Approximately 40 institutions will be affected by last year’s approved excise tax on net investment income of private colleges and universities, according to proposed regulations from the Internal Revenue Service.
The excise tax equivalent to 1.4% of the institution’s net investment is applicable to university endowments worth more than $500,000 per student with a minimum of 500 tuition-paying students, and a guidance release from the IRS clarifies how affected institutions can determine net investment income and basis in property.
Section 4940(c)(1) defines net investment income as “the amount by which the sum of the gross investment income and the capital gain net income exceeds certain specified allowable deductions.” Interest that derives from assets dedicated to charitable activities are “includible” in gross investment income.
Net investment income is determined under the rules of subtitle A, which encompasses all income tax provisions of the Internal Revenue Code including basis rules in section 1015, and therefore basis of property.
This guidance incorporates student loan interest as taxable net investment income, however, the IRS and Treasury Department recognize that if provided directly by an applicable school to its students, such as a scholarship, then it can be viewed as helping a school fulfill its educational mission.
Student loans provided by an applicable school can arguably be viewed as a form of deferred tuition paid when the student goes into the workforce, and therefore possibly different from investment income depending on the interest rate, the regulations said.
The rules go on to say that if the interest rate is set at a substantially below-market rate, the difference between the market interest rate and rate on the loan may be viewed similarly to a scholarship from the school to the student. In this case, the remaining below-market rate interest income might be considered distinguishable from income gained from assets obtained first and foremost for investment purposes.
But, “Any exception for student loan interest that is premised on the utilization of an interest rate that is substantially lower than a market rate would potentially present tax administrative challenges for both the IRS and taxpayers in determining the relevant market-rate and an acceptable lower rate, and in adjusting to rate changes during the course of the loan,” the regulations stated.
The regulations note that if property is used for charitable, educational or other similar exempt purposes with the exempt use amounting to 95% or more of the total use, then the property is considered exclusively for charitable, educational or other similar purpose.
Prior versions of the legislation approved by the House and Senate paved the way for President Donald Trump’s approval of the final bill in December 2017. Wealthy colleges and universities — such as Harvard University — that were subject to paying the excise tax expressed general discontent to taxation on their net-investment income or portion of it (NPN, 1/4/2018).
Harvard has been opposed to the endowment tax since its passage and plans to keep advocating for its repeal, according to the university’s daily newspaper The Harvard Crimson. University spokeswoman Brigid O’Rourke wrote, “We will continue to work with policy makers and others in the higher education community to push for Congress to re-examine this misguided and damaging provision in light of the Congress’s stated goals of increasing access and affordability.”
Berea College uses its endowment to cover tuition costs for all of its approximately 1,600 students, but may also be affected by the excise tax according to a Washington Post report published on July 3.
The report states that “the Kentucky school’s pledge that no one pays tuition should exempt it from the tax,” however, the tuition tab is only picked up after all federal, state and private grants are awarded, which means students technically do pay a portion of tuition and thus must follow treasury guidelines.
“Scholarship payments provided by third parties, even if administered by the institution, are considered payments of tuition on behalf of the student,” the regulations read. Further, a student will be considered tuition-paying if payment of any tuition or a fee is required for the enrollment or attendance of the student.
Berea school officials are reviewing the guidelines and understand that there may be an issue with how the draft regulations were written. Lyle Roelofs, president of Berea College wrote, “We will be weighing in with Treasury to clarify any impacts the draft language may have on Berea College to make sure that the final regulations reflect congressional intent.”
The guidance states that the IRS is accepting public comments and feedback for a 90-day period from the date of the regulations’ publication to advocate an exception for the interest received on student loans and how they could be addressed. The regulations may be found here.