Prop reliance regs explain excise tax on net investment income of colleges and universities

Preamble to Prop Reg REG-106877-18; Prop Reg §53.4968-1

IRS has issued proposed reliance regs for determining the 1.4% excise tax on the net investment income of certain private colleges and universities, and related organizations, under Code Sec. 4968.

Background. Code Sec. 4968 imposes on each applicable educational institution an excise tax equal to 1.4% of the institution’s net investment income, and of net investment income of certain related organizations, for the tax year.

An applicable educational institution is an eligible educational institution (as defined in Code Sec 25A(f)(2)) which during the preceding tax year had at least 500 tuition-paying students, more than 50% of whom were located in the U.S.; is not a state college or university; and had assets (other than those assets used directly in carrying out the institution’s exempt purpose) the aggregate FMV of which was at least $500,000 per student of the institution. (Code Sec. 4968(b)(1))

The number students of an institution is based on the daily average number of full-time students attending the institution (with part-time students taken into account on a full time student equivalent basis). (Code Sec. 4968(b)(2))

A related organization is either: a) any organization which controls, or is controlled by, an educational institution, or b) a supported organization (as defined in Code Sec. 509(f)(3)), or an organization described in Code Sec. 509(a)(3), during the tax year with respect to an educational institution. (Code Sec. 4968(d)(2))

Except as otherwise provided below, for purposes of determining the aggregate FMV of an institution’s assets and its net investment income, the assets and net investment income of any related organization with respect to the educational institution are treated as assets and net investment income, respectively, of the educational institution. (Code Sec. 4968(d)(1))

However, a related organization’s assets and net investment income are taken into account with respect to only one educational institution. (Code Sec. 4968(d)(1)(A)) Also, unless a related organization is controlled by the educational institution, assets and net investment income of the related organization that are not intended or available for the use or benefit of the educational institution are not taken into account. (Code Sec. 4968(d)(1)(B))

Proposed regs—Definition of student.   Code Sec. 4968 does not define “student.” The proposed regs would provide that “student” means a person enrolled in a degree, certification, or other program (including a program of study abroad approved for credit by the eligible institution at which such student is enrolled) leading to a recognized educational credential at an eligible educational institution, and not enrolled in an elementary or secondary school. (Prop Reg §53.4968-1(a)(3)(i))

Proposed regs—Definition of tuition-paying.   Code Sec. 4968 does not define “tuition-paying.” The proposed regs would provide that tuition-paying means the payment of tuition and fees required for the enrollment or attendance of a student for courses of instruction at an eligible educational institution but does not include any separate payment for supplies or equipment required during a specific course once a student is enrolled in and attending the course, e.g., art supplies. (Prop Reg §53.4968-1(a)(3)(ii)(A))

Tuition-paying would not include payment of room and board or other personal living expenses, and if a student is required to pay a fee (such as a comprehensive fee or a bundled fee) to an eligible educational institution that combines charges for tuition with charges for personal expenses such as room and board, then the student is a tuition-paying student. (Prop Reg §53.4968-1(a)(3)(ii)(B))

The preamble to the proposed regs notes that, notwithstanding the reference to “enrollment” for purposes of identifying tuition and fees, a tuition-paying student would also have to be attending the educational institution for purposes of determining if there are at least 500 tuition-paying students.

A student would be considered a tuition-paying student if payment of any tuition or a fee is required for the enrollment or attendance of the student for courses of instruction after the application of any scholarships offered directly by the institution or work study program operated directly by the institution. And, scholarship payments provided by third parties, even if administered by the institution, are considered payments of tuition on behalf of the student. (Prop Reg §53.4968-1(a)(3)(ii)(C))

Proposed regs—Located in the U.S.  A student would be considered to have been located in the U.S. if the student resided in the U.S. for at least a portion of the time the student attended the educational institution. This measurement would be based on the applicable educational institution’s preceding tax year. (Prop Reg §53.4968-1(a)(3)(iii))

Proposed regs—Full and part-time students. The determinations of full-time students, part-time students, full-time student equivalents, and daily average of students attending the institution would be made by each applicable educational institution if the determinations are consistent with the institution’s practices in determining full-time and part-time status for other purposes. (Prop Reg §53.4968-1(a)(3)(iv))

Proposed regs—Assets used directly in carrying out the institution’s exempt purpose. An asset would be used directly in carrying out an educational institution’s exempt purpose only if the asset is actually used by the institution in carrying out its exempt purpose. Whether an asset is used directly by the institution to carry out its exempt purpose would be determined based on all the facts and circumstances.

If property is used for an exempt purpose and for other purposes, and the exempt use represents 95% or more of the total use, the property is considered to be used exclusively for an exempt purpose. If the exempt use of such property represents less than 95% of the total use, the institution must make a reasonable allocation between such exempt and nonexempt uses. (Prop Reg §53.4968-1(a)(4)(i))

Certain assets would be considered to not be used directly in carrying out an institution’s exempt purpose, including assets that are held for the production of income or for investment (e.g., stocks, bonds, interest-bearing notes, endowment funds, or, generally, leased real estate), even if the income from those assets is used to carry out the exempt purpose. Similarly, non-exempt use assets would include property used for managing endowment funds of the institution. (Prop Reg §53.4968-1(a)(4)(iii))

Proposed regs—Related institution controlled by applicable educational institution. For purposes of whether a related institution is controlled by an applicable educational institution, “control” would mean (1) in the case of a corporation, ownership (by vote or value) of more than 50% of the stock of the corporation; (2) in the case of a partnership, ownership of more than 50% of the profits interests or capital interests in such partnership; (3) in the case of a trust with beneficial interests, ownership of more than 50% of the beneficial interests in the trust; or (4) in the case of a nonprofit organization or other organization without owners or persons having beneficial interests (nonstock organization), including a governmental entity, that more than 50% of the directors or trustees of the applicable educational institution or nonstock organization are either representatives of, or are directly or indirectly controlled by, the other entity or that more than 50% of the directors or trustees of the nonstock organization are either representatives of, or are directly or indirectly controlled by, one or more persons that control the applicable educational institution.

A “representative” would mean a trustee, director, agent, or employee, and control would include the power to remove a trustee or director and designate a new trustee or director. (Prop Reg §53.4968-1(c)(1))

Proposed regs—Allocation to not more than one institution. Regarding Code Sec 4968(d)(1)(A), the proposed regs would provide that, in any case in which an organization is a related organization with respect to more than one educational institution, the assets and net investment income of the related organization must be allocated between the educational institutions being supported by the related organization. The allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be consistently applied across all related organizations. (Prop Reg §53.4968-1(c)(2)(ii)(A))

Also, the proposed regs would provide that when a related organization controls an educational institution or is controlled by one or more persons which also control such institution, the assets and net investment income of the related organization must be allocated between those intended or available for the use and benefit of an educational institution and those not intended or not available for the use and benefit of that educational institution. The allocation must be made in a reasonable manner, taking into account all facts and circumstances, and must be consistently applied across all related organizations.

The proposed regs further explain that assets and net investment income of the related organization are intended or available for the use and benefit of an educational institution if the assets and net investment income are specifically earmarked or restricted for the benefit of, or are otherwise fairly attributable to, the educational institution. Conversely, assets and net investment income of a related organization are not intended or available for the use and benefit of an educational institution if those assets and net investment income are specifically earmarked or restricted for another entity or for unrelated purposes or are otherwise not fairly attributable to the educational institution. (Prop Reg §53.4968-1(c)(2)(ii)(B))

Effective date. The proposed regs are proposed to be effective when published as final regs. But taxpayers may rely on the proposed regs for tax years beginning before publication of the final regs. (Prop Reg §53.4968-1(d))

References: For excise tax on net investment income of colleges and universities, see FTC 2d/FIN ¶D-8170; United States Tax Reporter ¶49,684.