The building blocks for what could eventually form the base of U.S. tax reform include dramatic proposals that will impact universities and colleges. The 979-page “Tax Reform Act of 2014” discussion draft introduced by House Ways and Means Chairman Dave Camp (R-MI)in March 2014 is a comprehensive reform package that would reduce U.S. corporate and individual rates, reform U.S. international tax rules, and significantly alter the existing landscape of industry tax preferences.
As we noted in an earlier alert it is important to pay attention to these proposals as they will become possible offsets in any future tax bill, including a tax extenders bill.
Universities and colleges should be aware of the following proposals included in Chairman Camp’s draft and currently being discussed:
- Charitable contributions allowed only to the extent they exceed 2 percent of adjusted gross income (income before itemized deductions).
- Deduction for student loan interest is repealed.
- Contributions to an Educational IRA — currently nondeductible but come out tax-free if used for education expenses — will be disallowed.
- Repeal of the exclusion from the 10 percent penalty tax for distributions from a retirement plan that are used for qualified education expenses.
- Repeal of American Opportunity Tax Credit, Hope Scholarship Credit, Lifetime Learning Credit, and the above-the-line tuition deduction. These will be replaced by a US$2,500 American Opportunity Tax Credit. The first US$1,500 of the credit is refundable and would phase out once income exceeds US$86,000/US$43,000. The impact of this on universities is not clear at this point, but could be substantial.
- Income from research would be taxable as unrelated business taxable income (UBTI) unless the research results are made available to the public. Currently, income from research by a college or university is exempt.
- Private colleges and universities would be subject to a 1 percent excise tax on net investment income. The tax would apply if the institution has assets (other than those used in carrying out its educational purposes) of at least US$100,000 per full-time student.
- UBTI would have to be computed separately for each trade or business. Currently, a college or university can offset UBTI from one activity with losses from another, and a recent IRS study indicated that many do.
- Royalties for use of an institution's name and logo would be taxable. This would include income from, e.g., credit card affinity programs. Currently, these royalties may escape taxation if the institution is simply a passive licensor.
- An accuracy-related penalty would apply personally to the managers of an institution. The penalty, 5 percent of the tax resulting from an unsupportable position on the return, would be capped at US$20,000 and apply in those situations in which the institution is subject to the 20 percent accuracy-related penalty.
- Currently, where a private institution pays an insider (disqualified person) excessively, an excise tax equal to 25 percent of the excessive amount is imposed on the disqualified person and a corresponding 10 percent excise tax (up to US$20,000) is imposed on managers who participated in the decision. The excessive amount could be above-market compensation but could also, for example, involve property transactions between the disqualified person and the institution at a non-arm's-length price. There is a presumption that there is no excess benefit if the institution performs certain due diligence, including reliance on outside professionals, as to the appropriate amount to be paid. This presumption currently is rebuttable by the IRS. The new proposal would expand the scope of "disqualified persons" to include athletic coaches and investment advisors, often among the highest-paid employees of colleges and universities. It also would impose a new 10 percent excise tax on the institution itself when there is an excess benefit as described above, and the disqualified person would not enjoy any presumption created by the institution's due diligence. Finally, reliance by a manager on professional advice would not, by itself, excuse the excise tax.
- Exemption for qualified sponsorship payments would be limited. Currently, such payments (from business sponsors of events, who receive no benefit other than acknowledgement of the name, logo, or product lines of the business) are exempt. Under the proposal, they would be taxable if either (a) product lines are mentioned or (b) the aggregate payments for one event exceed US$25,000, and the sponsor's name or logo appears more prominently than the names of a significant portion of the other donors to the event. Thus, for example, an exclusive (i.e., no other donors) sponsorship payment of over US$25,000 would be taxable. UBIT is also triggered if the college “uses” the products in exchange for the sponsorship payment. Sports uniforms and shoes come to mind.
- The special rule that provides a charitable deduction of 80% of the amount paid for the right to purchase tickets for athletic events would be repealed.
- There is a US$1 million limit on the annual compensation of an employee of a tax-exempt organization, including a state or local college, if he or she is among the top 5 most highly-paid employees at the institution. Compensation above that limit is subject to a 25 percent excise tax. This could hit college coaches at schools with major sports programs, as well as senior college administrators at schools across the country.
- Under current law, the interest on private activity bonds that are used to finance projects such as schools, roads, parks, etc. are exempt from tax. Under the new proposal, the interest on all newly issued private activity bonds will be included in income and subject to tax.
Many Washington pundits have dismissed the Camp proposal as “dead on arrival.” We believe the truth to be very much the opposite if one takes a longer term perspective. It’s important for those affected to pay attention now to these proposals because:
- The tax revenue-raisers are being proposed by a Republican.
- The Camp tax reform proposals are being presented as the “right answer” on the policy merits, and so become the “correct policy” baseline for ongoing tax reform and future efforts.
- Once a revenue-raising proposal is out there, it remains available as a “pay for” to fund unrelated tax proposals.
- If the affected sector does not vigorously respond to an adverse proposal, that quiescence can be taken as acquiescence by those on the Hill.
Thus, Camp’s bill remains “on the shelf” and close at hand for as long as it takes for Congress to move tax reform.