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Tax Reform Law Creates New Compliance Hurdles for Colleges and Universities

December 20, 2017

Many provisions included in the recently-passed tax legislation impact college and university operations and the revenue streams on which they rely. With some provisions effective for tax year 2017, institutions need to take a close look at how current operations will be impacted and begin taking steps to educate staff and align campus procedures toward compliance with the new law.

Alongside immediate operational compliance plans will undoubtedly be longer-term strategic efforts to address the loss of revenue streams associated with new taxes on institutions, in addition to anticipated drops in charitable giving and longer-term challenges to state and local government budgets.

Short on specifics, for now. The new requirements included in the Tax Cuts and Jobs Act of 2017 (the Act) appear below. We understand that there are many questions and uncertainty about how to interpret some of these provisions: What are the definitions? How will we account for and report these new taxes?

Other than what is provided here (taken from the final bill and conference report) there simply are not any further details, definitions, or specifics that explain the provisions of the Tax Cuts and Jobs Act of 2017 at this time. Scores of regulations will need to be promulgated by the U.S. Treasury Department and the IRS to provide guidance on the new law for taxpayers, small businesses, tax-exempt organizations, and corporations. The IRS will be changing forms, publications, and updating withholding tables. There is no anticipated timeline for such guidance - NACUBO will report any notices or announcements along those lines. In the meantime, colleges and universities need to prepare to meet the new law's requirements.

Notable Provisions

New corporate rate. The Act permanently lowers the corporate rate from 35 percent to 21 percent.

Endowment excise tax. The Act imposes a 1.4 percent excise tax on the net investment income of private colleges and universities that:

  • Have at least 500 students
  • Have more than 50 percent of students located in the United States. For this purpose, the number of students at a location is based on the daily average number of full-time students attending the institution, with part-time students to be considered on a full-time student equivalent basis. 
  • Have assets (other than those used directly in carrying out the institution's educational purposes) valued at the close of the preceding tax year of at least $500,000 per full-time student. The Joint Committee on Taxation summary explains that "assets used directly in carrying out the institution's exempt purpose" include, for example, classroom buildings and physical facilities used for educational activities and office equipment or other administrative assets used by employees of the institution in carrying out exempt activities, among other assets, and are excluded from the assets-per-FTE calculation. 

The conference agreement states:

"It is intended that the Secretary promulgate regulations to carry out the intent of the provision, including regulations that describe: (1) assets that are used directly in carrying out the educational institution's exempt purpose; (2) the computation of net investment income; and (3) assets that are intended or available for the use or benefit of the educational institution."

Unrelated business income separately computed for each trade or business (aka "basketing"). For an organization with more than one unrelated trade or business, the proposal requires that unrelated business taxable income (UBTI) first be computed separately with respect to each trade or business and without regard to the specific deduction generally allowed under section 512(b)(12). The organization's UBTI for a taxable year is the sum of the amounts (not less than zero) computed for each separate trade or business, less the specific deduction allowed under section 512(b)(12). A net operating loss (NOL) deduction is allowed only with respect to a trade or business from which the loss arose.

The final bill tightened the deduction limitation to 80 percent of taxable income for losses arising in tax years beginning after 2017. We anticipate that this provision will cause many colleges and universities to incur a tax liability in spite of overwhelming NOLs, because of the combined effect of basketing and the new NOL limitation. The tax will be at the 21 percent corporate rate.

New taxes on fringe benefits provided to employees. An institution's or organization's unrelated business income (UBI) will be increased by the amount of certain fringe expenses. Tax-exempt entities will be taxed on the value of providing their employees with transportation fringe benefits, and on-premises gyms and other athletic facilities, by treating the funds used to pay for such benefits as UBI, thus subjecting the values of those employee benefits to a tax at the 21 percent corporate tax rate.

Executive compensation tax. A tax-exempt organization—generally including most public entities—would be subject to an excise tax on compensation in excess of $1 million paid to any of its five highest-paid employees for the tax year. The excise tax would apply to all remuneration paid to a covered person for services, including cash and the cash value of all remuneration (including benefits) paid in a medium other than cash, except for payments to a tax-qualified retirement plan, and amounts that are excludable from the executive's gross income.

Once an employee qualifies as a covered person, the excise tax would apply to compensation in excess of $1 million paid to that person as long as the organization pays them remuneration. The excise tax also would apply to excess parachute payments paid by the organization to such individuals. Under the provision, an excess parachute payment generally would be a payment contingent on the employee's separation from employment with an aggregate present value of three times the employee's base compensation or more.

The conference agreement exempts compensation paid to employees who are not highly compensated employees (within the meaning of Section 414(q)) from the definition of parachute payment, and also exempts compensation attributable to medical services of certain qualified medical professionals from the definitions of remuneration and parachute payment. For purposes of determining a covered employee, remuneration paid to a licensed medical professional which is directly related to the performance of medical or veterinary services by such professional is not taken into account, whereas remuneration paid to such a professional in any other capacity is.. A medical professional for this purpose includes a doctor, nurse, or veterinarian.

Under the conference agreement, the tax rate is equal to the corporate tax rate, which is 21 percent. In addition, for purposes of the requirement to treat remuneration as paid when the rights to the remuneration are no longer subject to a substantial risk of forfeiture, the conference agreement clarifies that "substantial risk of forfeiture" is based on the definition. under Section 457(f)(3)(B) which applies to ineligible deferred compensation subject to section 457(f). Accordingly, the tax imposed by this provision can apply to the value of remuneration that is vested (and any increases in such value or vested remuneration) under this definition, even if it is not yet received.

Repeal of advance refunding bonds. Interest on advance refunding bonds (i.e., refunding bonds issued more than 90 days before the redemption of the refunded bonds) will become taxable. Interest on refunding bonds issued prior to the change would continue to be tax exempt.

Thus, new advance refunding bonds are effectively eliminated beginning after December 31, 2017. Technically, the provision disallows exclusion from gross income interest on a bond issued to advance refund another bond. This change impacts any institution, public or private, that might have had future plans to advance refund bonds.

Other notable bond issues. While they were threatened during deliberations over the Act, private activity bonds were not eliminated and nonprofit organizations may continue to issue these bonds.

Bondholders are also advised to review existing bond covenants for income maintenance provisions. Some issuers may have agreed to increase payments to bondholders should there be any changes to the corporate tax rate. Enactment of this tax bill will trigger such provisions.

Charitable deductions. The standard deduction would be increased to $24,000 for joint filers and $12,000 for individuals. The bill estimates that that this would reduce the number of taxpayers who itemize deductions from approximately one-third under current law to fewer than 10 percent. The Joint Committee on Taxation has estimated that the Act will spur a dramatic drop in the amount of charitable giving in the U.S. with 32 million fewer people eligible to claim the deduction. This dramatic change, combined with the doubling of the estate tax exclusion from $5.49 million to $10.98 million could significantly affect donor behavior. The estate tax expansion expires after 2025.

Athletic seating. The Act prohibits charitable treatment for payment to an institution of higher education in exchange for the right to purchase tickets or seating at an athletic event.

Entertainment expenses. Under current law, a deduction (or partial deduction) was allowed for activities generally considered to be entertainment, amusement, or recreation ("entertainment") if the taxpayer establishes that the item was directly related to active conduct of the taxpayer's trade or business. The Act repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer's trade or business (and the related rule applying a 50 percent limit to such deductions).

International Students. Because the individual tax code will no longer allow personal exemptions, some international students may face new income tax liabilities.

State and local tax (SALT) deduction. The Act limits itemized deduction for all state and local taxes (i.e., property taxes and income tax or sales tax in lieu of income tax) to $10,000. It is anticipated that increased pressure from this provision on state governments will result in even further funding cuts for public institutions. Funding cuts at the state level often lead to increased pressure on tuition revenue that only raise college costs and limit access.

NACUBO is closely monitoring action from The Treasury Department and the IRS and will report on any guidance or announcements that are published related to these provisions.

Contact

Liz Clark
Senior Director, Federal Affairs
202.861.2553
E-mail

Mary Bachinger
Director, Tax Policy
202.861.2581
E-mail

Megan Schneider
Assistant Director, Federal Affairs
202.861.2547
E-mail