Overview
On September 18, Treasury and the IRS released final regulations for determining the excise tax applicable to the net investment income of certain private colleges and universities, as provided by section 4968. In general, section 4968, which was enacted as part of the Tax Cuts and Jobs Act (TCJA), imposes on each "applicable educational institution" an excise tax equal to 1.4% of the institution's "net investment income." The final regulations adopt rules that are much more generous than those proposed in July 2019.
The final regulations include guidance on the scope of applicable educational institutions to which the excise tax applies, including determining who will be counted as a "tuition-paying student," which institutions will be treated as "located in the United States," and which assets will be included in determining whether an institution meets the $500,000 per student threshold in the statute.
In determining which schools are subject to the tax, the final regulations expand the definition of student, so that institutions can include not only students that are enrolled in degree programs, but also students that are taking courses for academic credit. In addition, it changes the definition of "tuition paying" so that although scholarships from third parties are generally considered payment of tuition, grants made by the federal government or any state or local government are excluded.
The final regulations also include rules for calculating an applicable educational institution's net investment income. Section 4968 provides that the net investment income of an applicable educational institution should be determined under rules similar to those used to determine the net investment income of a private foundation under section 4940. The proposed regulations included certain modifications to the section 4940 rules to account for differences between applicable educational institutions and private foundations. Several commenters requested that the final regulations further tailor these rules to take into account these differences, including differences in funding sources, use of funds, structure, governance, and oversight. In response, the final regulations omit the use of a cross reference to the regulations under section 4940 to define net investment income for purposes of section 4968. Instead, the final regulations prescribe specific rules under section 4968 that provide many more exceptions and exclusions than the rules under section 4940.
In determining net investment income under these rules, the final regulations, unlike the proposed regulations, exclude the following items from the gross investment income of an applicable educational institution:
- Interest income from a student loan that was made by the applicable educational institution or a related organization to a student of the applicable educational institution in connection with the student’s attendance at the institution
- Rental income from the provision of housing by the applicable educational institution or a related organization to students of the applicable educational institution and from housing for faculty and staff if the housing is provided contingent on their roles as faculty or staff of the applicable educational institution
- Royalty income that is derived from patents, copyrights, and other intellectual property and intangible property to the extent those assets resulted from the work of student(s) or faculty member(s) in their capacities as such with the applicable educational institution
In addition, the final regulations provide the following modifications in determining capital gain net income:
- Capital gain net income from the sale or exchange of property used by an institution for its exempt purpose is disregarded for the portion of the property that is used for the exempt purpose
- Any appreciation in the value of donated property that occurred prior to the date of its donation to the institution is disregarded
- Capital loss carryovers are allowed but not capital loss carrybacks
Finally, the final regulations include guidance on the rules for treating certain assets and net investment income of certain related organizations as assets and net investment income of an educational institution. In comparison to the proposed regulations, the final regulations reduce the number of organizations that are related to the educational institution. To prevent multiple taxation of net investment income and overcounting of assets, the final regulations generally exclude from the definition of a "related organization" taxable corporations and taxable trusts, as well as partnerships, S corporations, or other pass-through entities, a portion of whose income flows through to the educational institution. The final regulations also generally provide that charitable remainder trusts, charitable lead trusts, and decedents' estates will not be considered to be related organizations. The final regulations further provide guidance under the related organization rules regarding the treatment of funded and unfunded employee benefit plans, the definition of "control," and the exclusion of assets and net investment income of certain related organizations that are not intended or available for the use or benefit of the educational institution.
The final regulations will apply to taxable years of an educational institution beginning after the date they are published in the Federal Register.
