My son is a college student in a a co-op program. Students alternate between attending classes and 6 month co-ops which are typically real, paid jobs. In 2010 my son took an unpaid co-op, working in a lab at a prestigious university. He performed experiments under the direction of a PhD, putting in regular hours, approximately 40 hrs per week. After he finished the co-op, the university sent him a check for $3500. They didn't "owe" him this money. Payment of any amount was never discussed as my son took the position as an unpaid internship. This was viewed by him as "icing on the cake," because he took the position as an unpaid internship and got very good lab experience and some great things for his resume. He did not really view it as "pay for work" because that would have worked out to $3.50 per hour.

At tax time the university sent him a 1099 MISC, and we forced it into "other income," paying income tax but no self employment tax.

I see it is a common problem with college interns getting paid with a 1099 MISC. Seems in most cases they bite the bullet and pay the full self employment tax.

I understand the IRS wants the ss and medicare tax, either split between employer and employee, or paid 100% by the self employed.

We cannot expect the University to treat my son as an employee because he was working in an unpaid position. On the other hand, I don't see how my son can be considered "self employed" by the IRS.

Is there any basis for considering the $3500 payment a gift, ie non taxable? My son would have very little in the way of expenses to declare if he throws in the towel and fills out a schedule C and pays self employment taxes. Of course the IRS has sent him a notice calculating he owes the self employment taxes.

“We cannot expect the University to treat my son as an employee because he was working in an unpaid position. On the other hand, I don't see how my son can be considered "self employed" by the IRS.”---->Agreed.

“Is there any basis for considering the $3500 payment a gift, ie non taxable?”---->I don’t think so UNLESS the payment is treated as fellowship award/stipend(or UNLESS there is proper logic for the school to provide him with a cash gift); for example, fellowship awards and stipends do not constitute taxable compensation for services if the recipient is required to apply his skill and training to advance research, creative work, or some other project or activity, and the recipient can show that:the benefits resulting from the services of the recipient are so minimal, given the actual services performed or expected to be performed, that they constitute no realistic basis for compensation by the institution sponsoring the fellowship or stipend; or the activities of the recipient are so closely and directly supervised and immediately controlled by regular faculty members so as to constitute a burden on the institution which would offset any benefit it receives from the recipient's activities; or the recipient is a candidate for a degree and the same activities are required for all candidates for that degree as a condition for receiving such a degree.
My son would have very little in the way of expenses to declare if he throws in the towel and fills out a schedule C and pays self employment taxes. Of course the IRS has sent him a notice calculating he owes the self employment taxes”----> IRS can not issue guidelines to employers on issue "employee or independent contractor". If you do not agree with your classification then you can file Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. I gues your son can report the extra income on 1040 line 21 , other income.. Please contact the IRS for more info.