(b) The 2017 Tax Act (Pub. L. No. 115-97)

The 2017 Tax Act (Pub. L. No. 115-97) (“the Tax Act”) made significant changes to the taxation of charitable organizations, including colleges and universities, with one particular provision targeted at certain colleges and universities, some of whom will be subject to an additional new tax on their investment income.

Because of the numerous uncertainties amid likely substantial tax liabilities, some of which must be paid via estimated tax payments, many affected colleges and universities have requested that Treasury delay implementation of this and other new provisions so that they have a reasonable period of time to “estimate our new tax burden” and “budget for this dramatic tax increase.”^32.1 In addition to interpretive guidance from Treasury, organizations and practitioners await revised Form 990-T, whereby UBIT, the focus of many of the changes, will be reported as well as Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42, in regard to reporting under § 4968 (tax applicable to certain private colleges and universities on investment income) and § 4960 (tax on excessive compensation).

(i) Tax on Investment Income—§ 4968. The Tax Act imposes a new 1.4 % excise tax on the “net investment income” of endowments of private colleges and universities with more than 500 students and net assets of at least $500,000 per student. The tax applies to private institutions with at least 500 tuition paying^32.2 students, more than half of whom are located in the United States, with an aggregate fair market value of assets (other than assets used directly in carrying out exempt purposes) of at least $500,000 per student at the end of the prior tax year. See § 4968(b)(1). The assets and investment income of related organizations are included in the calculations. See § 4968(d)(1). The investment assets language mirrors the language of § 4942, the private foundation payout rules.^32.3

The provision raises numerous questions, including the definition of “tuition paying students.” In comments to Treasury, it has been suggested that tuition paying be determined by the tuition invoice sent to the student and not be measured by how the tuition is paid (i.e., by scholarship or other assistance).^32.4 In regard to determining net investment income, § 4968 refers to the regulations under § 4940(c), the rules relating to private foundation excise tax on investment income for guidance.

In regard to the meaning of “related organization,” § 4968 (d)(1) specifies that assets and net investment income of related organizations controlled by it or described in § 509(a)(3) are to be included, except that assets and income not intended or available for the use or benefit of the reporting educational institutions shall not be included. “Related organization” is defined as any organization that controls or is controlled by such institution, is controlled by one or more of the same persons that control the educational institution, is a supported organization under § 509(f)(3), or is a supporting organization under § 509(a)(3).

Illustrating the complexity of identifying related organizations for purposes of determining assets and income to be included is one of many comment letters sent to the Treasury Secretary. In one such letter, an “applicable educational institution” has suggested that:

related organizations be defined to only include those organizations that are operating organizations (not passive investments) more than 80% controlled by the [reporting entity] (similar to the rules under IRC Section 368(c) and IRC Section 1563(a)(1) or are Type I supporting organizations under § 509(a)(3))….^32.5

In other words, this institution is suggesting that control be measured by an 80% threshold and that only one type of supporting organization under § 509(a)(3), Type I, be included. This suggestion illustrates the complex structural relationships of colleges and universities that have numerous affiliated organizations that they may not control and/or whose assets are restricted to use in their respective tax-exempt purposes. Unless the suggested definitions are applied, the educational institution asserts that because it can neither direct funds from those related organizations it does not control nor obtain relevant financial information for computational purposes, including the assets and income of such entities would result in the imposition of the § 4968 tax on organizations other than private colleges and universities.^32.6

In June 2018 the IRS released Notice 2018-55 relating to calculation of gain in regard to the sale of assets under § 4968. Section 3 of the Notice provides that for property held on December 31, 2017, and continuously thereafter to the date of its disposition, the basis of the property for purposes of determining gain is to be not less than its fair market value on December 31, 2017. In other words, in an effort to minimize the impact of the tax, organizations will have a step up in basis for assets that, when sold, will be subject to the tax. The Notice further states that taxpayers can rely on this guidance until further guidance is issued. As the IRS explained in its press release accompanying issuance of the Notice:

A private college or university, subject to the new 1.4 percent excise tax on net investment income, that sells property at a gain generally may use the property's fair market value at the end of 2017 as its basis for figuring the tax on any resulting gain, the Internal Revenue Service said today. In many instances, this new stepped-up basis rule will reduce the amount of gain subject to the new tax. Normal basis rules will continue to apply for calculating any loss.^32.7

(ii) Siloing of UBIT Activities—§ 512(a)(6). As described in subsection 2.1(1), many of the changes in the Tax Reform Act of 2017 that affect this sector involve modifications to UBIT. New IRC § 512(a)(6) requires exempt organizations with more than one unrelated trade or business to separately compute income and losses from those trades or businesses when computing UBIT. In other words, organizations are required to “silo” their revenue and losses for each trade or business so that the losses from one business cannot be used to offset the revenue of another. Although the IRS has added this issue to its Fiscal 2018 Priority Guidance Plan, colleges and universities in the meantime must struggle with determining reasonable approaches, including the allocation of expenses for dual use facilities when making these computations. (The allocation of expense issue has also been added to the FY 2018 Priority Guidance Plan).

To the extent colleges and universities have not yet “spun off” unrelated activities, such as summertime use of facilities, to a separate for-profit entity, this has now become a front and center issue, particularly because for-profits are not subject to siloing of revenue and expenses.

Of course, spinning off activities presents its own set of issues, such as the computation of UBIT from related entities under § 512(b)(13), the extent to which NOL's from an activity previously under the umbrella of a § 501(c)(3) can be utilized by the successor entity, and so on.

Incident to the question of spinning off one or more activities into a for-profit entity is the choice of entity (e.g., LLC or corporation). It has been suggested that the C corporation may deserve favorable consideration in creating a joint venture for several reasons, including the 21% tax rate, the § 1202 gain exclusion, and AMT changes.^32.8 On the other hand, use of a C corporation would mean that an asset sale would be taxable at the entity level; any income that might be related to the exempt organization's charitable purposes could not be excluded from income nor could interest, rents, royalties, or annuity income that would be exempt if there was pass-through under § 512(b)(13). Other considerations are whether joint venture partners prefer flow-through treatment of income, expenses, and so on, and whether there should be an activity by activity approach to the choice of entity question.^32.9

Practitioners and organizations are awaiting regulatory or other guidance on the interpretation of trade or businesses so they can make appropriate accounting adjustments; they are awaiting revised Forms 990-T as well. Many have requested delay in implementation of this provision.

(iii) Employer Provided Fringe Benefits—§ 512(a)(7). Congress has added a new UBIT provision that imposes tax on expenses for certain employee fringe benefits that would not qualify for a deduction by a taxable employer under § 274. Under § 512(a)(7), expenses for qualified transportation fringe benefits, parking facilities used in connection with “qualified parking,” and on-premises athletic facilities^32.10 are subject to UBIT. In other words, if a taxable employer would not be allowed to claim a deduction for an employee fringe benefit under § 274, the expense associated with providing that benefit will be subject to UBIT.

This change was effectuated so as to provide parity between for-profit employers, who can no longer deduct these expenses, and nonprofits. To the extent that an activity is a regularly carried on unrelated trade or business, however, § 512(a)(7) does not apply because the income therefrom is already subject to UBIT.

Among the numerous questions regarding this provision is whether a fringe benefit taxable under § 512(a)(7) must be counted as a trade or business when computing revenue and expenses under the siloing provisions.^32.11

(iv) Excess Compensation Tax—§ 4960. New § 4960 imposes a 21 percent excise tax on applicable tax-exempt organizations in regard to annual compensation that exceeds $1 million, including excess parachute payments contingent on separation from employment, paid to a covered employee applicable tax-exempt organizations and certain 80 percent controlled entities.^32.12 The tax applies to organizations exempt from tax under § 501(a) and political organizations under § 527(e)(1).^32.13 Employees are current employees who are one of the five highest paid employees during the taxable year and former employees during the preceding year. See Chapter 2, subsection 2.1 1(c).

(v) Denial of Deduction for Right to Purchase Stadium Tickets—§ 170(l). One of the more clear cut changes in the Tax Reform Act of 2017, but one with a dramatic negative impact on the revenue of colleges and universities with athletic programs, is in § 170(l), which disallows a deduction for amounts paid to or for the benefit of an institution of higher education where the taxpayer receives, directly or indirectly, the “right to purchase tickets for seating at an athletic event in an athletic stadium of such institution.”

(a) Publication of Nondiscrimination Policy

The IRS issued Revenue Procedure 2019-22, 2019-22 IRB 1260, which updates Revenue Procedure 75-50, 1975-2 C.B. 587, relating to school nondiscrimination policies, for the first time in almost 45 years. The revision relates to the manner of publicizing a tax-exempt school's policy prohibiting discrimination on the basis of race and, in recognition of modern technology, adds a third method for a private school to satisfy the notice requirement by using its Internet website. Now, in addition to publicizing nondiscrimination policies in newspapers, radio, and television, schools can publish their nondiscrimination policy on their primary publicly accessible Internet homepage at all times during the taxable year (excluding outages and maintenance windows) “in a manner reasonably expected to be noticed by visitor to the homepage.” Publicly accessible means that a visitor does not have to input information such as a user name and password to access the page. A link to a different page where the notice appears or a notice that “appears in a carousel or only by selecting a dropdown or by hover (mouseover)” is not acceptable. If a hosted website is used, the notice must appear on “its primary landing page” within the hosted website.

(b) Varsity Blues Investigation

The so-called Varsity Blues scandal described in Section 2.11 may lead the IRS to reexamine the practices of colleges and universities to receive contributions from donors whose children attend the schools.

(a) Basic Functions

p. 1134. Delete the citation in footnote 155 and replace it with the following:

Id.

p. 1135. Delete the citation in footnote 156 and replace it with the following:

Id.

(b) Entertainment, Sports, and Travel Activities

(c) Distance Learning

(f) University Endowments

(g) Other Commercial Arrangements.

A New Jersey property tax case has raised some interest.^318.7 The case involved a property tax exemption claimed by a restaurant operated on the campus of Kean University. The restaurant was located in the University's new science, technology, and math building; the New Jersey Educational Facilities Authority, which held title to the property, financed the building's construction. The Kean University Foundation hired a third party to operate the restaurant and pay the Foundation a $250,000 annual fee and 12.5 percent of the restaurant's gross revenues. The third-party manager had full discretion over all management decisions.

The local tax authority assessed property tax on the restaurant portion of the building. The restaurant claimed that it should be exempt from property tax on the grounds that, pursuant to New Jersey law, it is “used for public purposes” by attracting people to the campus who otherwise might not have known about the University's particular academic programs; was providing an upscale restaurant choice for visiting parents; had provided more than $259,000 in scholarship funds for University programs (the Foundation was required to allocate at least 10 percent of restaurant revenue to scholarships); and whose staff was principally comprised of university students.

The New Jersey appellate court held that the restaurant was “unique” in that it was located on campus and was viewed by the University as a recruiting tool. The court distinguished the restaurant “because it provides students, other members of the University community, and visitors to the campus an alternative dining experience.… concept of a public purpose ‘must expand when necessary to encompass changing public needs of a modern dynamic society.’”

While an appeal petition has been filed with the New Jersey Supreme Court, the opinion has been cited as potentially heralding the expansion of the concept of “public purposes” where there is some public benefit from a private, for-profit use of government property.^318.8