Contrary to its name, The Tax Cuts and Jobs Act resulted in a tax increase for certain entities. For example, certain well-endowed private universities and colleges are now subject to a 1.4% excise tax on their net investment income. This tax increase is set forth in Section 4968 of the Internal Revenue Code, and it generally applies to private universities that at the end of their prior taxable year (a) had at least 500 full-time, tuition paying students, and (b) whose endowment (i.e., assets not used for the university’s exempt purposes) had a fair market value that equaled at least $500,000 per student of the university. In addition, Section 4968 only applies if more than 50% of the tuition-paying students at the private university are located in the United States. Since Section 4968 is a brand-new statute, private universities had many unanswered questions regarding which universities are subject to the new excise tax and how to calculate it. Accordingly, the Treasury Department recently released proposed regulations that provide some guidance on these matters.
Linguistics Lesson – The proposed regulations define numerous terms that are used, but not defined, in the statute. For example, the proposed regulations shed light on what constitutes a “student,” what it means for that student to be “tuition-paying,” whether a student is “located in the United States,” which of the institution’s assets are “assets used directly in carrying out the institution’s exempt purpose,” and which organizations are “related organizations” for purposes of the new excise tax in Section 4968.
Statistics Lesson – What are the odds that this new excise tax applies to you? (A math competition you do not want to win.) The preamble to the proposed regulations cites two different studies, both of which are based on 2016 data obtained from the Integrated Post-Secondary Education Data System. The first study estimated that during 2016 there were approximately 27 university endowments with a fair market value that would equal or exceed $500,000 per full-time student. However, that count includes public universities, which are not (yet) subject to the 1.4% excise tax. The second study estimated that based upon the same 2016 data, 23 private universities would potentially be subject to the tax increase. It should be noted, however, that the $500,000 per full-time student threshold is not indexed for inflation. Thus, over time, more private universities are likely to become subject to the 1.4% excise tax.
Evaluation – The Treasury Department and the IRS would like to know what private universities and their tax advisors think about many provisions in the proposed regulations, and have thus requested comments regarding the same. They may not care that affected private universities that get an “A” in fundraising and an “A” in investing are being penalized. If it’s any solace to these private universities, to the extent their endowments are not restricted in use to the same projects that they wish to finance with qualified 501(c)(3) bonds, those endowments should not impede the issuance of those bonds. Although the excise tax won’t help with the repayment of those bonds . . . .
Effective Date – The proposed regulations will apply to taxable years beginning after the date they become adopted as final regulations.