any services by the recipient.
Research assistants and associates are paid in amounts which vary during their period of service and which are based upon maturity, competence (including the quality of their work at the lab), academic background, professional experience, and the percentage of time devoted to research. No additional amounts are received for ‘overtime’ work, i.e., beyond 40 hours per week. During 1963 and 1964, full-time research assistants at the lab received $500 to $700 per month. During this same period, the usual range of a stipend for a full-time research associate at the lab was $600 to $1,100 per month.
There is no authorization in sponsored contracts whereby the Research Foundation can make an outright grant to a student without services being performed in return. All persons working on sponsored research programs administered by the Research Foundation receive remuneration conforming to the general university salary structure for comparable positions and work. Payments to petitioner in 1964 were financially equivalent to the salary of an associate professor at the university.
In assigning research work, the lab considers the student's academic interests and goals and makes every effort to assign to him projects closely related thereto. On a specific problem, assignment preference usually goes to a candidate who will be writing a thesis or dissertation in a similar or related area. Research performed at the lab may be used for credit by a degree candidate. Such research is not always used for theses or dissertations, although a doctoral dissertation in electrical engineering must be based on actual research, and dissertations are usually based upon research performed at the lab. Students may fulfill their research requirements for a degree at places other than the lab. Degree candidates, holding graduate fellowship grants, and research assistants and associates who are not on graduate school fellowships work on the same projects.
Opportunities for research at the lab are in no way determined by whether the student plans or agrees to remain with the lab in a permanent capacity upon completing his degree requirements. Once the student achieves his doctorate, he normally leaves the lab.
The university uses two types of appointments for persons performing services therein. ‘Regular’ appointments are given to personnel required to provide full-time services either of a nonacademic nature or in the nature of teaching or research. ‘Special’ appointments are considered temporary in nature and are usually given to graduate students, teaching assistants, graduate assistants, research assistants and associates, visiting faculty, and the like. Those persons who receive regular appointments participate in university retirement and medical programs, taxes are withheld from their wages or salaries, and they are entitled to vacation and sick leave. Special appointees are not subject to withholding; the university does not pay any insurance premiums for them; nor are they entitled to retirement credits, sick leave, or vacation pay. Students receiving graduate fellowships receive only special appointments. Payments made to research assistants and associates are classified by the university as ‘salary and wages.’
In September 1960, his last undergraduate year, Petitioner enrolled in the graduate school of the university and began taking graduate courses. He received his bachelor's degree in March 1961. At that time, petitioner rejected two substantial offers from private industry. in order to continue his education, he accepted a position as a research assistant with the lab at $558 per month. From July 1, 1962, to June 30, 1963, he was paid at the rate of $664 per month; from July 1, 1963, to June 30, 1964, he was paid at the rate of $764 per month; from July 1, 1964, to October 1, 1965, he was paid at the rate of $864 per month; and from October 1, 1965, to September 30, 1966, he was paid at the rate of $964 per month.
On April 1, 1961, petitioner signed a document issued by the Research Foundation and entitled ‘Research Rules and Regulations, Research Foundation Projects.’ Under this document petitioner agreed:
(1) to observe university rules as to vacation, sick leave and the like.
(2) to give 30 days' advance written notice of intention to quit the projects to which he was assigned.
(3) to consult with his supervisor and keep him informed regarding his work.
(4) to maintain and preserve all data and notes concerning his work and to deliver the same to the Foundation.
(5) not to retain copies of such data or publish or disclose the same without the Foundation's consent.
(6) upon request, to prepare and submit interim and final reports.
(7) to assign to the Foundation all his right, title and interest in any inventions, patents, etc.
(8) to observe security requirements regarding classified information.
In August 1962, petitioner received his master's degree in electrical engineering. He remained enrolled in the graduate school and registered for a Ph.D. degree in electrical engineering.
From 1961 to 1965, petitioner's work at the lab consisted primarily of research on projects concerning high-gain antenna techniques and satellite communication. Such projects were undertaken pursuant to contracts between the Research Foundation and the Air Force and the National Aeronautics and Space Administration. During 1964, petitioner wrote, either alone or in coauthorship, research reports dealing with various aspects of these areas. At the time he prepared these reports, petitioner was not certain whether the information contained therein would be used in his doctoral dissertation. His decision as to the topic for his dissertation was not made until around September 1966. At the time of the trial herein, petitioner was working on such dissertation and expected to have it finished and approved and to receive his degree before the end of 1967. It generally takes a minimum of 3 to 4 years for a student to fulfill the requirements of the doctoral program in electrical engineering at the university.
Petitioner took and received credit for math and physics courses in various quarters during 1962, 1963, and 1964. He received credit for 1 hour of research in the summer quarter of 1962, 12 hours each in the autumn quarter of 1964 and the winter and spring quarters of 1965, 2 hours in the winter quarter of 1966, and 5 hours in the spring quarter of 1966.
During the 1964 academic year, petitioner received 9 hours of credit for courses in electrical engineering and physics, in addition to 12 hours' credit for research performed by him at the lab. Although originally registered for course work in the summer of 1964, petitioner subsequently withdrew from the university for that quarter. A son had been born to petitioners in July of 1964, and petitioner found it necessary to spend more time at home with his family. During this period, he continued, and was compensated for, his research activities at the lab. He resumed his studies in the following academic quarter. Petitioner successfully passed his oral examination for a doctor's degree and was ‘admitted to candidacy’ on April 21, 1966.
Petitioner applied for but never received a graduate fellowship. At no time did the university consider his academic performance of sufficiently high caliber to qualify for a fellowship. At the end of winter quarter 1964, petitioner was placed on academic probation. He was removed from such status at the end of spring quarter 1965.
Petitioner at all pertinent times paid his own tuition and other expenses while attending the university.
On the university ‘Payroll-Budget Action Form’ for the periods July 1, 1963, through June 30, 1964, and July 1, 1964, through June 30, 1965, petitioner was designated a ‘nonstudent’ and a ‘regular’ appointee. These forms were prepared in the administrative office of the Research Foundation. Petitioner participated in the university's retirement program, and group life and health insurance premiums were paid by the university on his behalf.
Amounts were withheld for Federal income tax from the payments to petitioner; $1,100 was so withheld in 1964.
On his 1964 Federal income tax return, petitioner listed his occupation as ‘Engineer’ and included in gross income the payments he received for his services at the lab. Appended to the return in support of petitioner's claimed deduction for ‘educational expenses' in the amount of $534 was the following statement signed by the assistant director of the lab:
This is to certify that the employment of Stephen L. Zolnay is contingent on his maintaining and improving his research skill. Since the program of this laboratory is of a basic research nature, the graduate courses taken provide the background essential for progress, and are customarily undertaken by the staff of this laboratory.
ULTIMATE FINDING OF FACT
The amounts paid to petitioner constituted taxable compensation for services rendered.
OPINION
We are again faced with the troublesome question of the extent to which section 117
applies to exclude payments received by a student who is a candidate for a degree and who receives payment for performing services which clearly have an academic coloration. There is no need to review the exhaustive analysis which we have already accorded the historical and legislative backdrop to section 117. See Elmer L. Reese, Jr., 45 T.C. 407 (1966), affirmed per curiam 373 F.2d 742 (C.A. 4, 1967), and the cases collected therein. Suffice it to say that the decided cases run the gamut of the full spectrum with all its shadings, making precisional line-drawing impossible. As a result, each case must turn upon its own particular facts and circumstances.
SEC. 117. SCHOLARSHIPS AND FELLOWSHIP GRANTS(a) GENERAL RULE.— In the case of an individual, gross income does not include—(1) any amount received—(A) as a scholarship at an educational institution (as defined in section151(e)(4)),or(B) as a fellowship grant, * * *(b) LIMITATIONS.—(1) INDIVIDUALS WHO ARE CANDIDATES FOR DEGREES.— In the case of an individual who is a candidate for a degree at an educational institution (as defined in section 151(e)(4)), subsection (a) shall not apply to that portion of any amount received which represents payment for teaching, research, or other services in the nature of part-time employment required as a condition to receiving the scholarship or the fellowship grant. If teaching, research, or other services are required of all candidates (whether or not recipients of scholarships or fellowship grants) for a particular degree as a condition to receiving such degree, such teaching, research, or other services shall not be regarded as part-time employment within the meaning of this paragraph.
See Chandler P. Bhalla, 35 T.C. 13, 17 (1960).
The American Council on Education, as amicus curiae, has submitted a most helpful brief, which attempts to distill the ground rules to be applied in cases of the type involved herein.
Initially, we can readily dispose of certain ancillary aspects of this case. Although petitioner was not ‘admitted to candidacy’ until 1966, it has not been seriously contended that he was not a ‘candidate for a degree’ during the taxable year involved herein, and we are satisfied that he meets the requirements of that phrase as used in section 117. See sec. 1.117-3(e), Income Tax Regs. Moreover, no issue has been presented as to whether petitioner's services were ‘full-time’ or ‘part-time,‘ so that the nuances of potential distinctions in this area are not involved herein, except as a possible aid in interpreting the nature of the payments to petitioner. See pp. 397-398, infra; cf. Elmer L. Reese, Jr., supra at 415 fn. 4.
In Elmer L. Reese, Jr., supra at 412-413, we pointed out that section 117(b) was a limitation on section 117(a) and that the provision engrafted on section 117(b) by the Senate was an exception to that limitation. As a consequence, we ruled that the Senate amendment did not establish a mechanical test for exclusion and that the threshold inquiry in cases of the type involved herein is whether there is a scholarship or fellowship within the intendment of section 117(a). We confirmed the use of the primary-purpose test applied to the objective facts and circumstances of each situation.
Recognizing that the application of this test presented an acute problem where a dual condition existed— i.e., where the services were required to obtain the degree and were also a prerequisite to receiving the scholarship or fellowship— we sought to answer the basic question: Was the taxpayer paid to work or paid to study? We adopt the same test herein and direct our attention to the same basic question.
In so doing, we noted the difficulties in applying that element of that test which relates to whether the payment is ‘primarily for the benefit of the grantor.’ Sec. 1.117-4(c)(2), Income Tax Regs.: Elmer L. Reese, Jr., 45 T.C. 407, 411. For the same reasons which caused us not to consider this element in Reese, and for the further reason that it is unnecessary to our decision herein, we refrain from determining whether the U.S. Air Force or the National Aeronautics and Space Administration, as the sponsoring agency, or the university was the grantor and the primary beneficiary of petitioner's services.
Petitioner's syllogism is not significantly different from that of the taxpayer in Elmer L. Reese, Jr., supra: (a) He was a candidate for a degree; (b) he did research related to obtaining his degree; (c) all candidates for such degree were required to do research; (d) ergo, he asserts that the requirements of section 117 were satisfied. The syllogism is premised on several erroneous assumptions. Close academic relationship of the services is not in and of itself sufficient. Nor is the fact that petitioner may have received the payments as a form of financial aid designed to enable him to continue his studies. Finally, the requirements of section 117 are not satisfied merely because all degree candidates are required to perform services.
It is with respect to the last element that we find a significant gap in petitioner's case. Section 117 obviously does not require that precisely the same services be rendered by all degree candidates. However, the requirement of reasonably equivalent activity, be it research or another type of service, seems to us to be, not only the touchstone of section 117(b), but an important element in determining the extent to which payments constitute a scholarship or fellowship in the first place. Admittedly, within limits, there may be quantitative and qualitative variations among the students, but a reasonable identity of the work pattern of the degree candidates is an essential precondition. Petitioner has not presented any evidence as to amount of time spent in research by holders of graduate fellowships and we think it more than likely that the well over 40 hours weekly which petitioner put in was far in excess of the research time normally expected of degree candidates. Moreover, petitioner was required to put in a minimum of 40 hours under his appointment. Nor have we been favored with sufficient evidence to permit us to make a qualitative comparison of the research done by petitioner with that performed by other students. While an attempt was made to assign research projects to graduate students in light of their academic interests and dissertation objectives, the research required of petitioner was basically geared to outstanding contractual commitments relating to a specifically sponsored project.
In both Chandler P. Bhalla, supra, and Lawrence Spruch, T.C. Memo. 1961-63, which respondent said he would apply in ‘substantially identical’ fact situations (Rev. Rul. 63-250, 1963-2 C.B. 79), equivalent research was required of all degree candidates. We think that this factor and the fact that the taxpayers in those cases received substantially smaller monetary benefits were the critical distinguishing elements and that consequently petitioner cannot claim the protective umbrella of respondent's ruling.
Respondent has yet to implement his thrice announced intention to revise the regulations under sec. 117. See Elmer L. Reese, Jr., 45 T.C.AT 416 fn. 6.
Aside from the gap in petitioner's case with respect to equivalent research, there are various additional considerations which lead us to the conclusion that, in the totality of the circumstances herein, petitioner was simply compensated for services rendered and did not receive an excludable fellowship within the meaning of section 117. These additional considerations include the following, listed without implication as to their order of importance or their relative qualitative significance:
(a) The services of petitioner were directly related to the fulfillment of a contractual commitment to a specifically sponsored project. Howard Littman, 42 T.C. 503 (1964).
(b) Petitioner's activities were subject to supervision, were geared to planned time schedules, and required specific progress reports. He was charged with considerable responsibility and his services played an essential and valuable part in enabling the lab to fulfill its commitments. Wrobleski v. Bingler, 161 F.Supp. 901 (W.D. Pa. 1958); Ethel M. Bonn, 34 T.C. 64 (1960); cf. William Wells, 40 T.C. 40 (1963).
(c) Petitioner was required to work 40 hours per week and in fact worked substantially longer hours. While we recognize that in the graduate area larger amounts of time devoted to research are often the order of the day, the consistent regularity of, and the lengthy time span during which petitioner performed his services, are another indication that he was paid to work rather than to study. Cf. Aileene Evans, 34 T.C. 720 (1960).
(d) Holders of graduate fellowships received substantially smaller stipends and were not directly compensated for the research work they performed at the lab. While section 117 imposes no limitation on the amount granted to a degree candidate, the very high rate of payment to petitioner cannot be ignored, particularly when compared to the rate of payment in the cases in which the taxpayer has received a favorable decision.
E.g., Chandler P. Bhalla, supra; Aileene Evans, supra. Similarly, while there is no statutory limitation on time spent as a degree candidate and while the road to a doctoral degree in electrical engineering may be long and tedious, it is significant that petitioner has been engaged in ‘graduate study’ since September 1960 (he received his master's degree in August 1962) and did not expect to get his doctor's degree until late in 1967. In this connection, we note that, according to a university bulletin, 3 to 4 years is all that is normally required to complete a doctorate in this field.
We note that, in the case of non-degree candidates, Congress imposed a $300 per month and 36-month limitation. Sec. 117(b)(2). The absence of a similar limitation with respect to degree candidates does not preclude us from considering the level of monetary benefits as a factor to be taken into account.
(e) Petitioner was uncertain whether his research would ultimately enter into his doctoral dissertation. He did not choose his dissertation topic until 1966 and it had not been completed as of the date of the trial herein (March 1967).
(f) Petitioner's application for a graduate fellowship was disapproved. Moreover, during a large part of the taxable year before us, he was on academic probation and therefore ineligible for such a fellowship.
(g) During the summer quarter of such taxable year, petitioner withdrew from the university but continued to perform his duties as usual at the lab.
(h) The university regarded petitioner as an employee. He was designated as a ‘regular’ appointee and the payments to him were accounted for as ‘salary and wages,‘ there being no authorization for outright grants in the sponsored research contracts on which he worked. The payments petitioner received were the equivalent of the salary of an associate professor. He was expected to render full-time services; was required to and did participate in the university retirement, medical, and life insurance programs; and had income taxes withheld from the amounts he received.
Petitioner was given regular increases in the amounts paid to him, much greater than the incidental and sporadic increases given to holders of graduate fellowship grants.
Admittedly, the fact of withholding standing alone is not determinative under sec. 117. Chandler P. Bhalla, 35 T.C.AT 17-18.
It may well be that research work at, rather than outside, the lab provided petitioner with a more suitable arrangement under which he could, as a worker in the academic vineyards, combine his studies with activities capable of providing him with financial support. But the fact that he was able to kill two birds with one stone— in the sense that he could derive both direct educational and financial benefit— does not mean that he was being paid to study rather than to work. On all the facts and circumstances herein, we are led inescapably to the conclusion that the payments involved herein were received as taxable compensation for services rendered and not as a fellowship excludable under section 117.
To reflect the concessions of the parties,
Decision will be entered under Rule 50.