Colleges and universities should pay close attention to the proposed regulations that the U.S. Department of the Treasury and the Internal Revenue Service recently issued interpreting the new “endowment tax” under Internal Revenue Code Section 4968, and may wish to consider writing comments even if they are not currently affected by the tax because the proposed regulations would tax more — potentially much more — than what is traditionally considered part of the endowment.
The proposed regulations take an expansive interpretation of what income may be subject to the tax; however, it is not uncommon for final regulations to take a narrower interpretation based on further considerations of issues raised during the comments process. Comments are due by Oct. 1, 2019.
Section 4968 imposes a 1.4% excise tax on the “net investment income” of certain colleges and universities. This “endowment tax,” as it is generally known, was enacted as part of the Tax Cuts and Jobs Act in 2017. Prior to enactment of the TCJA, private colleges and universities, like most nonprofits, were exempt from income tax on their investment income.If adopted in temporary or final regulations, the interpretive guidance in the proposed regulations would likely result in more private colleges and universities having to pay the section 4968 excise tax, with a greater amount of their income being subject to the excise tax, than many had expected.
As currently drafted, the proposed regulations would tax interest, dividends, rent and royalties a college or university earns from any asset it holds, including assets used in furtherance of a college or university’s educational mission.
As discussed below, this could in theory mean that rent paid by students to live in college dormitories, rent paid by other nonprofits for use of academic buildings for educational purposes and royalties from intellectual property produced by the ideas of university faculty may all be subject to the endowment tax.