Proposed Regulations on the TCJA Endowment Tax

| 7/11/2019
On July 3, the IRS published proposed regulations  under IRC Section 4968, enacted by the Tax Cuts and Jobs Act, which imposes a 1.4% excise tax on the net investment income of certain private colleges and universities. The proposed regulations provide guidance on which institutions are subject to the tax and clarify rules for calculating net investment income tax. Comments and requests for a hearing are due Oct. 1, 2019. Generally, the rules will apply prospectively to tax years beginning after the final regulations are published. However, the guidance provides that taxpayers may rely on the proposed regulations retroactively for tax years beginning before publication of final regulations.

Institutions subject to the tax

The tax generally applies to private colleges and universities that:
  • Are “applicable educational institutions” as described in Section 25A(f)(2), which generally includes institutions qualified to receive federal student financial aid.
  • Have at least 500 tuition-paying students, more than 50% of whom are located in the United States. The number of tuition-paying students is based on the daily average number of full-time students attending the institution. Part-time students are taken into account on a full-time student equivalent basis.
  • Are not state colleges or universities.
  • Have assets (other than those assets used directly in carrying out their exempt purpose) with an aggregate fair market value of at least $500,000 per student.

The proposed regulations define the following terms:
  • “Student” generally means an individual enrolled in a degree, certification, or other program (including a program of study abroad approved for credit by the institution) that will lead to a recognized educational credential at an institution.
  • “Tuition-paying” means the payment of any tuition or fees required to enroll in or attend courses of instruction at an institution after the application of any scholarships offered (or work-study program operated) directly by the institution. The term does not include payment for supplies or equipment required during a specific course once a student is enrolled in or attending the course or the payment of room and board or other personal living expenses. If a student is required to pay a fee to an institution that combines charges for tuition with charges for personal living expenses such as room and board, the student is a tuition-paying student.
  • “Located in the United States” means residing in the United States for at least a portion of the time an individual attended the institution during the preceding tax year.
  • “Assets used directly in carrying out an institution's exempt purpose” means assets actually used by the institution as such. Examples include administrative assets as well as real estate and physical property used by the institution directly in its exempt activities. A reasonable cash balance of 1.5% of the fair market value of noncharitable assets is considered to be used directly in carrying out the institution's exempt purpose. Assets held for the production of income or for investment are deemed to not be used directly in carrying out an institution’s exempt purpose. For purposes of valuing the institution’s nonexempt use assets, institutions generally must use the rules of Section 4942, with modifications.

Net investment income

Rules provided in IRC Section 4940(c) are used to determine net investment income. Under those rules, net investment income generally means the amount by which the sum of the gross investment income and the capital gain net income (except gain that is unrelated business income) exceeds the deduction for all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of income, with certain modifications for depreciation and depletion. An institution computes gain on the sale or disposition of donated property using the donor’s basis. For property held by an institution (including through an interest in a partnership) on Dec. 31, 2017, and continuously thereafter to the date of its disposition, the basis cannot be less than fair market value of such property on Dec. 31, 2017, as adjusted. Interest income received on student loans and room and board for students living in a dormitory are includable in the net investment income tax, although comments are specifically requested.

Controlled or supporting organizations

If a related organization is controlled by the educational institution or is a supporting organization, the assets and net investment income of the related organization must be taken into account as assets and net investment income of the institution. The definition of related organization generally aligns with the definition of related organization for purposes of the reporting requirements on Form 990, “Return of Organization Exempt From Income Tax.” Special rules apply for certain Type III supporting organizations.

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