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Joint AAMC and AACOM Statement on NHSC Scholarship Taxation

	Submitted to:	Committee on Ways and Means, United States House of Representatives
	Date:	June 23, 1999

The Association of American Medical Colleges (AAMC) and the American Association of Colleges of Osteopathic Medicine (AACOM) are pleased to have this opportunity to comment on reducing the tax burden on individuals through increased education incentives.

We believe that there is a compelling public interest in exempting payments for tuition and education-related expenses under the National Health Service Corps (NHSC) Scholarship Program from gross income for tax calculation purposes. The NHSC Scholarship Program provides highly educated health care professionals to federally-designated health professional shortage areas, often in rural or inner city locations. By levying a tax on the tuition and fees portion of NHSC scholarships, participation in the program is jeopardized, threatening the ability of under-served health communities to secure needed medical providers.

The NHSC Scholarship Program was established more than 20 years ago to provide health professions students with funding to cover tuition and education related expenses, as well as a monthly stipend for living expenses, in exchange for a commitment to provide primary health care services in a federally-designated health professional shortage area (HPSA). During this time, the NHSC Scholarship Program has produced over 23,000 doctors, physician assistants, nurse midwives and other health care professionals. The program attracts a culturally diverse applicant pool – over 40 percent of recipients are minorities – who are more sensitive to the health care issues in underserved areas, but at the same time also are more sensitive to incurring debt. Because the imposition of tax on the scholarship drastically reduces the amount of the monthly stipend, students may be forced to find additional funding sources or look at other scholarship options, reducing the ability to fulfill the national priority of increasing access to health care in medically underserved areas.

On August 29, 1997, the NHSC sent notification to health professions schools and students of their intention, based on the result of a new Internal Revenue Service (IRS) interpretation, to begin withholding federal income tax on the entire amount of scholarships awarded to NHSC scholarship recipients. According to the IRS, taxation of the entire scholarship amount is required to comply with a change in the tax code, specifically a 1986 amendment to 26 USC 117 (c).

In 1994, the NHSC sought clarification of the 1986 amendment to section 117 (c) from the IRS. The IRS interpretation concluded that NHSC scholarships are awarded as payment for substantial future services and therefore are not excludable from gross income under section 117 (c). The IRS distinguishes NHSC scholarships from other award programs administered by the Department of Health and Human Services such as Scholarships for Students with Exceptional Financial Need (EFN), Financial Assistance for Disadvantaged Health Professions Students (FADHPS), and Mental Health Clinical Traineeship (MHCT). The IRS concluded that these programs “do not impose the same substantial quid pro quo service requirements on the participants as are imposed upon NHSC participants” and therefore are not subject to the same federal taxation.

Prior to 1986, NHSC scholarship recipients were required to pay federal tax only on the stipend portion of the scholarship. Tuition and related expenses were excluded from gross income. Although an unintended effect of the Tax Reform Act of 1986 was to levy tax on NHSC scholarships, the provision went unnoticed and unenforced until the NHSC’s 1994 inquiry. To comply with the 1997 IRS interpretation, the NHSC began withholding the entire tax obligation from the stipend part of the scholarship, beginning December 1, 1997. Many NHSC scholarship recipients encountered drastic reductions in the amount of their monthly stipends as a result of the IRS interpretation.

A reduced stipend is likely to cause these students to seek supplemental financial assistance to meet their living expenses and creates a disincentive for students to participate in the program. The high cost of medical school tuition means that students could face thousands of dollars in tax payments on their scholarships. In addition, NHSC analysis shows that students in their second, third and fourth years of study are impacted to even greater degrees. In a worst case scenario, the NHSC estimates that a fourth year student at a high-cost institution would not only forfeit the entire stipend in federal tax payments, but additionally owe nearly $300.

Bipartisan legislation aimed at exempting NHSC scholarship payments from income for tax purposes was recently introduced in both chambers of Congress. Representatives Nancy Johnson (R-Conn.) and Karen Thurman (D-Fla.) introduced H.R. 1414 on April 14, 1999, and Senator Jim Jeffords (R-Vt.) introduced S. 288 on January 21, 1999. This version also exempts scholarships granted under the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program. The proposal is also part of Senate Finance Committee Chairman William Roth’s (R-Del.) education tax break package which was approved by his committee on May 19, 1999. The section related to NHSC and Armed Forces scholarship exemptions was costed at only $8 million over the next 10 years. This is a minimal price to pay to increase access to high quality health care in underserved areas.

There also is no opposition to this proposal. The current congressional proposals include significant support from both sides of the aisle, and similar language was approved by both chambers in the 105th Congress before being vetoed by the president for unrelated reasons. However, the Administration included a similar proposal in the FY 2000 budget request as part of a larger administration proposal to expand education initiatives. In the Analytical Perspectives volume of the FY 2000 Budget Proposal, the Administration proposes to amend current law to provide that "any amounts received by an individual under the NHSC Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program are "qualified scholarships" excludable from income, without regard to the recipient’s future service obligation."

In conclusion, the AAMC and AACOM believe that taxing tuition and education related expenses under the NHSC Scholarship Program creates a disincentive to participation in a program that serves a compelling national public policy interest. As you compose legislation aimed at reducing the tax burden on individuals, we urge you to include a provision exempting these important scholarships from gross income for tax purposes.

The AAMC represents the nation's 125 accredited medical schools, some 400 major teaching hospitals and health systems, 86 professional and scientific societies representing 87,000 faculty members, and the nation's medical students and residents.

AACOM represents the 19 accredited colleges of osteopathic medicine in the United States as well as all osteopathic medical students and osteopathic interns and residents.