Can I get donations to fund a scholarship and then after enough interest is earned return the principle?

I want to start a foundation for a scholarship. I would like to get funding in some large donations, earn interest to grow the account and then return the principle. The remaining interest would then be the principle for the scholarship fund. Basically it would be an interest free loan for maybe 6 months or a year to get the fund established. Is this legal? What are the tax implications for the original donors (corporate of personal)? Could they deduct the income one year and then have to count it the next?

Dave, your principles bear no interest for me ;-)

Getting back to the question, an interest-free loan to charity is not deductible. There are a number of reasons for this, but just suppose your benefactor did not loan you the money, but invested it himself and donated the income to your foundation. He would have offsetting items of income and deduction for zero net effect on taxable income. The same result arises from the interest free loan: No income, no deduction.

And it's principAL, not principLE, in case you missed the joke.

Any one can give any one else a cash gift of up to $12,000 in 2006 and not have to file a gift tax return. You'd have to get quite a few of these types of gifts to build the account to such a level that it would earn sufficient interest to pay for your college. For example, the interest on $1 million over 6 months assuming an interest rate of 4% is only $20,000 - hardly enough to cover a year at most universities.

Of course, there's always the thought that maybe you won't return the principal amount once enough interest has been earned. I'm not saying that you wouldn't, but a gift can't have any strings attached, so they'd be relying on your word. Not something that I would do.

People could make loans to you, but that would be a ton of paperwork to document the loans. If each loan was less than $10,000 there wouldn't be any issues with imputed interest, so there'd be no income recognition issues.

Try getting a job.

I would find it tough to give up my principles for a year. The choices and decisions I face every day are difficult and would be even more so without them. I was surprised to learn I could earn interest on them.