Guidance on the Determination of the Section 4968 Excise Tax Applicable to Certain Colleges and Universities, 65526-65564 [2020-20933]
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Federal Register / Vol. 85, No. 200 / Thursday, October 15, 2020 / Rules and Regulations
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 53
[TD 9917]
RIN 1545–BO75
Guidance on the Determination of the
Section 4968 Excise Tax Applicable to
Certain Colleges and Universities
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
This document contains final
regulations for determining the excise
tax applicable to the net investment
income of certain private colleges and
universities. The regulations affect
certain private colleges and universities.
DATES:
Effective Date: These regulations are
effective on October 14, 2020.
Applicability Date: For date of
applicability, see § 53.4968–4.
FOR FURTHER INFORMATION CONTACT:
Melinda Williams at (202) 317–6172 or
Amber Mackenzie at (202) 317–4086
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
SUMMARY:
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Background
This document amends the
Foundation and Similar Excise Tax
Regulations (26 CFR part 53) by adding
final regulations under section 4968 of
the Internal Revenue Code (Code).
Section 4968 was added to the Code by
section 13701 of Public Law 115–97
(131 Stat. 2054, 2167–68 (2017)),
commonly referred to as the Tax Cuts
and Jobs Act (TCJA). Section 4968(a)
imposes on each applicable educational
institution, as defined in section
4968(b)(1), an excise tax equal to 1.4
percent of the institution’s net
investment income, determined under
section 4968(c). Further, section 4968(d)
treats a portion of certain assets and net
investment income of certain related
organizations as assets and net
investment income of the educational
institution.
Section 4968(b)(1) defines the term
‘‘applicable educational institution’’ as
an eligible educational institution (as
defined in section 25A(f)(2)) that, during
the preceding taxable year, had at least
500 tuition-paying students, more than
50 percent of whom were located in the
United States, that is not a state college
or university as described in the first
sentence of section 511(a)(2)(B), and
that had assets (other than those assets
used directly in carrying out the
institution’s exempt purpose) the
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aggregate fair market value of which was
at least $500,000 per student of the
institution.
Section 4968(b)(2) provides that, for
purposes of section 4968(b)(1), the
number of students of an institution
(including for purposes of determining
the number of students at a particular
location) is based on the daily average
number of full-time students attending
such institution, with part-time students
taken into account on a full-time
student equivalent basis.
Section 4968(c) provides that, for
purposes of section 4968, ‘‘net
investment income’’ is determined
under rules similar to the rules of
section 4940(c).
Section 4968(d)(1) provides that, for
purposes of determining the aggregate
fair market value of an educational
institution’s assets not used directly in
carrying out its exempt purpose,1 and
for purposes of determining an
institution’s net investment income, the
assets and net investment income of any
related organization with respect to the
institution are treated as assets and net
investment income, respectively, of the
educational institution, with two
exceptions. First, no such amount is to
be taken into account with respect to
more than one educational institution.
Second, unless such organization is
controlled by such institution or is a
supporting organization described in
section 509(a)(3) with respect to such
institution for the taxable year, assets
and net investment income that are not
intended or available for the use or
benefit of the educational institution are
not taken into account.
Section 4968(d)(2) provides that the
term ‘‘related organization,’’ with
respect to an educational institution,
means any organization that: (1)
Controls, or is controlled by, such
institution; (2) is controlled by one or
more persons that also control such
institution; or (3) is a supported
organization (as defined in section
509(f)(3)), or a supporting organization
(as described in section 509(a)(3)),
during the taxable year with respect to
the educational institution.
The Conference Report for the TCJA,
H. Rept. 115–466, 115th Cong., 1st Sess.,
December 15, 2017 (Conference Report),
at 555, 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
1 Section 4968(d)(1) erroneously cross references
section 4968(b)(1)(C). The correct cross reference
should be to section 4968(b)(1)(D). See Joint
Committee on Taxation, ‘‘General Explanation of
Public Law 115–97’’ (JCS–1–18), December 2018, at
290, n. 1357.
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out an 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 an educational institution.
In June 2018, the Department of the
Treasury (Treasury Department) and the
IRS issued Notice 2018–55, 2018–26
I.R.B. 773, to provide interim guidance
on certain issues related to the
application of the tax imposed by
section 4968. Specifically, Notice 2018–
55 stated that, in the case of property
held on December 31, 2017, and
continuously thereafter to the date of its
disposition, the Treasury Department
and the IRS intended to propose
regulations stating that basis for
purposes of determining gain (but not
loss) is deemed to be not less than the
fair market value of such property on
December 31, 2017, plus or minus all
adjustments after December 31, 2017,
and before the date of disposition,
consistent with the regulations under
section 4940(c). Notice 2018–55
additionally stated that the Treasury
Department and the IRS expected the
proposed regulations to provide that
losses from sales or other dispositions of
property generally would be allowed
only to the extent of gains, with no
capital loss carryovers or carrybacks,
and that losses from sales or other
dispositions of property by related
organizations will be allowed to offset
overall net gains from other related
organizations or the applicable
educational institution.
On July 3, 2019, the Treasury
Department and the IRS published a
notice of proposed rulemaking in the
Federal Register (REG–106877–18, 84
FR 31795) that contained proposed
regulations regarding the requirements
of section 4968, including the manner
for determining the excise tax
applicable to the net investment income
of certain private colleges and
universities. The proposed regulations
incorporated the provisions set forth in
Notice 2018–55. The proposed
regulations also provided definitions for
several of the terms necessary for an
educational institution to determine
whether the section 4968 excise tax is
applicable to it, including the terms
‘‘student,’’ ‘‘tuition-paying,’’ ‘‘located in
the United States,’’ and ‘‘assets used
directly in carrying out an institution’s
exempt purpose.’’ Eighteen comments
were received in response to the
proposed regulations, one of which was
the collective comment of forty
educational institutions likely to be
subject to this excise tax. No public
hearing was requested or held.
After consideration of the comments
received, the proposed regulations
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under section 4968 are adopted as final
regulations as modified by this Treasury
Decision. The major areas of comment
and the revisions to the proposed
regulations are discussed in the
Summary of Comments and Explanation
of Revisions. Eight commenters voiced
objections to the Code section itself. No
regulatory response to these comments
is appropriate. Accordingly, these
comments are not discussed in the
Summary of Comments and Explanation
of Revisions. All comments are available
for public inspection at
www.regulations.gov or on request.
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Summary of Comments and
Explanation of Revisions
These final regulations provide
guidance on the tax imposed by section
4968 and the entities that are subject to
the tax.
1. Applicable Educational Institution
Section 4968(b)(1) defines the term
‘‘applicable educational institution,’’ in
part, as an eligible educational
institution defined in section 25A(f)(2).
Consistent with the statute, the
proposed regulations provided that the
term ‘‘applicable educational
institution’’ means any eligible
educational institution (as defined in
section 25A(f)(2) and § 1.25A–2(b)): (1)
That had at least 500 tuition-paying
students attending the institution during
the preceding taxable year; (2) more
than 50 percent of whose tuition-paying
students are located in the United
States; (3) that is not described in the
first sentence of section 511(a)(2)(B)
(relating to state colleges and
universities); and (4) the aggregate fair
market value of the assets of which at
the end of such preceding taxable year
(other than those assets that are used
directly in carrying out the institution’s
exempt purpose) is at least $500,000 per
student attending the institution.
Two commenters addressed the
definition of applicable educational
institution. The first commenter
recommended that the final regulations
provide additional guidance to clarify
that separate, but affiliated, educational
institutions that are under common
control (for example, within the same
university system) should be aggregated
for purposes of determining the number
of students used in both the 500-student
and the $500,000-per-student tests.
These final regulations do not adopt this
recommendation, because both section
4968(b)(1) and section 25A(f)(2) refer to
individual institutions and neither
contains any provisions for aggregating
affiliated institutions for purposes of
determining the number of students at
an institution. The only aggregation in
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section 4968 is the requirement to treat
certain assets and net investment
income of related organizations as the
assets and net investment income,
respectively, of the institution.
The second commenter stated that, for
purposes of defining ‘‘eligible
educational institution,’’ the final
regulations should not include a
reference to the regulations at § 1.25A–
2(b) and should use only the statutory
definition contained in section
25A(f)(2). Section 1.25A–2(b) provides
that an eligible educational institution
means, in general, a college, university,
vocational school, or other
postsecondary educational institution
that is described in section 481 of the
Higher Education Act of 1965 (20 U.S.C.
1088) as in effect on August 5, 1997
(generally all accredited public,
nonprofit, and proprietary
postsecondary institutions) that (1) is
participating in a Federal financial aid
program under title IV of the Higher
Education Act of 1965 or (2) is certified
by the Department of Education as
eligible to participate in such a program
but chooses not to participate.
The commenter explained that there
are several educational institutions
whose organizational documents and
mission prohibit them from applying for
or receiving Federal funds (including
accepting funds as part of a student
Federal financial aid program under
Title IV of the Higher Education Act of
1965). The commenter asked that
applicability of section 4968 be
determined based on the actions of an
institution rather than by a Department
of Education certification that is focused
on whether the students of an
institution can claim an individual tax
credit under section 25A for expenses to
attend the institution, which the
commenter sees as being incompatible
with both the terms of section 25A and
the mission of such institutions.
Although the Treasury Department
and the IRS appreciate the position of
the commenter, section 4968 expressly
defines applicable educational
institution by reference to section
25A(f)(2). Section 25A(f)(2) provides
that the term ‘‘eligible educational
institution’’ means an institution that is
described in section 481 of the Higher
Education Act of 1965 (20 U.S.C. 1088),
as in effect on the date of the enactment
of section 25A, and that ‘‘is eligible to
participate in a program under title IV
of such Act.’’
If the final section 4968 regulations
did not include a reference to § 1.25A–
2(b), an educational institution would
still be ‘‘eligible to participate in a
program under title IV of such Act’’ as
long as it satisfied all of the
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requirements of that Act even if it chose
not to participate in such a program and
even if it was not certified by the
Department of Education as eligible to
participate in such a program. Thus,
deleting the reference to § 1.25A–2(b)
would not address the commenter’s
concerns. Further, § 1.25A–2 was
adopted in 2002, and Congress is
presumed to have been aware of the
regulations when section 4968 was
enacted. Congress did not express any
intent in the legislative history of
section 4968 for the regulations under
section 25A to be disregarded for
purposes of defining eligible
educational institution. In addition, it
would be very difficult for the Treasury
Department and the IRS to provide in
the regulations under section 4968 that
the IRS is following a definition of
eligible educational institution that is
consistent with the statutory language of
section 25A(f)(2) without also
incorporating the regulations under
section 25A unless there was specific
language in section 4968 with which the
regulations were in conflict, and that is
not the case here. Lastly, the Treasury
Department and the IRS understand that
the number of educational institutions
that do not participate in the Federal
programs provided in the Higher
Education Act or that are not certified
as eligible to participate in the programs
is very small, and it would be
burdensome for the IRS to follow one
definition of eligible educational
institution for purposes of section 25A
and another under section 4968 when
both provisions are dependent on
section 25A(f)(2).
Thus, these final regulations adopt the
definition of applicable educational
institution as proposed.
2. Student
The proposed regulations defined
‘‘student,’’ based in part on section
25A(b)(3) and the Higher Education Act,
as a person enrolled in a degree,
certification, or other program
(including a program of study abroad
approved for credit by the eligible
educational institution at which such
student is enrolled) leading to a
recognized educational credential at an
eligible educational institution, and
who is not enrolled in an elementary or
secondary school.
The proposed regulations also
provided that the number of students of
an educational institution (including for
purposes of determining the number of
students at a particular location) is
based on the daily average number of
full-time students attending such
institution (with part-time students
taken into account on a full-time
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student equivalent basis). Under the
proposed regulations, the standards for
determining part-time students, fulltime students, full-time equivalents, and
daily average are determined by each
educational institution. However, the
standards may not be lower than the
applicable standards established by the
Department of Education under the
Higher Education Act of 1965 (20 U.S.C.
1088), as amended.
Three commenters addressed the
proposed definition of ‘‘student,’’
stating that section 4968 does not define
the term student but it does provide
that, for purposes of determining the
number of students of an institution, an
educational institution must determine
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.
Two of these commenters recommended
that the definition should include all
students attending the institution even
if not enrolled in a degree, certification,
or other program leading to a recognized
educational credential, stating that
section 4968 includes students that are
taking a less-than half time load and
that many of those students are not
seeking a degree. The commenters
stated that the definition of student for
purposes of the Lifetime Learning Tax
Credit (LLTC) 2 or the Family
Educational Rights and Privacy Act
(FERPA) 3 is broader than the definition
that applies for purposes of the Higher
Education Act and the American
Opportunity Tax Credit,4 which defines
2 The Lifetime Learning Credit, found in section
25A(c), provides a tax credit equal to 20 percent of
up to $10,000 of ‘‘qualified tuition and related
expenses’’ paid by the taxpayer during the taxable
year to acquire or improve job skills. Section
25A(f)(1) defines qualified tuition and related
expenses as tuition and fees required for enrollment
or attendance at an eligible educational institution
for courses of instruction at such institution.
3 The Family Educational Rights and Privacy Act
(FERPA) (20 U.S.C. 1232g; 34 CFR part 99) is a
Federal law that protects the privacy of student
education records. It defines the term ‘‘student’’ as
any individual who is or has been in attendance at
an educational agency or institution, including at
elementary and secondary school levels, and
regarding whom the agency or institution maintains
education records.
4 The American Opportunity Tax Credit, found in
section 25A(b), provides a tax credit equal to the
sum of 100 percent of so much of the qualified
tuition and related expenses paid by the taxpayer
during the taxable year (for education furnished to
the eligible student during any academic period
beginning in such taxable year) as does not exceed
$2,000, plus 25 percent of such expenses so paid
as exceeds $2,000 but does not exceed $4,000.
Section 25A(b)(3) defines an eligible student for
purposes of the American Opportunity Tax Credit
as a student who meets the requirements of section
484(a)(1) of the Higher Education Act of 1965 (20
U.S.C. 1091(a)(1)), as in effect on the date of the
enactment of section 25A, and is carrying at least
1⁄2 the normal full-time work load for the course of
study the student is pursuing.
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those eligible for student loans, and thus
is more consistent with and thus
appropriate for purposes of section
4968. In addition, two commenters
recommended against a definition based
on a recognized educational credential,
questioning who would decide what
constitutes such a credential and
whether this would allow potential
manipulation by the educational
institutions. One other commenter
suggested retaining the standard in the
proposed regulations.
The Treasury Department and the IRS
agree that section 4968 does not
expressly state that a person must be
enrolled in a degree, certification, or
other program to be considered a
student. However, section 4968 does
require that a student be attending the
institution: ‘‘. . . the number of
students of an institution . . . shall be
based on the daily average number of
full-time students attending such
institution (with part-time students
taken into account on a full-time
student equivalent basis).’’
The Treasury Department and the IRS
have concluded that the definition of
student provided in FERPA is overly
broad, as it includes, for example,
individuals who previously attended
the educational institution.
However, the LLTC, which provides a
tax credit based on certain tuition and
fees required ‘‘for the enrollment or
attendance of’’ an individual at an
eligible educational institution ‘‘for
courses of instruction of such individual
at such institution’’ does provide a
useful analogy, as it refers to a person
who is enrolled, attending, and paying
qualified tuition to an institution for
courses of instruction at such
institution.
Whereas the LLTC includes a
requirement that the purpose of the
course must be to acquire or improve
job skills of the individual, the Treasury
Department and the IRS have
determined that it would be more
appropriate and administrable instead
to require that the course be taken for
academic credit. Whereas neither an
applicable educational institution nor
the IRS is likely to know whether a
course is taken to acquire or improve job
skills of the individual, it should be
easy to determine whether a course was
taken for academic credit. Furthermore,
anyone taking a course for academic
credit is using the school’s resources to
receive the specific time and attention
of the school’s faculty for his or her
individual instruction. Thus, it is
appropriate to include taking a course
for academic credit as a component of
the definition of student for purposes of
section 4968.
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However, under the definition, a
student, whether full time or part time,
must be charged tuition at a rate that is
commensurate with the rate charged to
students enrolled for a degree. The
Treasury Department and the IRS have
concluded that this is necessary for a
part-time student to be considered as
attending the institution on an
‘‘equivalent basis’’ to a full-time
student.
Thus, these final regulations define
the term ‘‘student’’ for purposes of
section 4968 as a person who is enrolled
and attending a course for academic
credit from the institution and who is
being charged tuition at a rate that is
commensurate with the tuition rate
charged to students enrolled for a
degree. No inference is to be drawn from
this definition with regard to the
definition of student for other purposes,
including for purposes of applying
section 25A.
These final regulations also adopt the
portion of the definition of ‘‘student’’
found in the proposed regulations
providing that the number of students of
an educational institution (including for
purposes of determining the number of
students at a particular location) is
based on the daily average number of
full-time students (with part-time
students taken into account on a fulltime student equivalent basis). The
standards for determining whether a
student attends part-time or full-time
and for calculating full-time equivalents
and the daily average number of fulltime students are determined by each
educational institution. However, the
standards may not be lower than the
minimum applicable standards
established by the Department of
Education under the Higher Education
Act of 1965 (20 U.S.C. 1088), as
amended.
3. Tuition-Paying
The proposed regulations provided
that the term ‘‘tuition-paying’’ means
the payment of any tuition or fees
required for the enrollment or
attendance of a student for a course of
instruction at an eligible educational
institution. The proposed regulations
stated that this 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 or the payment of
room and board or other personal living
expenses. In addition, the proposed
regulations provided that whether a
student is ‘‘tuition-paying’’ is
determined after taking into account any
scholarships provided directly by the
educational institution and any work
study programs operated directly by the
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educational institution; however,
scholarship payments provided by third
parties, even if administered by the
institution, are considered payments of
tuition on behalf of the student.
Three commenters discussed the
meaning of ‘‘tuition-paying.’’ One
commenter expressed a concern that
smaller educational institutions might
modify their financial aid programs to
offer fewer partial scholarships and
more full scholarships to fall under the
threshold of having 500 tuition-paying
students. The Treasury Department and
the IRS have determined that a
modification to the regulations for this
purpose is not necessary because any
definition of tuition-paying may lead to
this result and because the same
definition of tuition-paying should
apply regardless of the size of the
institution.
Another commenter recommended
that a student should be considered
‘‘tuition-paying’’ regardless of the
source of tuition funds, except that an
eligible educational institution that does
not charge tuition to any student would
not be considered to have any tuitionpaying students. These final regulations
do not adopt this suggestion because the
statute does not refer to tuition
‘‘charged,’’ rather it refers to tuition
‘‘paid.’’
The third commenter asked whether
the term ‘‘scholarships’’ in the proposed
regulations was intended to include Pell
Grants and other forms of Federal and
state student financial aid as well as
non-governmental grants made on
behalf of students, recommending that
these grants from government and nongovernment sources not be treated as the
payment of tuition on behalf of
students. The Treasury Department and
the IRS agree that grants or scholarships
made by Federal, state, and local
governments should be disregarded
when determining whether a student is
tuition-paying. Grants or scholarships
made by Federal, state, and local
governments generally are governed by
legislation, are intended to make a
college education more affordable for all
potential students, and generally are
based on criteria that the government
sets (such as a determination of
financial need), applied without regard
to which educational institution the
student attends or the cost of the
education. Pell Grants and other Federal
grants are awarded and administered by
the Department of Education, which
determines each student’s financial
need and eligibility for the grant.
Finally, almost all educational
institutions, whether private or public,
use Federal and state grants to offset the
cost of tuition, and therefore it would be
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fundamentally unfair to include these
government grants as payment of tuition
by or on behalf of a student in
determining whether an educational
institution is liable for the excise tax
imposed by section 4968.
Thus, these final regulations adopt the
definition of ‘‘tuition-paying’’ found in
the proposed regulations, which
concluded that scholarships awarded by
the institution are not tuition ‘‘paid’’ on
behalf of the student, whereas
scholarships from third parties
essentially are payments of the student’s
tuition, but add that whether a student
is tuition-paying is also determined after
taking into account grants made by the
Federal government or any state or local
government.
4. Located in the United States
The proposed regulations provided
that the term ‘‘located in the United
States’’ refers to the location of a
student, and that a student is considered
to have been located in the United
States if the student resided in the
United States for at least a portion of the
time the student attended the institution
during the educational institution’s
preceding taxable year.
The preamble to the proposed
regulations provided three examples
relating to whether a student is
considered to have been located in the
United States. In the first example, a
student who attended an educational
institution in the preceding taxable year
and who is a citizen of a foreign country
is considered to have been a student
located in the United States if the
student resided in the United States for
at least a portion of the time the student
attended the educational institution in
the preceding taxable year. In the
second example, a student attending the
educational institution in the preceding
taxable year who was studying abroad
in a foreign country is considered to
have been a student located in the
United States if the student resided in
the United States for at least a portion
of the time the student attended the
educational institution. The third
example illustrates that, if a student did
not reside in the United States for any
portion of the time the student attended
the educational institution during the
preceding taxable year, then that
student would not be considered to
have been located in the United States
for purposes of section 4968(b)(1)(B).
The proposed regulations asked for
comments on whether further guidance
is needed relating to whether a student
is considered to have been located in
the United States in a preceding taxable
year.
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One commenter addressed the
definition of ‘‘located in the United
States.’’ This commenter recommended
that each institution be permitted to
determine whether a student is located
in the United States using any
reasonable approach, as long as it was
consistently used. However, the
commenter said that the approach
would have to consider students who
spend substantial time in the United
States attending classes as located in the
United States.
The proposed rule contemplated that
educational institutions could
determine whether a student resided in
the United States for at least a portion
of the time that the student attended the
institution during the institution’s
preceding taxable year using any
reasonable method, but these final
regulations make that explicit. The final
regulations otherwise maintain the rule
as proposed.
5. Assets Used Directly in Carrying Out
an Institution’s Exempt Purpose
a. In General
To be included in the definition of
applicable educational institution under
section 4968(b)(1), an institution must
have assets (other than those assets that
are used directly in carrying out the
institution’s exempt purpose) the
aggregate fair market value of which is
at least $500,000 per student. The
phrase ‘‘assets that are used directly in
carrying out the institution’s exempt
purpose’’ is not defined in section 4968,
but a similar phrase is used in section
4942.
For purposes of section 4942, a
private foundation must determine its
minimum investment return as part of
its calculation of its distributable
amount for any taxable year. Minimum
investment return is defined in section
4942(e) as five percent of the excess of
the aggregate fair market value of all
assets of the foundation ‘‘other than
those which are used (or held for use)
directly in carrying out the foundation’s
exempt purpose,’’ over the acquisition
indebtedness with respect to such
assets.
Because section 4968 contains a
phrase similar to the language used in
section 4942 (other than the omission of
the parenthetical ‘‘(or held for use)’’),
the proposed regulations generally
followed § 53.4942(a)–2(c) for purposes
of determining whether an educational
institution’s assets are used directly in
carrying out the institution’s exempt
purpose, but not including any assets
that would be considered ‘‘held for use’’
for section 4942 purposes.
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More specifically, the proposed
regulations provided that an asset is
used directly in carrying out an
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 must 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 percent 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 percent
of the total use, the institution must
make a reasonable allocation between
exempt and nonexempt uses.
The proposed regulations included
examples of assets that are used directly
in carrying out an institution’s exempt
purpose, stating that they include, but
are not limited to: (1) Administrative
assets, such as office equipment and
supplies used by the institution directly
in the administration of its exempt
activities; (2) real estate or the portion
of any building used by the institution
directly in its exempt activities; (3)
physical property such as paintings or
other works of art owned by the
institution that are on public display,
fixtures and equipment in classrooms,
research facilities and related
equipment that, under the facts and
circumstances, serve a useful purpose in
the conduct of the institution’s exempt
activities; (4) the reasonable cash
balances necessary to cover current
administrative expenses and other
normal and current disbursements
directly connected with the educational
institution’s exempt activities (and, for
this purpose, the proposed regulations
provided a safe harbor for determining
a reasonable cash balance: The portion
of an educational institution’s actual
cash balances at the end of a year that
does not exceed 1.5 percent of the fair
market value of the institution’s noncharitable use assets, determined
without regard to any reduction for
reasonable cash balances); and (5) any
property the educational institution
leases to other persons at no cost (or at
a nominal rent) to the lessee in
furtherance of the institution’s exempt
purposes.
The proposed regulations also
provided the following examples of
assets not considered to be used directly
in carrying out an institution’s exempt
purpose: (1) Assets that are held for the
production of income or for investment
(for example, stocks, bonds, interestbearing notes, endowment funds, or
leased real estate), even if the income
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from such assets is used to carry out
such exempt purpose; and (2) property
(such as offices) used for the purpose of
managing the institution’s endowment
funds.
The proposed regulations asked for
comments on whether the use of the
principles of the section 4942
regulations creates any concerns.
Commenters asked that the final
regulations expand the list of assets
considered used directly in carrying out
an institution’s exempt purpose to
include those that are ‘‘held for use’’ as
well as including certain intangible
assets and certain assets of functionally
related businesses. Commenters also
addressed how to calculate a reasonable
cash balance that would be considered
used directly in carrying out an
institution’s exempt purpose. In
addition, commenters asked whether an
asset of a related organization that is
treated as an asset of an educational
institution by section 4968(d) can be
considered used directly by the
institution in carrying out its exempt
purpose.
b. Assets That Are Held for Use
One commenter asked that the
proposed regulations be expanded to
include as assets ‘‘used directly in
carrying out the institution’s exempt
purpose’’ assets that are ‘‘held for use’’
to carry out such purposes, stating that
there is no legislative history suggesting
that Congress specifically intended to
not include the ‘‘held for use’’ language
contained in section 4942.
Because assets held for use could
include a much broader category of
assets, such as portions of an
endowment fund set aside in some
formal or informal way for an exempt
purpose, the Treasury Department and
the IRS have concluded that the
category of assets used directly for an
institution’s exempt purposes should
not be so expanded, especially because
the statutory language of section 4968
does not include the ‘‘(or held for use)’’
parenthetical language that appears in
section 4942. Accordingly, these final
regulations do not adopt the
commenter’s suggestion.
c. Intangible Assets
One commenter requested that the
final regulations permit intangible
assets, in appropriate cases, to be treated
as used directly in carrying out an
institution’s exempt purpose. The
Treasury Department and the IRS agree
that, in certain circumstances,
intangible assets may be treated as used
directly in carrying out an institution’s
exempt purpose. Thus, these final
regulations provide that, to the extent
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that royalty income would be excluded
from net investment income as
described in part 6.a.iii. of this
Summary of Comments and Explanation
of Revisions, the patents, copyrights,
and other intellectual property and
other intangible property generating
such royalty income are treated as assets
used directly by the institution in
furtherance of its exempt purposes.
These final regulations also provide that
trademarks on an institution’s logo or
name and intellectual property donated
or sold to the institution are not assets
used directly for the institution’s
exempt purposes.
d. Certain Assets of Functionally
Related Businesses
The preamble to the proposed
regulations asked for comments on
whether and how educational
institutions use functionally related
businesses in conducting their
operations and whether functionally
related businesses should be explicitly
included or excluded as examples of
exempt use assets in the final
regulations. One commenter requested
that the final regulations provide that
non-financial assets used in a
functionally related business be
considered assets used directly in
carrying out an educational institution’s
exempt purpose. The commenter stated
that university theatres that produce
plays, student newspapers with
circulation revenue or ad sales income,
or similar activities that operate as
legally separate businesses while
buttressing the educational mission of
an educational institution are examples
of functionally related businesses. The
commenter recommended that assets,
including intangible assets, of such a
functionally related business be
considered to be used directly in
furthering the educational institution’s
exempt purpose. The commenter further
recommended, however, that working
capital or other financial resources
relating to such a functionally related
business should be considered assets
not used directly in furthering the
educational institution’s exempt
purpose.
The Treasury Department and the IRS
agree that, in certain circumstances,
certain assets of functionally related
businesses may be treated as used
directly in carrying out an institution’s
exempt purpose. However, the Treasury
Department and the IRS note that the
concept of a functionally related
business is relevant only for private
foundations with respect to the excise
taxes imposed under sections 4942 and
4943. Thus, instead of providing a
special rule for a non-financial asset of
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an activity of an educational institution,
or of a related organization with respect
to the educational institution, that meets
the definition of a functionally related
business found in § 53.4942(a)–
2(c)(3)(iii), the general rule is that an
educational institution evaluates each
asset based on all the facts and
circumstances to determine whether the
asset is used directly in furthering the
institution’s exempt purpose applies.
e. Reasonable Cash Balance
The proposed regulations recognized
that, for section 4942 purposes, an
amount equal to 1.5 percent of the fair
market value of a private foundation’s
non-charitable use assets (i.e., assets not
actually used by an institution in
carrying out its exempt purpose),
determined without regard to the
reduction for the reasonable cash
balance, is deemed to be a ‘‘reasonable
cash balance’’ that is excluded from the
asset base used in calculating a private
foundation’s minimum investment
return under section 4942(e). For
consistency with the section 4942 rules,
the proposed regulations proposed to
adopt the same definition as a safe
harbor and asked for comments on
whether, in light of the differences
between the exempt activities and
valuation date(s) of a private foundation
and an educational institution, a
different percentage or other
measurement should be used as a
reasonable cash balance at the end of
the taxable year.
Two commenters stated that the 1.5
percent safe harbor should not be
included in the final regulations,
because there is a significant difference
between the activities, and thus the
need for cash for operating expenses, of
a private foundation and an educational
institution. The commenters indicated
that the operating expenses of a private
foundation whose exempt activity is
awarding grants, and even of an
operating private foundation, generally
are substantially less than the salaries,
maintenance, and other operating
expenses of an educational institution
with expansive physical facilities and
human resources for conducting
education and research.
One commenter stated that
educational institutions affected by the
excise tax under section 4968 vary
widely in size and focus, and that their
methods for the delivery of educational
services—which are the drivers of
operating expenses and corresponding
cash outflow and timing—vary widely.
This commenter also mentioned that
some institutions have a summer
session with a lower attendance
(therefore requiring fewer resources) as
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compared to their traditional fall or
spring sessions, and thus may have a
lower cash balance at the end of their
taxable year, which generally falls in the
middle of summer on June 30th or July
31st. This commenter also stated that
ratings agencies might downgrade the
credit rating of some institutions based
on their having cash on hand of only 1.5
percent of the value of non-exempt use
assets, and that bond proceeds for
exempt projects must be held in liquid
assets. One commenter also stated that
the amount required for the reasonable
cash needs of the institution should
include funds for the expenses of its
educational and research functions as
well as cash reserves for special projects
and bond covenants. Both commenters
recommended that the final regulations
instead permit educational institutions
to determine their own reasonable cash
needs as of the end of the taxable year,
based on the particular facts and
circumstances of that institution.
The Treasury Department and the IRS
note that the 1.5 percent safe harbor in
proposed § 53.4968–1(a)(4)(ii)(D) was
merely a safe harbor and did not prevent
an educational institution from
establishing under the general facts and
circumstance rule of proposed
§ 53.4968–1(a)(4)(i) that another cash
balance was reasonably necessary to
cover its current administrative
expenses and other normal and current
disbursements directly connected with
its exempt purposes. However, in
recognition that commenters did not
find the safe harbor useful, these final
regulations instead provide a different
safe harbor that is based on the specific
expenses incurred by each educational
institution. Specifically, these final
regulations provide that a reasonable
cash balance may be determined by any
reasonable method, and that one such
method would be to calculate an
amount equal to three months of
operating expenses allocable to program
services, calculated by dividing annual
functional expenses allocable to
program services (2019 Form 990, Part
IX, line 25, column (B), or the
corresponding line provision of any
successor Form 990) by four.
Alternatively, a larger amount may be a
reasonable cash balance for this purpose
if, under the facts and circumstances, a
larger amount is established to be
necessary to cover administrative
expenses and other normal
disbursements directly connected with
the institution’s exempt activity.
f. Assets of Related Organizations
One commenter noted that section
4968(d) treats certain assets of related
organizations with respect to an
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educational institution as assets of the
educational institution, and that section
4968(b)(1)(D) requires the educational
institution to determine whether, at the
end of the preceding taxable year, the
aggregate fair market value of its assets
(other than those assets that are used
directly in carrying out the institution’s
exempt purpose) is at least $500,000 per
student of the institution. This
commenter suggested that, in counting
the assets of a related organization for
this purpose, any asset of the related
organization that is used directly in
carrying out the educational
institution’s exempt purpose should be
excluded from section 4968(b)(1)(D). In
addition, the commenter asked how to
apply the ‘‘used directly in carrying out
the institution’s exempt purpose’’ test in
the case of a related organization with
exempt purposes differing from those of
the educational institution.
The Treasury Department and the IRS
agree with these comments. Therefore,
these final regulations provide that an
asset of a related organization that is
treated as an asset of the educational
institution (in accordance with section
4968(d) and § 53.4968–3(c)) and is used
directly in carrying out the educational
institution’s exempt purpose is
considered used directly by the
institution in carrying out its exempt
purpose. These final regulations further
provide that an asset of a related
organization that is treated as an asset
of the educational institution is
considered to be used directly in
carrying out the educational
institution’s exempt purpose if (1) the
related organization is described in
section 501(c)(3) and (2) the asset is
being used directly in carrying out the
related organization’s exempt purpose.
For example, under this rule, if an
educational institution controls (as
described in part 7.b.ii of this Summary
of Comments and Explanation of
Revisions) a nonprofit nonstock
organization that is a museum, then
section 4968(d)(1)(B) would treat all of
the museum’s assets as assets of the
educational institution, regardless of
whether the assets are earmarked or
restricted for the benefit of, or otherwise
fairly attributable to, the educational
institution, and even if they are
specifically earmarked or restricted for
another entity or for unrelated purposes
or are otherwise not fairly attributable to
the educational institution. However,
when for purposes of section
4968(d)(1)(D) the educational institution
values its assets (other than those used
directly in carrying out the institution’s
exempt purpose) at the end of the
preceding taxable year, the educational
institution could exclude any museum
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asset, such as artwork, that is being used
directly in carrying out the museum’s
exempt purpose, even if such use does
not directly carry out the educational
institution’s exempt purpose. (The
Treasury Department and the IRS note
that the general rule found in § 53.4968–
1(b)(5)(iii) that neither assets that are
held for the production of income or for
investment nor property (such as offices
and equipment) used for the purpose of
managing funds are considered used
directly in carrying out an exempt
purpose. Thus, a related organization
whose exempt purpose is grantmaking
generally will have few assets
considered to be used directly in
carrying out the educational
institution’s exempt purpose.)
g. Valuation of Assets Not Used Directly
in Carrying Out an Institution’s Exempt
Purpose
The proposed regulations provided
that, for purposes of valuing an
educational institution’s non-exempt
use assets, the institution should use
rules similar to the rules of section
4942(e) and § 53.4942(a)–2(c)(4), with
two modifications. First, the phrase
‘‘educational institution’’ is substituted
for ‘‘private foundation’’ or
‘‘foundation’’ every place they appear.
Second, an institution will have to make
such adjustments as are reasonable and
necessary to obtain the fair market value
of non-exempt use assets as of the last
day of the valuation taxable year, rather
than any other time(s) required by the
section 4942 regulations. The proposed
regulations also requested comments on
valuing assets using the principles of
section 4942, as modified by this special
timing rule. No comments were
received. Accordingly, the proposed
rule is adopted without substantive
changes.
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6. Net Investment Income
For taxable years beginning after
December 31, 2017, section 4968(a)
imposes a 1.4 percent excise tax on the
net investment income of an applicable
educational institution (as defined in
section 4968(c)), and on certain amounts
of net investment income of certain
related organizations, as described in
section 4968(d) and § 53.4968–3.
Section 4968(c) provides that net
investment income is determined under
rules similar to the rules of section
4940(c). Accordingly, the proposed
regulations provided that an applicable
educational institution generally must
calculate net investment income under
the rules of section 4940(c) and
§ 53.4940–1(c) through (f), with certain
modifications.
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Specifically, § 53.4968–1(b)(3) of the
proposed regulations (1) substituted
‘‘applicable educational institution’’ for
‘‘private foundation’’ or ‘‘foundation’’
each place they appear; (2) did not
apply the rule in § 53.4940–1(d)(3),
because it is narrowly focused on
section 302 stock redemptions by
corporations that are disqualified
persons and is not applicable to colleges
and universities; (3) substituted
‘‘December 31, 2017’’ for ‘‘December 31,
1969’’ every place that it occurs to
determine the basis of assets held on
December 31, 2017, for purposes of
determining gain upon the sale or
exchange of an asset held on December
31, 2017 in calculating the excise tax;
(4) applied the special basis rule to
assets held in partnerships as of
December 31, 2017, as well; and (5)
allowed overall net losses from sales or
other dispositions of property by one
related organization or by the applicable
educational institution to reduce (but
not below zero) overall net gains from
such sales or other dispositions by other
related organizations or by the
applicable educational institution.
Several commenters requested that
the final regulations further tailor those
rules to take into account differences
between a private foundation subject to
section 4940 and an educational
institution, including differences in
funding sources, use of funds, structure,
governance, and oversight. In response,
as discussed further in the following
paragraphs of this part 6, these final
regulations omit the use of a cross
reference to the regulations under
section 4940(c) to define net investment
income for purposes of section 4968.
Instead, these final regulations prescribe
specific rules under section 4968 that
are similar to the rules of section
4940(c) but that are more tailored to
educational institutions.
In particular, following the
regulations under section 4940(c), the
final regulations provide, as further
described in this part 6, that net
investment income generally is the
amount by which the sum of the gross
investment income and the capital gain
net income exceeds the allowable
deductions. Also consistent with section
4940(c)(5) and § 53.4940–1(c)(2), net
investment income is determined by
applying section 103 (relating to interest
on certain governmental obligations)
and section 265 (relating to expenses
and interest relating to tax-exempt
income). Finally, consistent with
section 4940(c)(1) and § 53.4940–1(c)(1),
net investment income is determined
under the principles of subtitle A of the
Code except to the extent inconsistent
with the Code or regulations.
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a. Gross Investment Income
The proposed regulations noted that
section 4968 does not expressly provide
that the tax on net investment income
is limited to net investment income
derived from assets that are not used
directly in carrying out an applicable
educational institution’s exempt
purpose. This lack of a limitation is in
contrast to the specific language in
section 4968(b)(1)(D) that excludes
assets used directly in carrying out an
institution’s exempt purpose in
determining whether the educational
institution is an applicable educational
institution. Instead, section 4968(c)
provides that net investment income is
determined under rules similar to the
rules of section 4940(c).
To implement this provision, the
proposed regulations proposed to adopt
by cross reference the rules provided in
section 4940(c) and the regulations
thereunder, including § 53.4940–1(d)(1),
which specifies that ‘‘gross investment
income’’ means the gross amounts of
income from interest, dividends, rents,
royalties (including overriding
royalties), and capital gain net income
received by a private foundation from
all sources, but does not include such
income to the extent included in
computing the tax on unrelated business
taxable income imposed by section 511.
Under this definition, consistent with
specific language in § 53.4940–1(d),
interest, dividends, rents, and royalties
derived from assets devoted to an
educational institution’s exempt
activities would be includible in gross
investment income. Therefore, for
example, under the proposed
regulations, interest received on a
student loan would have been
includible in income for purposes of
section 4968.
The proposed regulations requested
comments on whether specific types of
income should be excluded from gross
investment income under section 4968
because taxing those types of income
would not achieve the congressional
intent in enacting section 4968.
Commenters recommended excluding
interest from student and faculty loans,
rental income from student and faculty
housing, royalty income from exempt
functions, income from programmatic
activities, and income from endowment
funds if the income is used as a tuition
replacement fund.
These final regulations adopt most of
these recommendations. These final
regulations specify that, consistent with
section 4940(c), gross investment
income generally means the gross
amounts of income from interest,
dividends, rents, payments with respect
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to securities loans (as defined in section
512(a)(5)), and royalties, but not
including any such income to the extent
it is included in computing the tax
imposed by section 511. Gross
investment income also includes
income from sources similar to those in
the preceding sentence. In general, gross
investment income includes the items of
investment income described in
§ 1.512(b)–1(a).
However, in response to comments
and consistent with the overall purpose
of section 4968, these final regulations
exclude from the definition of gross
investment income (1) interest income
from a student loan that was made by
the applicable educational institution or
a related organization to a student of the
applicable educational institution in
connection with the student’s
attendance at the institution; (2) rental
income from the provision of housing
by the applicable educational institution
or a related organization to students of
the applicable educational institution
and from housing for faculty and staff if
the housing is provided contingent on
their roles as faculty or staff of the
applicable educational institution; and
(3) royalty income that is derived from
patents, copyrights, and other
intellectual property and intangible
property to the extent those assets
resulted from the work of student(s) or
faculty member(s) in their capacities as
such with the applicable educational
institution. However, neither royalty
income from trademarks on the
institution’s logo or name nor royalty
income from intellectual property
donated or sold to the institution is
excluded from gross investment income
under this rule).
i. Interest From Student Loans
The proposed regulations noted that
the regulations under section 4940(c)
specifically include student loan
interest as gross investment income.
However, recognizing that student loans
provided directly by an applicable
educational institution to its students
can be seen as helping the applicable
educational institution fulfill its mission
of educating its students, and that,
unlike private foundations, colleges and
universities educate students and charge
tuition as part of their primary exempt
activities, the preamble to the proposed
regulations asked whether student loans
provided by an applicable educational
institution to its students arguably can
be viewed as a form of deferred tuition
which will be paid when the student
enters the workforce.
The preamble to the proposed
regulations suggested distinguishing the
interest on a student loan from
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investment interest by reference to the
interest rate. If the interest is at a market
(or higher) rate, it would be difficult to
distinguish the interest on the student
loan and interest on assets acquired for
investment purposes. However, if the
interest rate is set at a substantially
below-market rate, the difference
between the market interest rate and the
interest rate on the student loan might
be viewed as similar to a scholarship
from the educational institution to the
student. Under these circumstances, the
remaining, below-market rate interest
income might be considered
distinguishable from income derived
from assets acquired primarily for
investment purposes. Finally, the
preamble to the proposed regulations
asked for comments on how a rule based
on interest rates could be addressed to
avoid 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.
Four commenters recommended
excluding all interest income from loans
to students from gross investment
income, stating that loans made by
colleges and universities to students are
not offered with the intent of earning
investment income for the institution,
but are instead made to assist students
who have gaps in funding and need
financial assistance to complete their
educations. Many of these student loans
are need-based loans to low-income
students who would not qualify for
other programs or commercial loans. In
addition, most of the student loans
made by educational institutions are
made on terms, taken as a whole, that
are more favorable than similar
commercial student loans. These better
terms include lower interest rates, fixed
interest rates, deferred or delayed
repayment periods, low or no
origination fees, relaxed eligibility
requirements, and more flexible
repayment plans than loans that are
offered on the open market.
In response to these comments, these
final regulations exclude from gross
investment income interest income from
a student loan that was made by the
applicable educational institution (or a
related organization of the institution) to
a student of the institution in
connection with the student’s
attendance at the institution.
While most of the student loans made
by educational institutions (or their
related organizations) may be made on
terms, taken as a whole, that are more
favorable than similar commercial
student loans, many of those favorable
terms are not centered on interest rates.
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For example, unlike commercial loans,
no collateral or demonstrations
regarding future income are required.
Therefore, an exception based on
whether terms are more favorable than
commercial loans would be unduly
burdensome to administer and these
final regulations do not include such a
requirement.
One commenter recommended
extending this reasoning to faculty
loans, which in many circumstances are
provided in order to give an educational
institution a competitive edge in
attracting talented educational
professionals. In most cases, this type of
financing is an alternative to providing
housing directly, the income or loss
from which the commenter also
recommended excluding. However, the
commenter noted that there are nuances
with respect to the types of faculty loans
that may be provided by an educational
institution that may warrant disparate
treatment, and that an examination of
all of the facts and circumstances (such
as the resources of the borrowers,
interest rate charged, availability of
credit in the local area, and scope and
extent of the program) would be
necessary to determine whether a
particular loan was effectively a
substitute for bank financing and thus
really an investment vehicle that should
be considered to produce gross
investment income.
These final regulations do not exclude
interest on loans to faculty from gross
investment income. Although loans to
faculty might indirectly benefit students
by attracting better faculty, so does
paying faculty higher salaries. Some
loans provide a substitute for bank
financing for a faculty member to
purchase a residence that then becomes
an asset of the faculty member. All loans
to faculty, even if on favorable terms as
part of a compensation package in order
to attract such faculty, are substantially
different from loans to students which
may be viewed as effectively
representing deferred tuition.
Furthermore, interest income received
on loans to faculty is more difficult to
distinguish from other interest income
that is includible under section 4940(c),
such as interest income at the applicable
Federal rate on a loan to acquire a
luxury home. While certain loans, such
as one to allow faculty to secure
appropriate housing that otherwise
would not be attainable by faculty,
might qualify as supporting the
institution’s exempt purposes, a similar
loan in other circumstances might not.
The difference would be heavily
dependent upon interest rates, the local
real estate market, and other facts and
circumstances. Thus, in accord with the
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language in section 4968(c) that net
investment income for section 4968
purposes should be similar to the rules
of section 4940(c), the final regulations
under section 4968 do not exclude
interest income on loans other than
loans to students in connection with
their attendance at the educational
institution.
ii. Rental Income From Student,
Faculty, and Staff Housing
The proposed regulations also noted
that colleges and universities offer
various types of housing (such as
dormitories or apartments) for use by
students, non-students (for example,
during the summer), and faculty. The
preamble to the proposed regulations
requested comments on the differences,
if any, among the housing arrangements,
whether any of the arrangements
include the signing of leases, the various
amounts charged by a college or
university related to provision of
housing and meals, and particular
factors that distinguish room and board
payments from students living in a
dormitory from rental income that
institutions receive.
Five commenters recommended
excluding income from student housing
from gross investment income. These
commenters stated that student housing
is provided by educational institutions
to their students for the purpose of
furthering the students’ education,
rather than to create an investment
return to the institution. On-campus
housing provides a sense of community
and creates non-classroom opportunities
for students to engage with individuals
with a similar academic focus as well as
those with diverse perspectives and
backgrounds, which promotes informal
learning and development of social
skills. It also facilitates studying and
attending classes on campus, provides
students with the full breadth of campus
security services, and provides
convenient access to campus dining
halls. Many educational institutions
require students to live in on-campus
housing for one or more years. Further,
several factors distinguish student
housing from other rental properties
that institutions may own. For example,
typical residential rental agreements
provide secure and exclusive access to
a specific property for the tenant’s use,
and the tenant has the right to
continuous occupancy and use of the
specified space over the term of the
lease. In contrast, students sign a
contract for housing, but typically do
not sign leases. They are assigned a
space, within a room often shared by at
least one other individual, frequently a
stranger. Residence halls and student
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apartments or houses are typically not
available year-round, but only during
academic terms. For example, that
housing might close over certain
holidays and during breaks between
semesters. Housing space normally is
contingent on enrollment at the
educational institution, and students
that withdraw from the institution must
vacate their rooms. Students are subject
to specific housing rules and codes of
conduct while in student housing, often
including a prohibition on cooking.
Residence halls also typically include
the presence of a resident advisor, who
is available 24 hours a day and may
monitor the students’ behavior. Guest
access to student residences often is
monitored or restricted.
The Treasury Department and the IRS
agree that income received from the
housing of current students of an
educational institution is
distinguishable from other types of
traditional rental income, and these
final regulations exclude such income
from gross investment income, whether
the housing is provided to the
educational institution’s students by the
institution or a related organization of
the institution.
Two commenters further
recommended that rental income from
faculty and staff housing also should be
excluded from net investment income,
stating that faculty and staff housing is
a critical strategic resource used by
universities to recruit and retain
exceptional personnel. The commenters
note that the provision of faculty and
staff housing allows faculty and staff to
live closer to campus, which not only is
a convenience for such individuals but
also allows them to more fully
participate in the campus experience,
contributing to a vibrant and dynamic
residential and academic campus. Two
commenters mentioned that housing
rental prices generally are not set based
on market rates but on actual cost, and
many institutions operate housing at a
loss, although it would be
administratively burdensome to
determine a theoretical market rate for
each housing unit as well as to break out
the income and expenses related to each
housing unit.
The Treasury Department and the IRS
agree that rental income from housing
provided to an institution’s faculty and
staff can be distinguished from other
types of rental income if the housing is
provided contingent on their capacities
as faculty or staff (for example, if the
rental agreement contains a provision
that the person must be currently
employed as faculty or staff of the
applicable educational institution).
Thus, these final regulations exclude
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such income from gross investment
income, whether the housing is
provided to the educational institution’s
faculty or staff by the institution or a
related organization of the institution.
These final regulations do not, however,
exclude rental income from other
persons, or from former faculty or staff.
Two commenters recommended that
rental income from dormitories and
other student housing that is made
available to students and nonstudents
alike for educational programs and
camps open to the public that are
outside of the institution’s academic
year, particularly during the summer
months, also be excluded from gross
investment income. These final
regulations do not adopt this suggestion.
Such income may, depending on the
circumstances, constitute unrelated
business taxable income and be
excluded from section 4968 for that
reason. For example, if the income is
from leasing to third parties that
conduct summer camps and programs at
the institution and the institution
provides substantial personal services
with respect to the rented facilities, it
likely is unrelated business taxable
income. Furthermore, the leasing of
student housing to third parties for the
operation of camps and programs run by
third parties is not materially
distinguishable from typical rental
income. Also, if the summer camp or
program is not operated by the
educational institution, then the
educational institution does not control
who is staying in the housing and the
housing is not necessarily provided for
the benefit of the institution’s current
students or to contribute directly to
achieving its educational purpose.
However, the Treasury Department and
IRS note that rental income from
dormitories and other housing provided
to current students that extends through
the summer months (such as graduate
student housing) would meet the
exception for housing provided to
students and would be excluded from
gross investment income.
iii. Royalty Income From Exempt
Functions
Two commenters asked that royalty
income derived from educational and
research activities conducted by an
applicable educational institution be
excluded from the institution’s gross
investment income. The commenters
stated that universities conduct research
as part of the pursuit of knowledge by
faculty and students rather than for the
purpose of earning income. Both
commenters stated that royalties derived
from research that is directly conducted
by students, faculty, and researchers is
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distinguishable from the royalty income
earned by most private foundations
because private foundations receiving
royalty income ‘‘normally’’ have passive
holdings in intellectual property that
was not developed by the private
foundations. (One commenter clarified
that royalty income earned from
‘‘passive investments’’ was not intended
to be included in this proposed
exception for purposes of section 4968.)
Both commenters represented that it
would be a significant administrative
burden to capture all expenses and costs
allocable to such royalty income,
including expenses incurred in applying
for, obtaining, and defending a patent
and in developing and negotiating
license agreements during the life of the
patent, and both commenters estimated
that such annual expenses would equal
or exceed the annual gross investment
income from such royalties.
The Treasury Department and the IRS
agree that applicable educational
institutions produce intellectual
property as part of the pursuit of
knowledge by faculty and students.
These activities generally are not
engaged in for profit and they are not
passive investment activity. Instead,
these activities are integral to an
educational institution’s exempt
purposes. As a result, these final
regulations exclude certain royalties
generated by such educational and
research activities from gross
investment income for purposes of
section 4968.
Specifically, these final regulations
exclude from gross income royalty
income that is derived from patents,
copyrights, and other intellectual
property and intangible property to the
extent those assets resulted from the
work of student(s) or faculty member(s)
in their capacities as such with the
applicable educational institution.
However, neither royalty income from
trademarks on the institution’s logo or
name nor royalty income from
intellectual property donated or sold to
the institution is excluded from gross
investment income under this rule.
iv. Income From Programmatic
Activities
Two commenters recommended
excluding any income derived by an
educational institution from the conduct
of its core educational and research
activities (that is, programmatic
activities) from gross investment
income. The commenters stated that
taxing income that is derived directly
from a college or university’s exempt
purpose is inconsistent with the intent
of section 4968, which is intended to tax
investment income. However, one
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commenter did not include any specific
examples of types of income that would
be gross investment income derived
from the conduct of an applicable
educational institution’s core
educational and research activities, and
the other commenter gave as examples
tuition, museum or gym admission fees,
and income from a related business,
such as a campus bookstore—none of
which would be included in the
definition of gross investment income
under the proposed regulations.
The Treasury Department and the IRS
note that private foundations may earn
gross investment income in the conduct
of their exempt activities, but that such
income is explicitly considered gross
investment income by section 4940(c)
and § 53.4940–1(d). The preamble to the
proposed regulations specifically asked
commenters, when commenting on
whether specific types of income should
be excluded from gross investment
income under section 4968 because
taxing those types of income would not
achieve the congressional intent in
enacting section 4968, to state
specifically how any such proposed
exclusion would still be ‘‘similar to’’ the
rules of section 4940(c) and the specific
characteristics of each type of such
income that would warrant deviating
from the rules provided in section 4940
and the regulations thereunder.
Furthermore, it is unclear what types of
income, other than student loan interest,
rental income from certain housing, and
certain royalty income, otherwise would
be gross investment income earned in
the conduct of an applicable
educational institution’s exempt
activities. Accordingly, other than the
exclusions listed in part 6.a.i., ii., and
iii., these final regulations do not
include an exclusion from gross
investment income for income earned in
the conduct of an applicable
educational institution’s exempt
activities.
v. Excluding Income on Endowment
Funds if the Income Is Used as a Tuition
Replacement Fund
One commenter recommended
excluding income from endowment
funds from gross investment income if
the income is used as a tuition
replacement fund for all of the
applicable educational institution’s
students.
Section 4968(c) provides that, for
purposes of section 4968, net
investment income is determined under
rules similar to the rules of section
4940(c). Neither section 4968(c) nor
4940(c) provide an exclusion from net
investment income for the income from
an institution’s endowment fund,
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regardless of what the income is
ultimately used for. Thus, these final
regulations do not exclude the income
from an institution’s endowment fund
(however defined) from gross
investment income, even if the income
from the endowment fund is used as a
tuition replacement fund.
b. Deductions
i. In General
As stated in part 6.a of this Summary
of Comments and Explanation of
Revisions, the proposed regulations
provided that an institution generally
must calculate net investment income
under rules similar to the rules of
section 4940(c). The proposed
regulations proposed to adopt this
approach, incorporating by cross
reference the provisions of § 53.4940–
1(c) through (f), with certain
modifications. These final regulations
delete the use of a cross reference to the
regulations under section 4940(c) and
instead prescribe specific rules that are
similar to the rules of section 4940.
Thus, consistent with section 4940(c)
and § 53.4940–1(e)(1)(i), § 53.4968–
2(c)(1)(i) of these final regulations
explicitly states that there is allowed as
a deduction from gross investment
income all the ordinary and necessary
expenses, including operating expenses,
paid or incurred for the production or
collection of gross investment income or
for the management, conservation, or
maintenance of property held for the
production of such income, determined
with the modifications described in part
6.b.ii of this Summary of Comments and
Explanation of Revisions.
An applicable educational
institution’s operating expenses related
to its gross investment income may
include compensation of officers, other
salaries and wages of employees,
outside professional fees, interest, and
rental payments and taxes upon
property used in the applicable
educational institution’s operations
other than in its exempt activities. An
applicable educational institution’s
operating expenses that are incurred
both for investment and exempt
purposes, such as salaries for officers or
other employees, must be allocated
between the investment and exempt
activities of that institution on some
reasonable basis. Similarly, consistent
with § 53.4940–1(e)(1)(iii), in cases in
which only a portion of property
produces, or is held for the production
of, income subject to the section 4968
excise tax, and the remainder of the
property is used for other purposes, the
expenses are apportioned between the
taxable and other uses. Furthermore, to
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the extent an applicable educational
institution’s expenses are taken into
account in computing the tax imposed
by section 511, they are not deductible
for purposes of computing the tax
imposed by section 4968.
Consistent with § 53.4940–1(e)(1)(iii),
no amount is allowable as a deduction
to the extent it is paid or incurred for
purposes other than the production or
collection of gross investment income as
determined for section 4968 purposes,
or for the management, conservation, or
maintenance of property held for the
production of such income. Thus, for
example, the charitable deduction
prescribed under section 170 or 642(c),
the net operating loss deduction
prescribed under section 172, and
certain special deductions for
corporations under sections 241 through
250 prescribed under part VIII of
subchapter B of chapter 1 of the Code
(part VIII of subchapter B) are not
allowable as a deduction in determining
section 4968 net investment income.
Taxes imposed under section 4968 are
not paid or incurred for the production
or collection of gross investment
income.
ii. Modifications
Consistent with section 4940(c) and
§ 53.4940–1(e)(2), these final regulations
provide that the following modifications
must be made in determining
deductions otherwise allowable under
these final regulations, as explained in
part 6.b.i of this Summary of Comments
and Explanation of Revisions.
First, consistent with section
4940(c)(3)(B)(i) and § 53.4940–1(e)(2)(i),
a depreciation deduction is allowed, but
only on the basis of the straight line
method provided in section 168(b)(3)
and without regard to paragraphs (1)
and (2) of section 168(b).
Second, consistent with section
4940(c)(3)(B)(ii) and § 53.4940–
1(e)(2)(ii), a depletion deduction is
allowed, but such deduction is
determined without regard to sections
613 and 613A, relating to percentage
depletion.
Third, consistent with § 53.4940–
1(e)(2)(iii), basis to be used for purposes
of calculating the deduction allowed for
depreciation or depletion is the basis
determined under the rules of part II of
subchapter O of chapter 1 of the Code
(part II of subchapter O), subject to the
previously described modifications for
calculating depreciation and depletion,
and without regard to § 53.4968–2(d)(2)
(relating to the basis for determining
gain for property held on December 31,
2017, and continuously thereafter to the
date of disposition, discussed in part 6.c
of this Summary of Comments and
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Explanation of Revisions) or section
362(c) (relating to certain contributions
to capital). Thus, an applicable
educational institution must reduce the
cost or other substituted or transferred
basis by an amount equal to the straightline depreciation or cost depletion,
without regard to whether the
institution deducted such depreciation
or depletion during the period prior to
its first taxable year beginning after
December 31, 2017. However, in cases
in which an applicable educational
institution has previously taken
depreciation or depletion deductions in
excess of the amount which would have
been taken had the straight line or cost
method been employed, such excess
depreciation or depletion also is taken
into account to reduce basis. If the facts
necessary to determine the basis of
property in the hands of the donor or
the last preceding owner by whom it
was not acquired by gift are unknown to
a donee applicable educational
institution, then the institution’s
original basis in such property is
determined under the rules of § 1.1015–
1(a)(3).
One commenter requested that the
step-up rule for calculating gain upon
the disposition of assets held on
December 31, 2017 (discussed later in
this Summary of Comments and
Explanation of Revisions) also apply for
purposes of calculating depreciation
and depletion, stating that educational
institutions, which are more likely than
private foundations to hold on to
depreciable assets, otherwise may be
motivated to engage in self-help by
selling assets they own and purchasing
similar use assets in order to obtain
depreciation deductions based on the
current fair market value basis. These
final regulations do not adopt such a
rule because it would be contrary to
section 4940(c) and applicable
educational institutions do not seem to
be distinguishable from private
foundations on this issue.
Fourth, consistent with § 53.4940–
1(e)(2)(iv), the deduction for expenses
paid or incurred in any taxable year for
the production of gross investment
income, as determined for section 4968
purposes, earned as an incident to a
charitable function can be no greater
than the income earned from such
function which is includible as gross
investment income for such year. For
example, where rental income is
incidentally realized in a year from
historic buildings held open to the
public, deductions for amounts paid or
incurred in that year for the production
of such income is limited to the amount
of rental income includible as gross
investment income for the year.
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c. Capital Gains and Losses
The proposed regulations contained
three special rules relating to capital
gains and losses. First, consistent with
Notice 2018–55, the proposed
regulations substituted ‘‘December 31,
2017’’ for ‘‘December 31, 1969’’ each
place it appears in § 53.4940–1(c)–(f), to
provide a step-up in basis (if any) for
purposes of calculating gain upon the
sale or other disposition of assets held
on December 31, 2017, and
continuously thereafter to the date of
disposition.
Second, in response to a comment
received in response to Notice 2018–55,
the proposed regulations provided that,
if an applicable educational institution
held an interest in a partnership
(including through one or more tiers of
partnerships) on December 31, 2017,
and continuously thereafter, and the
partnership held assets on December 31,
2017, and continuously thereafter to the
date of disposition, the partnership’s
basis in its assets with respect to the
applicable educational institution for
purposes of determining the applicable
educational institution’s share of gain
upon sale or other disposition of the
assets by the partnership will not be less
than the fair market value of such asset
on December 31, 2017, plus or minus all
adjustments as provided under
§ 53.4940–1(f)(2)(i) after December 31,
2017, and before the date of disposition.
The proposed regulations stated that, to
avail itself of this special partnership
basis rule, an institution must obtain
documentation from the partnership to
substantiate the basis used.
Third, the proposed regulations
provided that, for purposes of
§ 53.4940–1(f), overall net losses from
sales or other dispositions of property
by one related organization (or by the
applicable educational institution)
reduce (but not below zero) overall net
gains from such sales or other
dispositions by other related
organizations (or by the applicable
educational institution).
The preamble to the proposed
regulations stated that, consistent with
the requirement in section 4968(c) to
calculate net investment income under
rules similar to the rules under section
4940(c), the proposed regulations
generally followed the rules for
determining gain upon the sale or other
disposition of property that have been
used for section 4940(c) purposes since
1969. The preamble further stated that
section 4940(c)(1) provides that, except
to the extent inconsistent with the
provisions of section 4940, net
investment income is determined under
the principles of subtitle A. Subtitle A
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encompasses all of the income tax
provisions (sections 1 through 1564) of
the Code, including the basis rules in
section 1015 (basis of property acquired
by gift generally is the donor’s basis).
Accordingly, under the proposed
regulations, an applicable educational
institution generally must calculate gain
on the sale or other disposition of a
lifetime gift of property using the
donor’s basis. However, the preamble to
the proposed regulations requested
comments on whether a special rule
excluding from capital gain net income
any appreciation in a gift of donated
property that occurred before the date of
receipt by the applicable educational
institution should be included under
the final regulations and how a special
rule excluding from gain such predonation appreciation would be
consistent with the statutory language of
section 4968.
Commenters addressed several
aspects of the proposed rules for capital
gain net income, including the taxation
of capital gain net income on the sale of
exempt use property; capital gain net
income on the sale of donated property;
the step-up rule for assets held in a
partnership on December 31, 2017; and
whether capital loss carryovers should
be allowed.
In response to these public comments
and as discussed in in more detail in
part 6.c.i through iii of this Summary of
Comments and Explanation of
Revisions, these final regulations
provide that (1) capital gain net income
from the sale or exchange of property
used by an institution for its exempt
purpose is disregarded for the portion of
the property that is used for the exempt
purpose; (2) any appreciation in the
value of donated property that occurred
prior to the date of its donation to the
institution is disregarded; and (3)
capital loss carryovers are allowed but
not capital loss carrybacks.
Consistent with section 4940(c)(4)(A)
and (D) and the proposed regulations,
these final regulations also provide that
in determining capital gain net income
for purposes of the tax imposed by
section 4968, no gain or loss from the
sale or other disposition of property is
taken into account to the extent that
such gain or loss is taken into account
for purposes of computing the tax
imposed by section 511.
i. Capital Gain Net Income on Sale of
Exempt Use Property
Two commenters recommended
excluding from capital gain net income
gain from the sale of exempt use
property. One of the commenters stated
that exempt use property is excluded
from section 4968(b)(1)(D)’s calculation
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for determining the applicability of
section 4968, and that it would thus be
inconsistent to tax the educational
institution on the sale of such property.
This commenter also stated that taxing
income that is derived directly from a
college or university’s exempt purpose
assets is inconsistent with the intent of
section 4968, which is aimed at
investment income. The other
commenter said that the proposed
regulation’s reference to § 53.4940–
1(f)(1) suggested such a result, but asked
that the final regulations clarify this
reading.
Section 4940(c)(4)(A) was amended in
2006 5 to provide that ‘‘there shall not be
taken into account any gain or loss from
the sale or other disposition of property
to the extent that such gain or loss is
taken into account for purposes of
computing the tax imposed by section
511.’’ By implication, section
4940(c)(4)(A) thus provides that all gain
or loss from the sale or other disposition
of any and all property, other than any
gain or loss that is taken into account for
purposes of computing the tax imposed
by section 511, is taken into account for
purposes of section 4940(c).6
Section 4968(c) provides that net
investment income for purposes of
section 4968 is determined under rules
similar to the rules of section 4940(c).
Section 4940(c) was specifically
amended in 2006 and 2007 to provide
that capital gain net income is no longer
limited only to property that was held
for investment purposes and, instead,
extends to all property held by a private
foundation, including property used for
exempt purposes. The only exceptions
to this general rule are for ‘‘any gain or
loss from the sale or other disposition of
5 The amendments to section 4940(c)(4)(A) were
made by the Pension Protection Act of 2006, Public
Law 109–280, and the Tax Technical Corrections
Act of 2007, Public Law 110–172 (which conformed
the language of section 4940(c)(4)(A) to the 2006
JCT Technical explanation).
6 According to the JCT Technical explanation
(JCX–38–06), the reason for amending section
4940(d)(4)(A) in 2006 and 2007 was that section
4940(c) does not provide for the blanket exclusion
of gain or loss from the sale or other disposition of
assets used for exempt purposes that was provided
in the section 4940 regulations. Section 53.4940–
1(f)(1)), which has not been updated to reflect the
amendments made in 2006 and 2007, provides that
‘‘there shall be taken into account only capital gains
and losses from the sale or other disposition of
property held by a private foundation for
investment purposes’’ and ‘‘gains and losses from
the sale or other disposition of property used for the
exempt purposes of the private foundation are
excluded.’’ (Emphasis added.) Although the section
4940 regulations, which have not been revised since
1992, have not been revised to reflect the changes
to section 4940(c)(4)(A) made in 2006 and 2007, the
current statute is clear that capital gain net income
includes (and is intended to include) gain from
property used by a private foundation for exempt
purposes.
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property to the extent that such gain or
loss is taken into account for purposes
of computing the tax imposed by section
511’’ and for certain like-kind exchangetype dispositions. See Section
4940(c)(4)(A) and (D).
However, educational institutions as a
general matter own more tangible
property and more different types of
tangible property used in the
performance of their exempt purposes
than a typical private foundation.
Further, constantly changing and
growing student populations, as well as
new developments and innovations and
needs in education and research,
requires educational institutions to
continually reevaluate their needs for
property and possibly to replace or
upgrade certain property. This process
is likely to result in the need to sell
assets in order to best serve the
educational institution’s exempt
purposes. For instance, property such as
residential and educational buildings,
libraries, laboratories, and information
technology assets often are sold as needs
change. Income from such sales
generally is reinvested in acquiring
upgrades or replacements for that
property, and therefore is integral to the
performance of the exempt function of
the institution, rather than for an
investment purpose. Accordingly, these
final regulations exclude from capital
gain net income the gain from the sale
or exchange of exempt use property for
the portion of the property that is used
for the exempt purpose.
ii. Capital Gain Net Income From the
Sale of Donated Property
Five commenters responded to the
proposed regulations’ request for
comments on the calculation of capital
gain net income from the sale of
donated property, all recommending
that any appreciation that occurred
prior to an institution’s receipt of the
donated property be excluded from such
gain. The commenters stated that the
purpose of section 4968 is to tax
institutions on their own net investment
income, not to tax donations, and that
it would thus be inequitable to tax
applicable educational institutions on
the appreciation in value that occurred
before the donee institution received the
donation of a capital asset. Commenters
also stated that donated property
normally is not actually retained and
held as an investment; instead,
applicable educational institutions
typically sell donated property as soon
as possible. Thus, the gain upon sale of
donated property often is attributable to
the appreciation that occurred before
the institution received the property.
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Three commenters noted that,
although a private foundation must use
the donor’s transferred basis in
computing any gain from the sale of
donated property, a private foundation
has the option of making gifts of
appreciated property to section 501(c)(3)
public charities by funding their grants
in kind, resulting in no excise or income
tax being imposed on either
organization when the property
eventually is sold. These commenters
stated that it would be difficult for
applicable educational institutions to
take advantage of this strategy. One
commenter opined that private
foundations generally are able to time
their sales to offset losses more
efficiently than educational institutions
can. The commenter asserted that the
substantially higher operational
expenses of an educational institution
sometimes require that institution to sell
a donated asset upon receipt. The
commenter also opined that, because
these donated assets are not retained for
investment purposes, they do not
produce net investment income.
All commenters stated that the
requirement to obtain a donor’s basis
information will be administratively
burdensome. Unlike private
foundations, which typically receive
donations from a small number of
known donors, applicable educational
institutions receive a large number of
donations from a wide variety of donors.
In many cases, institutions will be
unable to determine (or verify) the
transferred basis under section 1015 of
the donated property. Further, the
commenters stated, requesting donors to
provide their basis information could
negatively affect an applicable
educational institution’s relationships
with donors.
One commenter stated that applicable
educational institutions could work
around this issue by encouraging donors
to donate any appreciated property to a
donor advised fund that then could sell
the property and contribute the cash
proceeds to the institution.
The Treasury Department and the IRS
agree that the differences between
applicable educational institutions and
private foundations with respect to
donations of property justify a rule
under section 4968 that is different from
the treatment found in section 4940(c)
for the treatment of the capital gain net
income of property donated to a private
foundation. In addition, such a rule will
increase administrability for both
taxpayers and the IRS by removing the
requirement to determine the donor’s
basis of the donated property.
Furthermore, it will avoid placing
different applicable educational
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institutions receiving stock of equal
value but with different bases in
different positions with regard to the
computation of their respective net
investment income merely from
receiving the donated property.
Accordingly, these final regulations
provide that any appreciation in the
value of donated property that occurred
prior to the date of donation to the
applicable educational institution is
disregarded in calculating gain for
purposes of section 4968. This special
rule does not, however, change the
transferred basis of the donated
property; thus, an applicable
educational institution must obtain the
transferred basis of donated property
under section 1015 for purposes of
claiming a loss upon its sale or other
disposition or for purposes of
calculating depreciation or depletion.
One commenter requested that the
final regulations recognize that a college
or university that disposes of
contributed property at the first
reasonable opportunity is not holding
such property for investment purposes
and, accordingly, exclude all of the
proceeds from the sale of such
contributed property from capital gain.
The same commenter suggested a safe
harbor under which property disposed
of within 30 days of receipt would be
treated as having been disposed of at the
first reasonable opportunity. These final
regulations do not adopt either
suggestion, because there is no analog in
section 4940(c) or in any other provision
of the Code. Furthermore, any cut off
would be arbitrary and there is no
justification for why one day versus
another day should not result in the
recognition of gain. While these final
regulations disregard any appreciation
that occurred prior to an institution’s
receipt of the donated property,
appreciation that occurs after an
institution’s receipt of the donated
property is included in net investment
income. For consistency with the rules
applicable to charitable deductions, the
date of donation is determined under
the timing rules of § 1.170A–1(b) and
the value on the date of donation is
determined under the valuation rules of
§ 1.170A–1.
iii. Capital Loss Carryovers
One commenter requested that capital
loss carryovers be allowed. This
commenter represented that a private
grant-making foundation, to the extent it
has satisfied its minimum distribution
requirements, can easily curtail its
spending (and the realization of capital
gains while converting investment
assets to cash) by issuing fewer or
smaller grant awards to manage its
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section 4940 tax liability. The
commenter contrasted such a
foundation with an educational
institution that typically has a large
operating budget with significant
nondiscretionary expenses related to
employees and infrastructure and must
find ways to meet its ongoing cash
needs, which may involve selling
investments at particular times that may
not be advantageous from an investment
or tax perspective.
Although section 4940(c) explicitly
allows losses from sales or other
dispositions of property only to the
extent of gains from such sales or other
dispositions, and does not allow capital
loss carryovers or carrybacks, the
commenter represented that, given the
differences between private foundations
and educational institutions, the
allowance of capital loss carryovers is
necessary to achieve outcomes for
educational institutions under section
4968 that are ‘‘similar to’’ the outcomes
for private foundations under section
4940(c).
The Treasury Department and the IRS
acknowledge that there are various and
notable differences between private
foundations subject to section 4940(c)
and educational institutions in their
missions, functions, and operating
expenses. Therefore, based on a general
understanding, as further informed by
commenters, of the way educational
institutions manage both their
substantial, nondiscretionary operating
expenses in furthering their exempt
purposes and their investment
activities, these final regulations allow
the use of capital loss carryovers.
Accordingly, these final regulations
adopt the rule in the proposed
regulations that overall net losses from
sales or other dispositions of property
by one related organization (or by the
applicable educational institution)
reduce (but not below zero) overall net
gains from such sales or other
dispositions by other related
organizations (or by the applicable
educational institution). In addition,
these final regulations adopt the rule in
the proposed regulations that, should
overall net losses from sales or other
dispositions of property exceed gains
from sales or other dispositions of such
property during the same taxable year,
such excess may not be deducted from
gross investment income in any taxable
year, nor may such excess be used to
reduce gains in prior taxable years.
However, the final regulations provide
that capital loss carryovers are allowed
and may be deducted from capital gains
in a future year.
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d. Basis
These final regulations provide rules
for determining basis or a substitute for
basis (in the context of section 4968) for
purposes of determining (1) gain from
the sale or other disposition of property
other than a partnership interest; (2) a
distributive share of gain from the sale
or other disposition of an asset held in
a partnership; (3) gain on the sale of a
partnership interest; and (4) loss.
i. Basis for Purposes of Determining
Gain From the Sale or Other Disposition
of Property Other Than a Partnership
Interest
Consistent with the proposed
regulations and with section 4940(c),
these final regulations provide that the
basis for purposes of determining gain
from the sale or other disposition of
property (other than a partnership
interest) is generally the greater of (1)
fair market value of the property on
December 31, 2017, plus or minus all
adjustments after December 31, 2017,
and before the date of its disposition
under the rules of part II of subchapter
O, provided that the property was held
by the applicable educational institution
on December 31, 2017, and
continuously thereafter to the date of its
disposition, or (2) basis as determined
under the rules of part II of subchapter
O, subject to the three modifications
described at the beginning of part 6.b.ii.
of this Summary of Comments and
Explanation of Revisions (referring to
the modifications relating to deductions
against gross investment income). See
parts 6.d.ii. and 6.e. of this Summary of
Comments and Explanation of Revisions
for special rules regarding determining
a distributive share of capital gain from
the sale or other disposition of an asset
held in a partnership and on the sale of
a partnership interest.
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ii. Basis for Purposes of Determining a
Partner’s Distributive Share of Gain
From the Sale or Other Disposition of an
Asset Held in a Partnership and Gain
From the Sale or Other Disposition of a
Partnership Interest
The proposed regulations provided
that if an applicable educational
institution held an interest in a
partnership (including through one or
more tiers of partnerships) on December
31, 2017, and continuously thereafter,
and the partnership held an asset on
December 31, 2017, and continuously
thereafter to the date of disposition by
the partnership, the partnership’s basis
in such asset (for purposes of
determining the applicable educational
institution’s share of gain upon sale or
other disposition of that asset) is not
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less than the fair market value of such
asset on December 31, 2017, plus or
minus all adjustments as provided
under § 53.4940–1(f)(2)(i) after
December 31, 2017, and before the date
of disposition.
Four commenters addressed the
requirement in the proposed regulations
that, for purposes of applying this rule,
an applicable educational institution
must obtain documentation from the
partnership to substantiate the basis
used. The commenters stated that, while
an applicable educational institution
can obtain documentation to establish
its basis in its partnership interest
(outside basis) as of December 31, 2017,
obtaining documentation to establish its
share of the basis of each partnership
asset (inside basis) would be extremely
burdensome and that an asset-by-asset
determination of gain might, therefore,
not be possible.
The commenters stated that
applicable educational institutions often
hold interests in hundreds of
partnerships, many with numerous
investors, that may involve multiple
tiers of flow-through entities, and that
applicable educational institutions
generally are passive investors in these
partnerships. Commenters stated that it
would be very difficult, if not
impossible, for applicable educational
institutions to obtain the required basis
documentation from all the
partnerships, especially because there is
no requirement for partnerships to
provide such documentation and
because reporting from partnerships
generally is done on an aggregate basis
and not on an asset-by-asset basis.
Commenters added that many
partnerships may not even be aware that
their partners include an applicable
educational institution.
The commenters recommended that
the substantiation rule in the proposed
regulations be removed and that an
applicable educational institution
instead be allowed to determine the
amount of built-in gain in the applicable
educational institution’s share of
partnership assets using any reasonable
method. Two commenters
recommended a method, described in
part 6.e. of this Summary of Comments
and Explanation of Revisions, that
would use the difference between fair
market value and outside basis of a
partnership interest on December 31,
2017, to approximate the amount of
cumulative built-in gain in an
applicable educational institution’s
share of partnership assets on such date.
The Treasury Department and the IRS
recognize the problem described by
commenters with regard to the proposed
substantiation rule and agree that
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65539
another approach for determining the
amount of built-in gain in partnership
assets solely for purposes of applying
section 4968 would be appropriate in
alleviating the problem. Accordingly,
these final regulations remove the
proposed substantiation rule and
eliminate the need to determine a stepup in a partner’s share of bases in
partnership assets for purposes of
section 4968. As a result, the bases of
partnership assets on December 31,
2017, are not stepped up for purposes of
section 4968. Rather, for purposes of
determining an applicable educational
institution’s share of gain upon the sale
or other disposition of an asset held in
a partnership, these final regulations
provide that the applicable educational
institution’s basis in each partnership
asset generally is determined under the
rules of subchapter K of chapter 1 of the
Code (subchapter K), but also provide a
method, more fully described in part
6.e. of this Summary of Comments and
Explanation of Revisions, which
generally enables an applicable
educational institution to offset its
distributive share of capital gain net
income from partnership asset
dispositions by a portion of the built-in
gain in the applicable educational
institution’s interest in the partnership
as of December 31, 2017.
These final regulations provide a
similar rule for determining an
applicable educational institution’s gain
upon the sale or other disposition of all
or a portion of a partnership interest.
iii. Basis for Purposes of Calculating
Loss
Consistent with the proposed
regulations and with section 4940(c), for
purposes of determining loss from the
sale or other disposition of property,
basis is determined under the rules of
part II of subchapter O, subject to the
modifications of part 6.b.ii. of this
Summary of Comments and Explanation
of Revisions (referring to the
modifications relating to depreciation
and depletion deductions against gross
investment income). For purposes of
determining loss from the sale or other
disposition of a partnership interest,
basis is determined under the rules of
subchapter K.
e. Special Rules Regarding Partnership
Interests and Partnership Assets
As described in part 6.d.ii. of this
Summary of Comments and Explanation
of Revisions, commenters stated that it
would be very difficult, if not
impossible, for institutions to obtain the
basis documentation necessary to apply
the partnership asset basis step-up rule
provided in the proposed regulations.
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As an alternative, two commenters
recommended a method that would use
the difference between the fair market
value and outside basis of an applicable
educational institution’s partnership
interest on December 31, 2017, to
approximate the difference between the
fair market value and inside basis of,
and thus the amount of built-in gain in,
the applicable educational institution’s
share of partnership assets on such date.
The commenters stated that the
difference between fair market value
and tax basis of an applicable
educational institution’s partnership
interest on December 31, 2017, generally
should reflect the amount of the
applicable educational institution’s
built-in gain in its share of the
partnership’s assets on such date, and
that, because educational institutions
should know the fair market values and
tax bases of their partnership interests
on December 31, 2017, they should be
able to calculate the built-in gain in
their partnership interests as of
December 31, 2017.
Specifically, the commenters
recommended that an applicable
educational institution should be
allowed to offset the distributive share
of partnership capital gain net income
after December 31, 2017, allocated by a
partnership by the amount of the builtin gain the applicable educational
institution had in its partnership
interest, determined as of December 31,
2017. Under the commenters’ approach,
an applicable educational institution
would determine its built-in gain in a
partnership interest as of December 31,
2017, and then not report any capital
gain allocated from that partnership
after December 31, 2017, as being
subject to section 4968 until the
cumulative amount of such excluded
gain equals the amount of built-in gain
in the interest. The commenters
recommended that this rule be applied
on a partnership-by-partnership basis
and be available to reduce the amount
of an applicable educational
institution’s capital gain net income on
a first-recognized basis.
For the reasons described in part d.ii
of this Summary of Comments and
Explanation of Revisions, these final
regulations adopt an approach that is
similar to the approach recommended
by the commenters in regard to
determining an applicable educational
institution’s distributive share of gain
allocated from a partnership
(partnership asset disposition rule), as
well as adding a partnership interest
disposition rule. These final regulations
provide that, for each partnership
interest an applicable educational
institution held on December 31, 2017,
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the applicable educational institution
may determine an unadjusted step-up
amount that is equal to the excess, if
any, of the fair market value of such
partnership interest on December 31,
2017, over the adjusted basis of such
partnership interest on December 31,
2017. Then, for purposes of computing
net investment income for taxable years
beginning after December 31, 2017, an
applicable educational institution will
reduce its distributive share of capital
gain net income from such partnership
by the least of (1) the applicable
educational institution’s share of
applicable capital gain from such
partnership (that is, both short-term and
long-term capital gain for the first
taxable year after December 31, 2017,
but only long-term capital gains and
losses for subsequent years because
short-term capital gains and losses in
such years could not have been
included in the amount of outside builtin gain as of December 31, 2017); (2)
one-third of the applicable educational
institution’s unadjusted step-up for such
partnership; or (3) the applicable
educational institution’s adjusted stepup for such partnership (which, in
general, is its unadjusted step-up
reduced by any capital gain that was
previously excluded pursuant to the
partnership asset disposition rule or the
partnership interest disposition rule
described in this paragraph).
These final regulations do not apply
the capital gain net income reduction
rule on a first-recognized basis, as
recommended by the commenters. The
excess of fair market value over tax basis
of a partnership interest on December
31, 2017, may reflect built-in gain in
partnership assets that would not be
included in net investment income for
purposes of section 4968—for example,
ordinary income property. Additionally,
application of the rule to offset all firstrecognized capital gain net income in
determining the educational
institution’s net investment income
could provide a benefit to applicable
educational institutions that would be
inconsistent with the purpose of section
4968 by permitting a reduction in
capital gain net income subject to
section 4968 that is attributable to a
partnership asset both acquired, and
disposed of, after December 31, 2017.
Accordingly, these final regulations
adopt a middle ground position that
spreads the exclusion without
burdensome asset-by-asset matching by
providing that the maximum amount of
an applicable educational institution’s
capital gain net income from a
partnership that may be excluded in any
given year cannot exceed one-third of
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the applicable educational institution’s
unadjusted step-up for such
partnership.
Commenters did not provide a
recommendation for coordinating the
partnership asset disposition rule with a
partnership interest disposition rule.
However, consistent with permitting an
applicable educational institution to
offset its distributive share of capital
gain net income from partnership asset
dispositions, these final regulations also
provide a capital gain net income
reduction rule in the context of a sale or
other disposition of all or a portion of
a partnership interest. These final
regulations provide that, for purposes of
computing net investment income, an
applicable educational institution
reduces the amount of its capital gain
net income upon the sale or other
disposition of all or a portion of a
partnership interest by an amount that
bears the same relation to the applicable
educational institution’s adjusted stepup for such partnership as the fair
market value of the transferred portion
of the interest bears to the fair market
value of the applicable educational
institution’s entire interest in such
partnership before the sale or other
disposition.
7. Related Organizations
Section 4968(d)(1) provides, in part,
that the assets and net investment
income of any related organization with
respect to an educational institution are
to be treated as assets and net
investment income, respectively, of the
educational institution. To determine
which assets of a related organization
are included by section 4968(b)(1)(D) for
a particular year, an educational
institution determines which
organizations are related organizations,
as defined in section 4968(d)(2), as of
the end of the educational institution’s
preceding taxable year, and values the
relevant assets on that date. To
determine the amount of net investment
income of a related organization that is
included by the applicable educational
institution in calculating the tax
imposed by section 4968(a) for a
particular taxable year, an applicable
educational institution determines
which organizations are related
organizations, as defined in section
4968(d)(2), as of the end of that taxable
year of the applicable educational
institution and includes the net
investment income from each related
organization’s tax year that ends with or
within that same taxable year of the
applicable educational institution. If an
organization becomes a related
organization within the applicable
educational institution’s taxable year
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and remains a related organization as of
the end of the taxable year, then the
applicable educational institution
includes the organization’s net
investment income for the portion of the
year that it was a related organization,
using any reasonable method.
The statute provides two exceptions
to the rules for including assets and net
investment income of a related
organization as assets and net
investment income of the educational
institution: (1) No such amount is to be
taken into account with respect to more
than one educational institution, and (2)
unless the related organization is
controlled by the institution or is
described in section 509(a)(3) (relating
to supporting organizations) with
respect to the institution for the taxable
year, assets and net investment income
that are not intended or available for the
use or benefit of the institution are not
to be taken into account by it. Section
53.4968–3 of these final regulations
provides definitions and special rules
relating to related organizations.
a. Definition of Related Organization
Under section 4968(d)(2), the term
‘‘related organization’’ means, with
respect to an educational institution,
any organization that (1) controls the
educational institution; (2) is controlled
by the educational institution; (3) is
controlled by one or more persons that
also control the educational institution;
(4) is a supported organization (as
defined in section 509(f)(3)) with
respect to the educational institution
during the taxable year; or (5) is a
supporting organization (as described in
section 509(a)(3)) with respect to the
educational institution during the
taxable year.
The first three categories of related
organizations require control of an
organization, but the statute does not
define the term ‘‘control.’’ Furthermore,
whether the educational institution is
the controlling or controlled entity
matters because if the related
organization controls the educational
institution, or is controlled by one or
more persons that also control the
educational institution, then 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. In contrast, if a related
organization is controlled by an
educational institution, then all the
assets and net investment income of the
related organization are taken into
account by the educational institution,
with the exception that the same assets
are not taken into account by more than
one educational institution.
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The proposed regulations provided a
definition of control derived from
section 512(b)(13)(D) and the
regulations thereunder, consistent with
the definition of control contained in
Notice 2019–09, ‘‘Interim Guidance
Under Section 4960’’ (2019–04 I.R.B.
403), and requested comments on
whether there were any circumstances
in which this proposed definition of
control should be modified in the
context of section 4968.
Specifically, the proposed regulations
defined control as: (1) In the case of a
corporation, ownership (by vote or
value) of more than 50 percent of the
stock of the corporation; (2) in the case
of a partnership, ownership of more
than 50 percent 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
percent 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, (a) more than 50 percent of the
directors or trustees of the educational
institution or nonstock organization are
either representatives of, or are directly
or indirectly controlled by, the other
entity or (b) more than 50 percent 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 educational institution. For
this purpose, a ‘‘representative’’ means
a trustee, director, agent, or employee,
and ‘‘control’’ includes the power to
remove a trustee or director and
designate a new trustee or director.
Finally, the proposed regulations stated
that section 318, which contains rules
for determining constructive ownership
of stock, applies for purposes of
determining ownership of stock in a
corporation, and similar principles
apply for purposes of determining
ownership of an interest in any other
entity.
Commenters stated generally that use
of the proposed definition of ‘‘control’’
would result in educational institutions’
being required to take into account
assets and net investment income that
the educational institutions do not
actually control and that they will never
receive because the assets and income
actually belong to unrelated third
parties. The commenters also stated that
such a rule is inconsistent with
Congressional intent to include assets
and income of related organizations
only when the educational institution
actually has control over the use of the
related organization’s assets and net
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65541
investment income, and would not
address Congressional concerns that
educational institutions might attempt
to avoid the section 4968 excise tax by
holding assets in structures that, as
compared to direct ownership, represent
a difference in form but not substance.
More specifically, commenters stated
that entities under common control with
an educational institution could be
deemed to be controlled by the
educational institution, contrary to
reality and thus inappropriately
inflating the net investment income of
the educational institution. In addition,
the commenters stated that including
controlled taxable entities, partnerships,
split interest trusts, and employee
benefit plans as related organizations for
purposes of section 4968 would lead to
double or triple taxation.
Parts 7.a.i. through v. of this Summary
of Comments and Explanation of
Revisions address entities that
commenters recommended disregarding
in applying the related organization
provisions of section 4968(d): Taxable
corporations; partnerships and other
pass-through entities; certain trusts;
employee benefit plans; and decedent’s
estates. Part 7.b of this Summary of
Comments and Explanation of Revisions
describes the rules for determining
whether an educational institution will
be considered to ‘‘control’’ an entity that
is not disregarded for purposes of
section 4968(d). Part 7.c of this
Summary of Comments and Explanation
of Revisions addresses the application
of the rule that assets and net income of
a controlled entity will be treated as the
assets and net income of only one
educational institution. Part 7.d of this
Summary of Comments and Explanation
of Revisions addresses the application
of the rule that assets and net
investment income of certain related
organizations that are not intended or
available for the use or benefit of an
educational institution are not taken
into account by the institution.
i. Taxable Corporations
The preamble to the proposed
regulations stated that, because the net
investment income that a taxable entity
distributes or transfers to an educational
institution has already been taxed, the
Treasury Department and the IRS did
not consider it consistent with
Congressional intent to tax the income
again under section 4968. Furthermore,
with regard to the assets of a taxable
corporation that is a related
organization, the educational institution
likely already has included the value of
the shares of the corporation’s stock that
it owns in its non-exempt use assets;
however, the stock value may differ
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from the value of the taxable
corporation’s underlying assets. The
proposed regulations requested
comments on how to account for this
difference without double-counting the
assets, as well as more general
comments on the treatment of taxable
entities that may be related
organizations for purposes of section
4968.
Commenters agreed that educational
institutions should not be required to
take into account the net investment
income of a related organization that is
a taxable entity, stating that this would
result in double, and sometimes triple,
taxation (U.S. Federal income tax at the
entity level on the taxable entity’s
income; section 4968 tax on any
payments of net investment income by
a taxable entity to the educational
institution; and section 4968 tax on the
net investment income of the controlled
taxable entity that is treated as the
institution’s income under section
4968(d)). Furthermore, the commenters
said that the value of the educational
institution’s holdings in the taxable
entity would already be reflected on the
educational institution’s books, and, if
the educational institution owned more
than 50 percent, but less than 100
percent, of the taxable entity, the
proposed definition would attribute to
the institution income and assets that
actually belong to unrelated third
parties.
To prevent this multiple taxation of a
taxable entity’s net investment income
and to prevent overcounting of a taxable
entity’s assets, these final regulations
exclude from the definition of ‘‘related
organization’’ a taxable corporation and,
as described in part 7.a.iii. of this
Summary of Comments and Explanation
of Revisions, taxable trusts, in each case
whether foreign or domestic.
The Treasury Department and the IRS
note that any investment-type income
that is paid to an educational institution
by a taxable entity (such as interest on
money loaned by the institution to the
taxable entity) is included in net
investment income for purposes of
section 4968(c) in the same manner as
any other such investment-type income
received by an institution from any
other entity, regardless of whether the
other entity is or is not controlled by the
institution. In addition, for purposes of
section 4968(b)(1)(D), the value of the
educational institution’s interest in a
taxable entity is based on the fair market
value of the interest on the last day of
the preceding taxable year, rather than
on the book value of the interest
reflected on the educational institution’s
books and records.
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ii. Partnerships and Other Pass-Through
Entities
Commenters stated that the proposed
regulations’ definition of control of
partnerships (i.e., that ownership of
more than 50 percent of the profits
interest or capital interest in a
partnership would result in the
educational institution’s being deemed
to control the partnership), likewise
would result in double taxation (section
4968 tax on the net investment income
that is allocated to the educational
institution by the partnership and
section 4968 tax on the net investment
income of the partnership that is treated
as the institution’s income under
section 4968(d)), which is inconsistent
with the principles of subchapter K.
Furthermore, the value of the
educational institution’s interest in the
partnership already would be reflected
on the educational institution’s books,
and, if the educational institution owns
more than 50 percent, but less than 100
percent, of the profits interest or capital
interest in such partnership, the
proposed definition would attribute to
the institution income and assets that
actually belong to other partners,
including unrelated third parties.
One commenter stated that an
educational institution often is a limited
partner in an investment partnership
and asked that the final regulations
provide that an educational institution
that is a limited partner in a partnership
not be treated as controlling the
partnership for purposes of section
4968. This commenter added that, even
if an educational institution served as
the general partner of a partnership, it
would have limited powers to change
equity holders’ entitlements to the
partnership income and thus would not
control all of the income or assets of the
partnership.
To prevent double taxation of a
partnership’s net investment income
and overcounting of its assets, these
final regulations exclude from the
definition of ‘‘related organization’’ a
partnership, S corporation, or other
pass-through entity a portion of whose
income flows through to the educational
institution.
The Treasury Department and the IRS
note that any net investment income
that flows through to an educational
institution is included in that
institution’s net investment income for
purposes of section 4968(c). In addition,
for purposes of section 4968(b)(1)(D),
the value of an educational institution’s
partnership interest is the fair market
value of the institution’s partnership
interest on the last day of the preceding
taxable year, rather than the book value
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of that interest carried on the
educational institution’s books and
records.
iii. Certain Trusts
Multiple commenters stated that the
proposed regulations’ definition of
control of trusts, which provided that
ownership of more than 50 percent of
the beneficial interests in a trust results
in an educational institution being
deemed to control the trust, would lead
to inequitable results. In particular,
commenters recommended excluding
split-interest trusts described in section
4947(a)(2) from the definition of related
organization, stating that, with respect
to charitable remainder trusts, an
educational institution generally is not
able to receive any benefit, and cannot
use assets in the trust, until the
termination of the interests of the
income beneficiaries (which may be
decades into the future). This is true
even if the value of the educational
institution’s interest in the trust exceeds
50 percent of the present value of all
beneficial interests in the trust. In
addition, even though it is unlikely that
an educational institution would receive
any income from such a trust while the
grantor is alive, income paid from a
split-interest trust is not considered net
investment income for purposes of
section 4940(c) (see Notice 2004–35),
and it seems inconsistent to treat
income that would not be net
investment income if it were received
directly from the trust to be treated as
net investment income when not
received from the trust. Further, it
seems inequitable and contrary to
Congressional intent to tax an
educational institution on income that
is paid to the grantor or other noncharitable beneficiary during the
grantor’s lifetime. Finally, it would be
difficult for an educational institution to
obtain information about the income of
a split-interest trust, as there is currently
no Federal requirement for a splitinterest trust to report this information
to its remainder beneficiary(ies).
One commenter recommended that
the final regulations provide that a
charitable remainder trust is within the
control of the institution only if the
institution (1) has a vested remainder
interest of at least 50 percent of all
actuarial interests in the trust, (2) serves
as the trustee of the trust, and (3) under
the terms of the trust document, has the
right as trustee to make distributions
from the trust to itself as a charitable
organization.
The Treasury Department and the IRS
considered whether the present value of
an educational institution’s share of the
remainder assets of a charitable
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remainder trust should be included as
assets of the institution for purposes of
the $500,000-of-assets-per-student test
in section 4968(b)(1)(D), given that such
assets can demonstrate creditworthiness
and because money is fungible.
However, the Treasury Department and
the IRS have determined that, for ease
of administrability for both educational
institutions and the IRS, and in view of
the risk that, as a result of market forces,
the remainder eventually received by
the educational institution could be
significantly less than its present value
each year, an educational institution
will not count the assets of a charitable
remainder trust as its own assets until
the educational institution actually
becomes entitled to those assets at the
termination of the interest of the income
beneficiary. If this were not the rule, an
educational institution would have to
determine annually its share of the fair
market value of the assets of each
charitable remainder trust for which the
educational institution is a remainder
beneficiary, even though the
educational institution might not know
it had a remainder interest in all cases,
the educational institution’s remainder
interest could be given to another
charity in some instances, and the
educational institution might not
receive its remainder interest if the
trust’s investment returns turn out to be
insufficient for the trust to possess any
assets at the termination of the interests
of the income beneficiaries. An
educational institution similarly would
have difficulty determining such a
trust’s net investment income.
Therefore, these final regulations
provide that a charitable remainder trust
is not considered to be a related
organization for purposes of section
4968(d).
An educational institution will not be
a remainder beneficiary of a charitable
lead trust. Instead, some portion of the
trust’s income is payable currently to
one or more charities for a term, after
which the remaining assets of the trust
will be payable to noncharitable
beneficiaries. Thus, an educational
institution does not have any right to or
interest in the principal or remainder of
such a trust. As an income beneficiary
of a charitable lead trust, any income
payable currently to an educational
institution will be included in the
institution’s net investment income for
the current year. (This is true whether
the trust is a grantor trust (whose
income is taxed to the deemed owner of
the trust and for which there is no
current income tax deduction for the
current distribution to charity) or a
nongrantor trust (whose income is taxed
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to the trust itself, subject to a charitable
deduction).) Thus, because the assets of
a charitable lead trust are not available
to the educational institution, and its
net investment income is already
included in the educational institution’s
assets and net investment income as
received, the final regulations exclude
charitable lead trusts from the definition
of a related organization.
In addition, because there are only
limited circumstances in which the
educational institution would have
sufficient control over a trust to justify
treating the trust as a related
organization, the final regulations also
exclude all other taxable trusts from the
definition of a related organization
except to the extent the educational
institution is deemed to control the
trust, as provided in part 7.b.ii.B of this
Summary of Comments and Explanation
of Revisions.
iv. Employee Benefit Plans
Commenters stated that various
retirement and benefit plans (including
but not limited to section 403(b), section
457, voluntary employees’ beneficiary
associations (VEBAs) under section
501(c)(9), and defined benefit plans),
should be excluded from the definition
of related organization for purposes of
section 4968(d), stating that the
beneficiaries of these plans are
employees of the educational
institutions and it was not the intent of
Congress to tax the investment income
of these entities. One commenter also
asked that other assets that are set aside
or dedicated by an educational
institution to pay for the institution’s
commitment to provide certain
employee benefits be excluded from the
definition of related organization.
These final regulations base the
determination of whether assets held by
or related to an employee benefit plan
of an educational institution are
considered assets of the educational
institution on whether the arrangement
is considered to be a funded or
nonfunded plan. An employer’s
obligation to pay an employee benefit
generally is considered to be ‘‘funded’’
when the assets are set aside from the
employer exclusively to provide for the
employees’ benefits in a manner that the
assets are no longer subject to claims of
the employer’s general creditors and
may not revert back to the employer’s
general assets for use by the employer.
See Sproull v. Commissioner, 16 T.C.
244 (1951), aff’d per curiam, 194 F.2d
541 (6th Cir. 1952). For example,
contributions to the section 501(a) trust
of a section 401(a) qualified retirement
plan are considered to fund the
obligation to provide employees’ future
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retirement benefits. Similarly, a section
403(b)(1) annuity contract or amounts
held in a section 403(b)(7) custodial
account are considered to ‘‘fund’’ the
obligation to pay employees’ section
403(b) retirement benefits. In each of
these cases, the assets held in the trust,
contract, or account are considered to be
set aside to ‘‘fund’’ the employer’s
benefit obligation and are not treated as
assets of the employer. Further, amounts
held in a section 419(e) welfare benefit
fund (including a VEBA) are set aside to
provide welfare benefits for employees,
are not subject to the claims of general
creditors, and would not be treated as
assets of the employer or as assets of a
related organization.
In contrast, plans under section 457
are unfunded because funds are not set
aside for the purpose of providing
benefits to plan participants in a manner
that would result in a ‘‘funded’’
obligation to provide benefits under the
plan. Under section 457(b)(6), assets
held pursuant to an eligible deferred
compensation plan, including amounts
held in a grantor trust, must remain
solely the property and rights of the
employer and would be subject to the
claims of the employer’s general
creditors. See § 1.457–8(b)(2). Similarly,
amounts set aside by an eligible
employer intended to pay for benefits
under an ineligible section 457(f) plan,
including assets set aside in a grantor
trust, are treated as assets of the
employer and subject to the claims of
the employer’s general creditors.
Accordingly, assets set aside and held
by an educational institution, including
in a grantor trust, to be used to pay the
employees’ benefits under an
educational institution’s section 457(b)
or section 457(f) plan are considered
assets of the educational institution. As
a result, these final regulations provide
that a grantor trust or other financing
vehicle used in connection with these
unfunded plans is a ‘‘related
organization’’ for purposes of section
4968(d), and its assets will be treated as
the assets of the educational institution.
The Treasury Department and the IRS
note that, because assets in an unfunded
plan are available to the employer just
like any other assets, they are not
considered ‘‘used directly in carrying
out the institution’s exempt purpose’’
for purposes of section 4968(b)(1)(D).
Other unfunded employee benefits,
such as a typical health flexible
spending arrangement (health FSA) or
accrued leave cashout program, have no
related grantor trust or other financing
vehicle but instead use the employer’s
general assets as a source of payment.
Any general assets that are used to
satisfy benefit obligations are
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considered assets of the employer. Thus,
if the employer is an educational
institution or is a related organization
with regard to an educational
institution, such assets are considered to
be assets of the educational institution,
and no special rule is needed in the
regulations.
Solely for purposes of determining the
status of an employee benefit plan as a
funded or unfunded arrangement, an
educational institution and all of its
related organizations are treated as a
single sponsor and payor of the benefits.
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v. Decedents’ Estates
A few commenters asked that the final
regulations clarify that decedents’
estates are not ‘‘related organizations’’
under section 4968(d). Commenters
stated that, because a decedent’s estate
is a separate legal entity created at a
person’s death, it should not be
considered a related organization under
section 4968(d), and, in any case, an
educational institution would not be in
a position to control a decedent’s estate.
The Treasury Department and the IRS
agree, and to eliminate any question for
purposes of section 4968, these final
regulations provide that a decedent’s
estate is not a related organization.
However, the Treasury Department and
the IRS note that any assets of an estate
that ultimately are transferred to an
educational institution will be
considered the educational institution’s
assets upon receipt by the institution.
b. Control
As stated in part 7.a of this Summary
of Comments and Explanation of
Revisions, the first three categories of
related organizations described in
section 4968(d)(2) require the presence
of an element of control to exist for an
organization to be considered to be
‘‘related’’ to an educational
organization, but the statute does not
define the term ‘‘control.’’ The proposed
regulations provided a definition of
control based on section 512(b)(13)(D)
and the regulations thereunder and
requested comments on whether there
are any circumstances in which this
definition of control should be modified
in the context of section 4968.
Commenters asserted that the
proposed definition of control would
lead to unintended and undesirable
results. For example, commenters stated
that the downward attribution rules of
section 318 would cause all brother/
sister organizations of an educational
institution to be considered to be
controlling each other and that an
educational institution controlled by a
church could be deemed to own all the
assets of the church or the assets of
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another, unrelated church just because
the two churches were invested in the
same investment partnership.
The proposed regulation’s definition
of control did not differentiate between
an educational institution’s control of
another organization or another
organization’s control of an educational
institution. The Treasury Department
and the IRS recognize that the types of
entities that would be deemed to control
an educational institution under the
proposed rule are likely to be very
different from those that would be
controlled by an educational institution.
In addition, the direction of control
matters for purposes of determining
whether all the assets and net
investment income of a related
organization are attributable to the
educational institution or whether only
the assets and net investment income
that are intended or available for the use
or benefit of the educational institution
are attributable to the educational
institution. Accordingly, these final
regulations provide separate rules for
the different relationships that may
exist. Specifically, these final
regulations, among other things,
separately define control for
organizations that control an
educational institution, that are
controlled by an educational institution,
and that are controlled by one or more
persons that also control an educational
institution, and do not apply the
downward attribution rules of section
318.
i. Controls Such Institution
The Treasury Department and the IRS
anticipate that most applicable
educational institutions are set up as
nonstock organizations, but to cover all
circumstances, these final regulations
set out rules for control of various types
of organizational forms.
Generally, an organization will be
considered to control an educational
institution if the organization owns (by
vote or value) more than 50 percent of
the stock or membership interest of the
educational institution.
In the case of any educational
institution that does not have stock or
membership interests, the other
organization will be considered to
control an educational organization if
the other organization (or one or more
of its managers, directors, officers,
trustees, or employees, acting only in
their capacities as representatives of the
organization) can (1) appoint or elect
(which must include the power to
remove and replace) more than 50
percent of the members of the
educational institution’s governing body
(such as directors, officers, or trustees),
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or otherwise has an ongoing power to
appoint or elect more than 50 percent of
such members with reasonable
frequency; (2) require the educational
institution to make an expenditure (or
prevent the educational institution from
making an expenditure); or (3) require
the educational institution to perform
any act that significantly affects its
operations (or prevent it from
performing such an act). Such control
includes control by aggregating votes or
positions of authority (including by veto
power) but applies regardless of the
method by which the control is
exercised or exercisable.
As discussed in part 7.d of this
Summary of Comments and Explanation
of Revisions, an educational institution
generally does not take into account
assets and net investment income of a
related organization that controls the
educational institution unless the assets
and net investment income of the
related organization are intended or
available for the use or benefit of the
educational institution. However, if a
related organization both controls the
educational institution as described in
this paragraph and is also a supporting
organization described in section
509(a)(3) during the taxable year with
respect to the educational institution, as
described in part 7.b.iv of this Summary
of Comments and Explanation of
Revisions, then the rule that attributes
the largest amount of assets and net
investment income of the related
organization to the educational
institution must be applied.
ii. Is Controlled by Such Institution
The Treasury Department and the IRS
have determined that only tax-exempt
corporations, certain trusts, and
nonstock organizations controlled by an
educational institution should be
considered controlled related
organizations with respect to an
educational institution for purposes of
determining an educational institution’s
assets and net investment income under
section 4968(d)(1).
As discussed in part 7.d of this
Summary of Comments and Explanation
of Revisions, if an educational
institution controls an organization
under this definition, then it must take
into account all the assets and net
investment income of the controlled
related organization, except as provided
in parts 7.b.ii.B (relating to certain
controlled trusts), 7.c (relating to no
amount being taken into account with
respect to more than one educational
institution), 7.d.iii (relating to certain
organizations that were Type III
supporting organizations with respect to
an educational institution on December
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31, 2017), and 7.d.iv (relating to when
assets used directly in carrying out a
related organization’s exempt purpose
are considered to be used directly in
carrying out the educational
institution’s exempt purpose) of this
Summary of Comments and Explanation
of Revisions.
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A. Tax-Exempt Corporations
No comments were received relating
to the proposed rule for control of taxexempt corporations. Thus, these final
regulations retain the proposed rule and
provide that a tax-exempt corporation is
controlled by an educational institution
if the educational institution owns (by
vote or value) more than 50 percent of
the voting and nonvoting stock or
membership interest of the tax-exempt
corporation.
B. Trusts
As discussed in part 7.a.iii of this
Summary of Comments and Explanation
of Revisions, several commenters stated
that the proposed rule for control of
trusts, which provided that control of a
trust with beneficial interests means
ownership of more than 50 percent of
the beneficial interests in the trust,
would not appropriately capture trusts
that are controlled by the educational
institution within the generally
accepted meaning of that term.
Commenters stated that the trustee of a
trust does not control a trust in a way
that is relevant for purposes of section
4968, because the trustee is required to
administer the trust in accordance with,
and to the extent of the trustee’s duties
and powers as determined by, the terms
of the trust and applicable law. One
commenter suggested that, given the
limited roles of the trustee and the
beneficiary, an educational institution
should be considered to control a trust
only if the educational institution is
both a beneficiary and a trustee with the
discretionary power to make current
distributions of the trust’s income and/
or principal to itself, pursuant to the
terms of the trust.
The Treasury Department and the IRS
agree with commenters that a control
rule for trusts based on an educational
institution having a more than 50
percent beneficial interest leads to
unintended results. However, the
Treasury Department and the IRS
believe that the commenter’s
recommended rule is too narrow and
could allow an educational institution
to transfer endowment assets into a trust
that it would not be considered to
control under the recommended rule,
but that it did control in substance.
The Treasury Department and the IRS
acknowledge that the concept of control
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does not comport well with trusts.
Possibly the only person with control
over a trust is a person with the power
to revoke the trust; even the trustee’s
‘‘control’’ is limited by the provisions of
the trust instrument and applicable law.
In attempting to construct a replacement
for the control rule for trusts to be used
in the context of section 4968, the
Treasury Department and IRS identified
the four specific circumstances under
which a trust should be deemed to have
a relationship with the educational
institution that is sufficiently similar to
that generally intended by the concept
of control. However, in two of these
circumstances, these final regulations
recognize that the deemed control is
only with regard to some of the assets
of the trust; consequently, in the third
and fourth circumstances explained in
the subsequent paragraphs, only a
portion of the trust is considered to be
a related organization and only some of
the assets and net investment income
are attributed to the educational
institution.
The first circumstance is where the
educational institution is the sole
permissible trust beneficiary. In this
circumstance, several factors would be
irrelevant, such as the identity of the
trustee, the timing and standards for
making trust distributions, and the
donors to the trust. To prevent the
existence of another trust beneficiary,
whether purely discretionary or with
only a minimal interest in the trust,
from being used to avoid this rule, the
test refers to the educational institution
being ‘‘substantially’’ the sole trust
beneficiary.
A second circumstance is where the
trust is a pooled income fund described
in sections 642(c)(3) and 642(c)(5).
Although a certain portion of the net
income of the fund is payable on a
current basis to the donors to the fund,
the fund is managed by the educational
institution, the educational institution is
the sole remainderman of the fund, and
a portion of the fund becomes payable
to the educational institution as each
donor’s interest expires. Given the
different times (generally based on the
date of death of individual donors)
when portions of the trust principal will
become payable to the educational
institution, and the control of the fund
by the educational institution, the
Treasury Department and the IRS have
determined that it is appropriate to
deem a pooled income fund described
in sections 642(c)(3) and 642(c)(5) to be
controlled by that institution.
A third circumstance is where the
trust has been funded with assets of the
educational institution. If, and only to
the extent that, the trust’s funding
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consisted of assets contributed to the
trust by the educational institution (or
by a person controlled by the
educational institution), the Treasury
Department and the IRS concluded that
the trust’s assets and net income should
be attributed to the educational
institution.
Finally, the Treasury Department and
the IRS concluded that any portion of a
trust that the educational institution (or
a person controlled by the educational
institution) can demand or cause to be
distributed to the educational
institution (or a person controlled by the
educational institution) should be
attributed to the educational institution.
Therefore, these final regulations
provide that a trust is a related
organization, and an educational
institution is deemed to control that
trust, only: (1) If the educational
institution is substantially the sole
permissible trust beneficiary or
appointee of both income and principal,
whether or not the timing of
distributions is subject to the trustee’s
discretion; (2) if the trust is a pooled
income fund described in section
642(c)(3) and (5); (3) if, but only to the
extent that, the assets of the trust were
contributed to the trust by the
educational institution (or by a person
controlled by the educational
institution, as determined under these
regulations); or (4) if, but only to the
extent that, the educational institution
(or a person controlled by the
educational institution, as determined
under these regulations) has the right to
demand (or can otherwise cause) a
distribution of principal from the trust
to the educational institution (or a
person controlled by the educational
institution).
For purposes of this definition, a
person is controlled by an educational
institution if the educational institution
has the power to remove and replace
such person or otherwise controls the
person under one of the tests in
§ 53.4968–3(b)(2)(i), (ii), or (iii), with
similar principles applying for purposes
of determining control of any other form
of entity.
C. Nonstock Organizations
One commenter objected to the
proposed rule for control of nonstock
organizations, stating that the portion of
the rule that is based on directors or
trustees of the educational institution
being representatives of the other
organization often incorrectly
determines which entity controls the
other, as the presence of common
directors or trustees alone is not
determinative of control. The
commenter stated that the
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representatives test from the proposed
regulations could be especially
devastating to hierarchical religious
organizations using corporation sole or
similar structures, which have neither
directors nor trustees. If one made a
natural extension of the proposed rule
by treating the incumbent officer of a
‘‘corporation sole’’ as a sole director or
trustee, hierarchical religious
organizations could be affected because
an ecclesiastical officeholder could not
be on the board of any educational
institution without causing that
religious organization to be deemed to
be controlled by that educational
institution. The commenter stated that
control tests found in other sections of
the Code relating to tax-exempt
organizations, such as the control tests
found in sections 507, 509, 4911, 4941,
4942, and 4943, would be more relevant
and appropriate for purposes of section
4968. For example, these tests include
the power to cause a certain act, often
acting solely in the capacity of
foundation manager.
The Treasury Department and the IRS
agree that a modified version of control
for nonstock organizations that is based
on the power of the educational
institution (or one or more of its
managers, directors, officers, trustees, or
employees acting only in the capacity as
a representative of the educational
institution) to cause (or prevent) a
certain act would also appropriately
reflect control by the educational
institution over the nonstock
organization.
Thus, these final regulations provide
that an educational institution controls
a nonstock organization if the
educational institution (or one or more
of its managers, directors, officers,
trustees, or employees acting only in
those capacities) can (1) appoint or elect
(which must include the power to
remove and replace) more than 50
percent of the members of the nonstock
organization’s governing body (such as
directors, officers, or trustees), or
otherwise has the ongoing power to
appoint or elect more than 50 percent of
such members with reasonable
frequency; (2) require the nonstock
organization to make an expenditure (or
prevent the organization from making
an expenditure); or (3) require the
nonstock organization to perform any
act that significantly affects its
operations (or prevent it from
performing such an act). Such control
includes control by aggregating votes or
positions of authority (including by veto
power) but applies regardless of the
method by which the control is
exercised or exercisable.
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iii. Is Controlled by One or More
Persons That Also Control Such
Institution
The proposed regulations provided a
rule relating to control of a nonstock
organization by one or more persons
that also control an educational
institution, finding control if more than
50 percent of the directors or trustees of
the nonstock organization are directly or
indirectly controlled by one or more
persons that control the educational
institution.
In recognition that the other
organization might be other than a
nonstock organization, these final
regulations provide a separate rule for
organizations that are controlled by one
or more persons that also control such
institution. Under these final
regulations, an organization is
controlled by one or more persons that
also control the educational institution
if more than 50 percent of the members
of the governing body of the other
organization is directly or indirectly
controlled by persons that comprise
more than 50 percent of the members of
the governing body of the educational
institution.
As discussed in part 7.d of this
Summary of Comments and Explanation
of Revisions, an educational institution
does not take into account assets and
net investment income of a related
organization that is controlled by one or
more persons that also control the
educational institution unless the assets
and net investment income are intended
or available for the use or benefit of the
educational institution. However, if a
related organization is both (1)
controlled by one or more persons that
also control the educational institution,
as described in this part 7.b.iii, and also
is (2) controlled by the educational
organization, as described in part 7.b.ii
of this Summary of Comments and
Explanation of Revisions or is also a
supporting organization described in
section 509(a)(3) during the taxable year
with respect to the educational
institution, as described in part 7.b.iv of
this Summary of Comments and
Explanation of Revisions, then the rule
that attributes the largest amount of
assets and net investment income of the
related organization to the educational
institution must be applied.
Nevertheless, the exceptions allowing
certain assets and net investment
income to not be taken into account
described in parts 7.b.ii.B (relating to
certain controlled trusts), 7.c (relating to
no amount being taken into account
with respect to more than one
educational institution), 7.d.iii (relating
to certain organizations that were Type
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III supporting organizations with respect
to an educational institution on
December 31, 2017), and 7.d.iv (relating
to when assets used directly in carrying
out a related organization’s exempt
purpose are considered to be used
directly in carrying out the educational
institution’s exempt purpose) of this
Summary of Comments and Explanation
of Revisions, continue to apply.
iv. Supporting Organizations Described
in Section 509(a)(3)
Section 4968(d)(2)(C) includes within
the definition of related organization
any supporting organization (as
described in section 509(a)(3)) during
the taxable year with respect to the
educational institution.
One commenter noted that a Type I
supporting organization 7 controlled by
a community foundation that supports a
class of entities that includes an
educational institution within the class
should be considered to be a Type I
supporting organization only ‘‘with
respect to’’ the controlling community
foundation and not ‘‘with respect to’’ an
educational institution. The commenter
suggested that an organization be
considered a supporting organization
with respect to the educational
institution only if the supporting
organization meets the organizational,
operational, and relationship tests with
respect to the educational institution,
considered in isolation. The Treasury
Department and the IRS agree that a
section 509(a)(3) organization is a
supporting organization ‘‘with respect
to’’ an educational institution only if the
supporting organization meets the
organizational, operational, and
relationship tests with respect to the
educational institution, and have
clarified this point in these final
regulations.
The commenter further suggested that
an organization be deemed to be
described in section 509(a)(3) with
respect to an educational institution
only if (1) it is described in section
7 Organizations described in section 509(a)(3) are
known as ‘‘supporting organizations.’’ Supporting
organizations achieve their public charity status by
providing support to one or more organizations
described in section 509(a)(1) or (2), which, in this
context, are referred to as ‘‘supported
organizations.’’ To be described in section 509(a)(3),
an organization must satisfy several tests, including
having one of three ‘‘relationships’’ with one or
more supported organizations. A supporting
organization that is operated, supervised or
controlled by one or more supported organizations
is known as a ‘‘Type I’’ supporting organization. A
supporting organization that is supervised or
controlled in connection with one or more
supported organizations is known as a ‘‘Type II’’
supporting organization. A supporting organization
that is operated in connection with one or more
supported organizations is known as a ‘‘Type III’’
supporting organization.
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509(a)(3); (2) it bears a Type I, Type II,
or Type III relationship to the
educational institution; and (3)
substantially all, or at least a majority,
of its activities are for the benefit of,
perform the functions of, or carry out
the purposes of the educational
institution or other public charities
controlled by the educational
institution. The Treasury Department
and the IRS disagree with this reading
because a supporting organization may
be a supporting organization (as
described in section 509(a)(3) and the
regulations under section 509(a)(3))
with respect to the educational
institution, despite the fact that less
than a majority of its activities are for
the benefit of, perform the functions of,
or carry out the purposes of the
educational institution or other public
charities controlled by the educational
institution. Thus, these final regulations
do not adopt this recommendation.
The commenter noted that a
supporting organization that is not a
supporting organization ‘‘with respect
to’’ an educational institution may still
be related to the institution under one
of the other tests, and that a Type I or
Type II supporting organization with
respect to the educational institution
may be considered both a supporting
organization with respect to the
educational institution described in
section 4968(d)(2)(C) and an
organization controlled by the
educational institution described in
section 4968(d)(2)(A) or an organization
controlled by one or more persons that
also control the educational institution
described in section 4968(d)(2)(B). The
Treasury Department and the IRS agree,
but in cases in which an organization is
a related organization with respect to an
educational institution on more than
one basis, if one of the bases is that the
organization is either controlled by the
educational institution as described in
part 7.b.ii of this Summary of Comments
and Explanation of Revisions, or is a
supporting organization (as described in
section 509(a)(3)) with respect to the
educational institution during the
taxable year, then the rule that attributes
the largest amount of assets and net
investment income of the related
organization to the educational
institution must be applied.
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v. Constructive Ownership
The proposed regulations provided
that the principles of section 318 apply
for purposes of determining ownership
of stock in a corporation and that
similar principles apply for purposes of
determining ownership in any other
entity.
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Commenters noted that section 318
provides rules for attribution from
entities under section 318(a)(2) (upward
attribution) and to entities under section
318(a)(3) (downward attribution). In
general, under upward attribution, (1)
partners in a partnership are each
considered to own a proportionate share
of stock owned by or for the
partnership; (2) beneficiaries of a trust
are each considered to own a
proportionate share of stock owned by
or for the trust based on their actuarial
interests in the trust; and (3) a person
that owns stock representing 50 percent
or more of the value of a corporation is
considered to own a proportionate share
of the stock owned by or for such
corporation. In general, under
downward attribution, partnerships and
trusts are considered to own stock
owned by or for their partners and
beneficiaries, respectively, and
corporations are considered to own
stock owned by or for a person that
owns stock representing 50 percent or
more of the value of the corporation.
Commenters noted that application of
the downward attribution rules can lead
to an institution being deemed to
control an organization that it does not
actually control.
The Treasury Department and the IRS
agree with commenters that application
of the principles of section 318(a)(3)
may lead to unintended results. Thus,
these final regulations provide that the
principles of section 318(a)(2) apply for
purposes of determining ownership of
stock in a corporation, and similar
principles apply for purposes of
determining ownership of interests in
any other entity.
c. Assets and Net Income Treated as
Assets and Net Income of Only One
Educational Institution
As noted at the beginning of this part
7, section 4968(d)(1) provides, in part,
that for purposes of determining the
aggregate fair market value of an
institution’s assets and its net
investment income, the assets and net
investment income of all related
organizations with respect to the
educational institution are treated as
assets and net investment income,
respectively, of the educational
institution. However, section
4968(d)(1)(A) provides an exception
under which no such amount is taken
into account with respect to more than
one educational institution.
In order to effectuate the exception
contained in section 4968(d)(1)(A), the
proposed regulations provided that, in
any case in which an organization is a
related organization with respect to
more than one educational institution,
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65547
the assets and net investment income of
the related organization must be
allocated among the educational
institutions as to which the organization
is a related organization. The proposed
regulations provided that such
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 Treasury Department
and the IRS requested comments on
whether more specific guidance is
required concerning the allocation of a
related organization’s assets and net
investment income among multiple
educational institutions being supported
by the same related organization, and if
so, what such additional guidance
should be provided. One commenter
agreed with the proposed regulation,
saying that any reasonable methodology
that takes into account all facts and
circumstances and is applied
consistently across all related
organizations is appropriate for
purposes of avoiding double-counting of
related organizations’ assets and
income. Thus, these final regulations
adopt the proposed rule and add that
the allocation must be consistently
applied.
d. Assets and Net Investment Income of
Related Organizations
For purposes of attributing assets and
net investment income of related
organizations to educational
institutions, section 4968(d)(1)(B)
provides that, unless a related
organization is controlled by the
educational institution or is a
supporting organization described in
section 509(a)(3) with respect to such
institution for the taxable year, 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.
Put another way, if a related
organization (1) controls the educational
institution (but is not described in
section 509(a)(3) with respect to the
educational institution for the taxable
year as described in part 7.b.iv of this
Summary of Comments and Explanation
of Revisions), (2) is controlled by one or
more persons that also control such
institution (but is neither controlled by
the educational institution as described
in part 7.b.ii of this Summary of
Comments and Explanation of Revisions
nor is described in section 509(a)(3)
with respect to the educational
institution), or (3) is a supported
organization (as defined in section
509(f)(3)) with respect to the
educational institution during the
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taxable year, then the related
organization’s assets and net investment
income are taken into account as assets
and net investment income of the
educational institution only to the
extent the assets and net investment
income are intended or available for the
use and benefit of the educational
institution.
However, if a related organization
either (1) is controlled by the
educational institution or (2) is a
supporting organization described in
section 509(a)(3) with respect to such
institution for the taxable year, then all
the assets and net investment income of
the related organization are considered
assets and net investment income of the
educational institution, except as
provided in parts 7.b.ii.B (relating to
certain controlled trusts), 7.c (relating to
an exception under which no such
amount is taken into account with
respect to more than one educational
institution), 7.d.iii (relating to certain
organizations that were Type III
supporting organizations with respect to
an educational institution on December
31, 2017), and 7.d.iv (relating to when
assets used directly in carrying out a
related organization’s exempt purpose
are considered to be used directly in
carrying out the institution’s exempt
purpose) of this Summary of Comments
and Explanation of Revisions.
i. Related Organizations That Control
the Educational Institution, Are
Controlled by One or More Persons That
Also Control the Educational
Institution, or Are Supported
Organizations (as Defined in Section
509(f)(3)) With Respect to the
Educational Institution During the
Taxable Year
As discussed in part 7.d of this
Summary of Comments and Explanation
of Revisions, the assets and net
investment income of certain related
organizations are taken into account
only to the extent that they are intended
or available for the use and benefit of
the educational institution. In
determining which assets and net
investment income are considered
‘‘intended or available for the use and
benefit of’’ the educational institution,
the Conference Report states, ‘‘[f]or
example, assets of a related organization
that are earmarked or restricted for (or
fairly attributable to) the educational
institution would be treated as assets of
the educational institution, whereas
assets of a related organization that are
held for unrelated purposes (and are not
fairly attributable to the educational
institution) would be disregarded.’’ H.
Rept. 115–466, 115th Cong., 1st sess., at
555 (December 15, 2017).
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The proposed regulations provided
that when an educational institution is
determining which assets and net
investment income are ‘‘intended or
available for the use or benefit of’’ the
educational institution, the educational
institution must make an allocation
between those assets and net investment
income that are intended or available for
the use and benefit of the educational
institution and those not intended or
not available for the use and benefit of
that educational institution. Such
allocation must be made in a reasonable
manner, taking into account all facts
and circumstances, and must be
consistently applied across all related
organizations.
One commenter agreed with this
approach, stating that it is reasonable to
permit an educational institution to take
into account its own unique facts and
circumstances and use any reasonable
method to allocate the assets and net
investment income.
The preamble to the proposed
regulations further explained that assets
and net investment income of such a
related organization are intended or
available for the use and benefit of an
educational institution if such 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 such assets
and net investment income are
specifically earmarked or restricted for
another entity or for unrelated purposes
or otherwise are not fairly attributable to
that educational institution.
The preamble to the proposed
regulations requested comments on
situations in which an organization’s
assets or net investment income is not
specifically earmarked or restricted for
the benefit of any particular
organization but otherwise is fairly
attributable to the educational
institution or to another organization.
For example, the proposed regulations
asked whether, absent any earmarking
or restriction, total distributions from a
related organization to an educational
institution in one taxable year should
establish a presumption for section 4968
purposes that at least an equal amount
is fairly attributable to that educational
institution for the following taxable
year, absent demonstrated facts and
circumstances supporting attribution of
a lesser amount.
One commenter stated that, because
earmarked and restricted funds are
subject to legally binding requirements
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that the assets must be used solely for
the designated recipient, such funds are
a clear example of assets ‘‘intended for’’
a particular organization. In contrast,
internal board decisions to allocate
funds to certain purposes do not
typically convert funds into restricted
funds because the board still has
authority to reverse its previous
decision without obtaining any outside
consent. However, the commenter noted
that certain assets that have been
affirmatively designated for use by an
educational institution could be
‘‘intended for’’ the institution, and thus
‘‘fairly attributable,’’ even if not subject
to a binding restriction. This commenter
recommended that the unrestricted,
undesignated assets of a related
organization will not be treated as
intended or available for the educational
institution unless they have been
affirmatively designated or appropriated
for the educational institution or made
available for the educational institution
to draw upon at will; in other words, if
they have been approved and directed
by the related organization for use by
the educational institution. These final
regulations adopt this recommendation.
A few commenters said that total
distributions from a related organization
to an educational institution in one
taxable year should not establish a
presumption for section 4968 purposes
that at least an equal amount is fairly
attributable to the educational
institution for the following taxable
year. One commenter recommended
creating a rebuttable presumption based
upon an average of distributions from
the related organization over a number
of years. Another commenter noted that
there is no need to estimate possible
future distributions because the excise
tax under section 4968 is based on data
that is known at the time the annual
return is being prepared, so the exact
amount of distributions do not have to
be estimated. This commenter stated
that if such a presumption did apply, it
should be rebuttable based on facts
showing that the previous year’s
amounts distributed were for special
projects and not ‘‘intended or available
for’’ the educational institution the
following year. In response to the
comments, these final regulations do not
include a presumption based on
previous distributions.
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ii. Related Organizations That Are
Controlled by the Educational
Institution or That Are Supporting
Organizations (as Described in Section
509(a)(3)) With Respect to the
Educational Institution During the
Taxable Year
If a related organization (1) is
controlled by an educational institution,
as described in part 7.b.ii of this
Summary of Comments and Explanation
of Revisions, or (2) is a supporting
organization (as defined in section
509(a)(3) and described in part 7.b.iv of
this Summary of Comments and
Explanation of Revisions) with respect
to the educational institution during the
taxable year, then the assets and net
investment income of the related
organization must be taken into account
as assets and net investment income of
the educational institution, regardless of
whether the assets and net investment
income are earmarked, restricted for the
benefit of, or otherwise are fairly
attributable to that educational
institution, and even if they are
specifically earmarked or restricted for
another entity or for unrelated purposes
or otherwise are not fairly attributable to
that educational institution. However,
the special rule in section 4968(d)(1)(A)
continues to apply, preventing the
assets and net investment income of the
related organization from being taken
into account by more than one
educational institution. See part 7.c of
this Summary of Comments and
Explanation of Revisions. In addition,
assets that are used directly for the
related organization’s exempt purpose
are considered used directly in carrying
out the educational institution’s exempt
purpose for purposes of section
4968(b)(1)(D), as described in parts 5.e
and 7.d.iv of this Summary of
Comments and Explanation of
Revisions. There also is a special rule
for related organizations that were Type
III supporting organizations with respect
to the educational institution on
December 31, 2017, as described in part
7.d.iii of this Summary of Comments
and Explanation of Revisions.
iii. Special Rule for Related
Organizations That Were Type III
Supporting Organizations With Respect
to an Educational Institution on
December 31, 2017
In recognition that section 509(a)(3)
Type III supporting organizations,
unlike section 509(a)(3) Type I and Type
II supporting organizations, are not
directly or indirectly controlled by their
supported organizations,8 and because
8 As mentioned in footnote 9 of this preamble,
there are three types of supporting organizations:
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educational institutions may not be able
to get the needed information from their
Type III supporting organizations on a
timely basis, the proposed regulations
provided a special rule for related
organizations of an educational
institution that were Type III supporting
organizations with respect to an
educational institution on December 31,
2017.
That special rule allowed an
educational institution with a related
organization that was a Type III
supporting organization with respect to
the educational institution on December
31, 2017, to take into account only the
assets and net investment income of the
related Type III supporting organization
that are intended or available for the use
and benefit of the educational
institution, rather than the value of all
of that organization’s assets or amount
of net investment income. The proposed
regulations provided that an educational
institution can determine whether the
assets and net investment income of
such a Type III supporting organization
are intended or available for the use and
benefit of the educational institution
using any reasonable method. The
proposed regulations set out one
method for determining the amount of
net investment income available to the
educational institution that would be
considered to be reasonable (i.e., using
all the distributions received from a
Type III supporting organization subject
to this special rule as net investment
income of the educational institution
each year) and one method for
determining assets available to the
educational institution that would be
considered to be reasonable (i.e., using
the distributions received from a Type
III supporting organization to calculate
the percentage of the Type III
supporting organization’s total net
income that was distributed to the
educational institution, and using the
same percentage to calculate the value
of the underlying assets of the Type III
supporting organization that are
intended or available for the use and
benefit of the educational institution
each year). The proposed regulations
requested comments on whether
additional guidance pertaining to Type
III supporting organizations was needed.
One commenter stated that the safe
harbor methods in the proposed
regulations would in many cases lead to
strange results, stating that the fact that
a particular subsidiary makes a
distribution to an educational
Type I, Type II, and Type III. The relationship of
a Type III supporting organization with its
supported organization(s) is much more attenuated
than the other two types.
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65549
institution in one year in no way
implies that the educational institution
has similar amounts available to it in
future years, let alone to a
corresponding portion of the related
organization’s entire asset base. The
commenter suggested that only the
amounts actually distributed or
appropriated to the educational
institution should be treated as intended
or available for the educational
institution.
For consistency with the general rule
for determining which assets and net
investment income are considered
‘‘intended or available for the use and
benefit of’’ an educational institution,
and in response to the comment, these
final regulations do not include the safe
harbor method in the proposed
regulations. Instead, these final
regulations provide that a method using
assets and net investment income of the
Type III supporting organization (with
respect to the educational institution as
of December 31, 2017), that are
specifically earmarked for an
educational institution, are restricted for
the benefit of an educational institution,
and are otherwise fairly attributable to
an educational institution (such as those
that have been affirmatively designated
or appropriated for the educational
institution or made available for the
educational institution to draw upon at
will) will be deemed to be reasonable.
Several commenters asked that the
special rule for related organizations
that were Type III supporting
organizations with respect to the
educational institution on December 31,
2017, be extended to cover all Type III
supporting organizations. One asked
that the special rule be extended to
Type I and Type II supporting
organizations, one asked that it be
extended to split-interest trusts, and one
asked that it cover all related
organizations for which the educational
institution lacks ‘‘effective control.’’
Although the Treasury Department
and the IRS have concluded that a
transition rule with respect to entities
that were Type III supporting
organizations with respect to an
educational institution on December 31,
2017, is appropriate, extending this rule
to other organizations would be contrary
to the statute. In addition, the Treasury
Department and the IRS have concluded
that excluding certain categories of
organizations from the definition of
related organization, as described in
part 7.a of this Summary of Comments
and Explanation of Revisions, and
explaining that a supporting
organization must be described in
section 509(a)(3) ‘‘with respect to’’ an
educational institution during the
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taxable year, as described in part 7.b.iv
of this Summary of Comments and
Explanation of Revisions, address most
of the commenters’ concerns.
iv. Interaction With Section
4968(b)(1)(D)
As described in part 5.f of this
Summary of Comments and Explanation
of Revisions, these final regulations
provide that an asset of a related
organization that is treated as an asset
of an educational institution by section
4968(d) and that is used directly in
carrying out an educational institution’s
exempt purpose is considered to be
used directly by the educational
institution in carrying out its exempt
purpose for purposes of section
4968(b)(1)(D). In addition, an asset of a
related organization described in section
501(c)(3) that is treated as an asset of an
educational institution by section
4968(d) and that is used directly in
carrying out the related organization’s
exempt purpose is considered to be
used directly by the educational
institution in carrying out its exempt
purpose for purposes of section
4968(b)(1)(D).
8. Penalty Waiver
One commenter asked that any
penalties arising from underpayment of
the excise tax for tax years prior to and
including tax years in which final
guidance is issued be waived. A waiver
of penalties is beyond the scope of these
regulations. In addition, these final
regulations are not effective until the
taxable year beginning after publication
of the final regulations. Thus, applicable
educational institutions will have up to
a year to comply with the final
regulations, and for prior taxable years
applicable educational institutions can
comply with the statute using a
reasonable good faith interpretation.
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Applicability Date
These final regulations apply to
taxable years of an educational
institution beginning after October 15,
2020.
Special Analyses
Executive Orders 12866, 13563, and
13771 direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits, of
reducing costs, of harmonizing rules,
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and of promoting flexibility. The
Executive Order 13771 designation for
this regulation is regulatory.
The final regulations have been
designated by the Office of Management
and Budget’s (OMB) Office of
Information and Regulatory Affairs
(OIRA) as subject to review under
Executive Order 12866 pursuant to the
Memorandum of Agreement (April 11,
2018) between the Treasury Department
and OMB regarding review of tax
regulations. OIRA has determined that
the final rulemaking is significant and
subject to review under Executive Order
12866 and section 1(b) of the
Memorandum of Agreement.
Accordingly, the final regulations have
been reviewed by OMB.
I. Need for Regulation
The Conference Report, at 555, states
that Congress intended that the
Secretary promulgate regulations to
carry out the intent of section 4968.
These final regulations are in response
to this congressional intent. The final
regulations provide guidance for
determining the excise tax applicable to
the net investment income of certain
private colleges and universities, as
provided by the TCJA. The regulations
are intended to clarify which
educational institutions are subject to
the excise tax under section 4968
(excise tax) and how net investment
income is calculated for purposes of this
excise tax.
The Treasury Department and the IRS
received 18 formal comments regarding
these proposed definitions and rules,
and there was a degree of taxpayer
uncertainty as to whether the
definitions of the various terms and
whether the rules for computing net
investment income would remain the
same as those provided in the notice of
proposed rulemaking.
Pursuant to section 6(a)(3)(B) of
Executive Order 12866, the following
qualitative analysis provides further
details regarding the anticipated
impacts of the final regulations. The
statute and the final regulations are
briefly described in Part II of this
Special Analyses section. The baseline
used for the analysis is described in Part
III. Part IV describes the types of entities
affected by the proposed regulations.
Part V provides a qualitative assessment
of the potential economic effects,
including the benefits and costs, of the
proposed regulations compared to the
baseline.
II. The Statute and the Final
Regulations
Section 4968 imposes a 1.4 percent
excise tax on the net investment income
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of applicable educational institutions.
Under the statute, an ‘‘applicable
educational institution’’ is an eligible
educational institution (which is
described in section 25A(f)(2)) that has
at least 500 tuition-paying students
during the preceding taxable year, more
than 50 percent of whom are located in
the United States, that is not a state
college or university, and the fair market
value of the assets of which (other than
those assets that are used directly in
carrying out the institution’s exempt
purpose) is at least $500,000 per student
at the end of the preceding taxable year.
Under section 4968, net investment
income is determined under rules
‘‘similar to’’ the rules of section 4940(c)
(the rules for the calculation of the net
investment income of private
foundations). In addition, the statute
contains a rule under which the assets
and net investment income of related
organizations generally are treated as
the assets and net investment income of
the educational institution.
Section 4968 does not define the
terms ‘‘student,’’ ‘‘tuition-paying
student,’’ or ‘‘assets used directly in
carrying out the institution’s exempt
purpose.’’ Section 4968(c) states that, for
the purposes of the excise tax in section
4968, net investment income is
determined under rules ‘‘similar to’’ the
rules of section 4940(c) but does not
define what is meant by ‘‘similar to.’’
Section 4968 does not define the term
‘‘control’’ as it relates to the definition
of a ‘‘related organization with respect
to an educational institution.’’ The final
regulations provide general definitional
guidance with respect to these and other
terms and rules relevant to the
implementation of the statute.
III. Baseline
The Treasury Department and the IRS
have assessed the benefits and costs of
the final regulations relative to a noaction baseline reflecting anticipated
Federal income tax-related behavior in
the absence of these final regulations.
IV. Affected Entities
One researcher used data from the
Integrated Post-Secondary Education
Data System (IPEDS) on endowment
values at the end of the 2015–2016
academic year and enrollment data to
estimate the number of institutions at
risk of having liability under this excise
tax.9 Under the assumption that none of
the assets in the endowment are for
9 Levine, Phillip. ‘‘The University Endowment
Income Tax: Who Will Pay it and Why Was it
Implemented?’’, Econofact, January 25, 2018,
available at https://econofact.org/the-universityendowment-tax-who-will-pay-it-and-why-was-itimplemented, accessed April 29, 2019.
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exempt purposes, he estimates that 23
institutions are likely to be currently
subject to tax. Using the same IPEDS
data, another researcher estimated that
in 2016, among four-year public and
not-for-profit private institutions located
in the United States with at least 500
full-time equivalent students, and
excluding endowments held at the
university system level, there were 27
endowments worth at least $500,000 per
student.10 These estimates do not take
into account all of the provisions of the
statute and regulations. For example,
limiting this set of institutions to the
not-for-profit private institutions subject
to tax and excluding assets that are used
for the institutions’ exempt purpose
would reduce the number of affected
institutions. On the other hand, as both
authors note, because the $500,000 per
student threshold for the aggregate fair
market value of assets (other than those
assets which are used directly in
carrying out the institution’s exempt
purpose) that in part determines
whether the excise tax in section 4968
applies to an educational institution is
not indexed for inflation, the number of
institutions to which the excise tax in
section 4968 applies is expected to
increase over time. In addition, these
studies did not consider assets held by
related organizations; including such
assets could increase the number of
affected institutions.
V. Economic Effects of the Final
Regulations
The Treasury Department and the IRS
anticipate that the issuance of guidance
pertaining to section 4968 will provide
a marginal net economic benefit to the
overall U.S. economy.
The final regulations clarify a number
of definitions related to the excise tax in
section 4968. In the absence of
guidance, affected taxpayers would have
to calculate their tax liability without
the definitions and clarifications
provided by the final regulations, a
situation that is generally considered
more burdensome and could lead to
greater conflicts with tax administrators.
The final regulations make use of a
number of existing statutory and
regulatory provisions in defining
students, tuition, exempt purpose, fair
market value, net investment income
and related organizations. Many
taxpayers already will be familiar with
these definitions. Thus, the Treasury
Department and the IRS project that the
final regulations will reduce taxpayer
compliance burden relative to the no10 Hinrichs, Peter. ‘‘College Endowments.’’
Economic Commentary 2018–04 (May 17, 2018),
Federal Reserve Bank of Cleveland, Table 1.
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action baseline, including in
determining whether the excise tax
applies to the institution and the
computation of the excise tax. However,
it is possible that the final regulations
will have other economic effects based
on the time needed to file the return as
well as the costs of tax administration,
including monitoring the compliance of
taxpayers with the excise tax.
The guidance provided in the final
regulations also ensures that the excise
tax liability is calculated similarly
across taxpayers, avoiding situations
where one taxpayer receives preferential
treatment over another taxpayer for
fundamentally similar economic
activity. For example, in the absence of
these final regulations, an educational
institution may have uncertainty over
whether it is subject to the excise tax
under section 4968 and what assets are
used in determining the net investment
income for purposes of the excise tax
under section 4968. As a result, in the
absence of guidance, similar institutions
might take different positions and pay
different amounts of tax, introducing
economic inefficiency and inequity.
Based on this analysis, the Treasury
Department and the IRS anticipate the
net economic contribution of the final
regulations will be modest and will be
positive relative to not issuing any such
guidance and conditional on the
relevant statutes. In the proposed
regulations, the Treasury Department
and the IRS requested comments on a
number of aspects of the proposed
regulations, which included comments
on the economic effects, any behavioral
changes caused, or the unintended costs
and benefits of the regulations. The
Treasury Department and the IRS did
not receive any comments on these
issues.
VI. Economic Analysis of Specific
Provisions
The regulations embody certain
regulatory decisions that reflect the
necessary exercise of regulatory
discretion. These decisions specify more
fully how section 4968 is to be
implemented.
A. Clarifications of Definitions
Consistent with the statute, the final
regulations provide that the term
‘‘applicable educational institution’’
means any eligible educational
institution: (1) That had at least 500
tuition-paying students attending the
institution during the preceding taxable
year; (2) with more than 50 percent of
whose tuition-paying students are
located in the United States; (3) that is
not described in the first sentence of
section 511(a)(2)(B) (relating to state
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colleges and universities); and (4) the
aggregate fair market value of the assets
of which at the end of such preceding
taxable year (other than those assets that
are used directly in carrying out the
institution’s exempt purpose) is at least
$500,000 per student attending the
institution.
Many provisions of the final
regulations clarify definitions related to
the tax imposed by section 4968,
minimizing the burdens entities bear to
comply with the tax, and have little
other economic impact. Clarifications
reduce uncertainty, lower the effort
required to infer which institutions are
subject to the section 4968 tax and the
potential for conflict if entities and tax
administrators interpret provisions
differently. Examples of clarifications
include the definition of ‘‘applicable
educational institution,’’ ‘‘student,’’
‘‘tuition-paying,’’ ‘‘located in the United
States,’’ and ‘‘assets.’’
i. Definition of ‘‘Student’’
The definition of ‘‘applicable
education institution’’ relies on the
definition of ‘‘student.’’ In section
25A(b)(3) and the Higher Education Act,
a ‘‘student’’ is defined as a person
enrolled in a degree, certification, or
other program (including a program of
study abroad approved for credit by the
eligible educational institution at which
such student is enrolled) leading to a
recognized educational credential at an
eligible educational institution, and
who is not enrolled in an elementary or
secondary school.
The proposed regulations provided
that the number of students of an
educational institution (including for
purposes of determining the number of
students at a particular location) is
based on the daily average number of
full-time students attending such
institution (with part-time students
taken into account on a full-time
student equivalent basis). Under the
proposed regulations, the standards for
determining part-time students, fulltime students, full-time equivalents, and
daily average are generally determined
by each educational institution.
Two commenters recommended that
the definition of ‘‘student’’ be expanded
to include all students attending the
institution even if not enrolled in a
degree, certification, or other program
leading to a recognized educational
credential. One concern was that the
term ‘‘recognized educational
credential’’ was ambiguous.
The final regulations define the term
‘‘student’’ as a person who is enrolled
and attending a course for academic
credit from the institution and who is
being charged tuition at a rate that is
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commensurate with the tuition rate
charged to students enrolled for a
degree.
ii. Definition of ‘‘Tuition-Paying’’
The proposed regulations provided
that the term ‘‘tuition-paying’’ means
the payment of any tuition or fees
required for the enrollment or
attendance of a student for a course of
instruction at an eligible educational
institution. The proposed regulations
stated that this 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, or the payment of
room and board or other personal living
expenses. In addition, the proposed
regulations provided that whether a
student is ‘‘tuition-paying’’ is
determined after taking into account any
scholarships provided directly by the
educational institution and any work
study programs operated directly by the
educational institution; however,
scholarship payments provided by third
parties, even if administered by the
institution, are considered payments of
tuition on behalf of the student.
Commenters sought clarification on
how scholarships from different sources
counted toward tuition, given that the
proposed regulations considered tuition
after taking into account scholarships
and work-study programs offered
directly from the institution. One
commenter was specifically concerned
with Federal and state financial aid and
non-governmental scholarships not paid
by the institution. The final regulations
do not count Federal, state, and local
grants or financial aid as ‘‘tuition,’’ but
do count grants and scholarships
provided by a non-governmental party
other than the particular educational
institution as ‘‘tuition.’’
In summary, ‘‘tuition’’ excludes
payments made by or on behalf of the
student by the institution or from any
Federal, state, and local governmental
sources. These clarifications in the final
regulations will more easily allow
institutions to determine the
applicability of the statute.
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iii. Definition of ‘‘Located in the United
States’’
The proposed regulations provided
that the term ‘‘located in the United
States’’ refers to the location of a
student, and that a student is considered
to have been located in the United
States if the student resided in the
United States for at least a portion of the
time the student attended the institution
during the educational institution’s
preceding taxable year.
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One commenter sought clarification
on this definition, recommending that
each institution be able to use any
reasonable approach to consider which
students are located in the United
States, as long as it is consistently
applied. The final regulations make
explicit the commenter’s suggestion.
iv. Clarifications of ‘‘Assets Used
Directly in Carrying Out an Institution’s
Exempt Purpose’’
The final regulations also provide
clarification of ‘‘assets used directly in
carrying out an institution’s exempt
purpose.’’ The definition of an asset
counted for purposes of section 4968
rests on whether the asset is used for an
exempt purpose. If an asset is used for
both an exempt purpose and for other
purposes, and the exempt use represents
95 percent 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 percent of the
total use, the institution must make a
reasonable allocation between exempt
and nonexempt uses. Non-exempt assets
generally include assets held for the
production of income or for investment
and property used to manage the
institution’s endowment.
A commenter recommended
expanding the definition of exempt
assets to include intangible assets and
non-financial assets used in a
functionally related business. Such
functionally related businesses would
be things like a school newspaper that
generated ad revenue. The Treasury
Department and IRS agreed that in
certain circumstances these types of
assets may be included in exempt
assets.
Another aspect of what is considered
as assets held directly for an exempt
purpose is a reasonable cash balance to
carry out the institution’s purpose. The
proposed regulations recognized that an
amount equal to 1.5 percent of the fair
market value of the educational
institution’s non-charitable use assets
(i.e., assets not actually used by an
institution in carrying out its exempt
purpose), determined without regard to
the reduction for the reasonable cash
balance, is deemed to be a ‘‘reasonable
cash balance’’ that is excluded from the
educational institution’s asset base.
These final regulations provide that a
reasonable cash balance may be
determined by any reasonable method
and provide one example that would be
deemed to be reasonable. The final
regulations therefore increase the
flexibility of educational institutions in
establishing an appropriate reasonable
cash balance.
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Commenters also requested
clarification of the treatment of assets of
organizations related to the educational
institution. The final regulations
provide that an asset of a related
organization that is treated as an asset
of the educational institution (in
accordance with section 4968(d) and
§ 53.4968–3(c)) and is used directly in
carrying out the educational
institution’s exempt purpose is
considered used directly by the
institution in carrying out its exempt
purpose. These final regulations further
provide that an asset of a related
organization that is treated as an asset
of the educational institution is
considered to be used directly in
carrying out the educational
institution’s exempt purpose as long as
(1) the related organization is described
in section 501(c)(3) and (2) the asset is
being used directly in carrying out the
related organization’s exempt purpose.
Further discussion of ‘‘related’’
organizations is below.
B. Differences in Definition of ‘‘Net
Investment Income’’ for Educational
Institutions Versus Private Foundations
Section 4968(a) imposes a 1.4 percent
excise tax on the net investment income
of an applicable educational institution
and on certain amounts of net
investment income of certain related
organizations. Section 4968(c) provides
that net investment income is
determined under rules similar to the
rules of section 4940(c). Section 4940(c)
defines net investment income for an
excise tax on private foundations’ net
investment income.
Several commenters requested that
the Treasury Department and IRS
further tailor these rules to take into
account differences between a private
foundation subject to section 4940 and
an educational institution subject to
section 4968, including differences in
funding sources, use of funds, structure,
governance, and oversight. The Treasury
Department and IRS responded by
tailoring the final regulations to define
net investment income more specifically
for educational institutions.
Following the regulations under
section 4940(c), the final 4968
regulations provide that net investment
income generally is the amount by
which the sum of the gross investment
income and the capital gain net income
exceeds the allowable deductions.
Commenters sought clarification and
modification of what is included as
‘‘gross investment income’’ and ‘‘capital
gain net income.’’
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i. Gross Investment Income
Commenters recommended
clarifications and modification to what
is included in gross investment income
for purposes of section 4968. The final
regulations specify that, consistent with
section 4940(c), gross investment
income generally means the gross
amounts of income from interest,
dividends, rents, payments with respect
to securities loans, and royalties, but not
including any such income to the extent
it is included in computing the tax
imposed by section 511.
In response to commenters, the final
regulations exclude from the definition
of gross investment income interest
income from a student loan made by an
educational institution (or a related
organization) to a student of the
institution in connection with the
student’s attendance at the institution.
Section 4940(c) specifically includes
student loan interest as gross investment
income. Commenters noted that loans
made by colleges and universities to
students are not offered with the intent
of earning investment income for the
institution.
The final regulations also exclude
from the definition of gross investment
income rental income from the
provision of housing to current students
of the educational institution and from
housing for faculty and staff if the
housing is provided contingent on their
roles as faculty or staff of the
educational institution. The final
regulations exclude from the definition
of gross investment income royalty
income that is derived from patents,
copyrights, and other intellectual
property and intangible property to the
extent those assets were created by the
institution’s current students or faculty
in their capacities as such. Commenters
represented that it would be a
significant administrative burden to
capture all expenses and costs allocable
to such royalty income. The Treasury
Department and the IRS agree that
applicable educational institutions
produce intellectual property as part of
the pursuit of knowledge by faculty and
students. However, royalties from
trademarks on the institution’s logo or
name, as well as royalties on property
donated or sold to the educational
institution, are not excluded from gross
investment income under this rule.
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ii. Capital Gains and Losses
Commenters addressed several
aspects of the proposed rules for capital
gain net income, including the taxation
of capital gain net income on the sale of
exempt use property; capital gain net
income on the sale of donated property;
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the step-up rule for assets held in a
partnership on December 31, 2017; and
whether capital loss carryovers should
be allowed.
a. Capital Gain Net Income on Sale of
Exempt Use Property
In response to public comments, these
final regulations provide that capital
gain net income from the sale or
exchange of property used by an
institution for its exempt purpose is
disregarded for the portion of the
property that is used for the exempt
purpose.
b. Capital Gain Net Income From the
Sale of Donated Property
Commenters recommended that any
appreciation that occurred prior to an
institution’s receipt of the donated
property be excluded from the
calculation of capital gain net income
from the sale of donated property.
Private foundations subject to section
4940 are generally passive grant-making
organizations that have the ability to
dispose of appreciated property by
making a grant of the property instead
of selling the appreciated property and
making a grant in cash. Educational
institutions, on the other hand, nearly
always immediately liquidate the gifts
and use the proceeds to fund the
institution’s activities; they therefore
cannot avoid the net investment income
from the sale of appreciated property
like private foundations. In response,
these final regulations provide that any
appreciation in the value of donated
property that occurred prior to the date
of donation to the applicable
educational institution is disregarded in
calculating gain for purposes of section
4968.
c. Basis for Purposes of Determining a
Distributive Share of Gain From the Sale
or Other Disposition of an Asset Held in
a Partnership
Commenters expressed concern with
the proposed section 4968 rules
proposing calculation of the basis of
assets held in partnerships in which an
educational institution owns an interest.
Four commenters noted that it would be
extremely burdensome for institutions
to obtain documentation to establish
their share of the basis of a particular
partnership asset and that an asset-byasset determination of gain, therefore,
might not be possible.
The Treasury Department and the IRS
acknowledge the problem described by
commenters. These final regulations
provide a method, described in
paragraph 6.e. of the Summary of
Comments and Explanation of
Revisions, which generally enables an
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65553
applicable educational institution to
offset its distributive share of capital
gain net income from partnership asset
dispositions by using the applicable
educational institution’s adjusted stepup for such partnership (described in
paragraph 6.e of the Summary of
Comments and Explanation of
Revisions), if any, at the time of such
partnership asset disposition.
Specifically, the proposed regulations
provided that, if an applicable
educational institution held an interest
in a partnership on December 31, 2017,
and continuously thereafter, and the
partnership held an asset on December
31, 2017, and continuously thereafter to
the date of its disposition by the
partnership, the applicable educational
institution’s basis in such asset (for
purposes of determining the applicable
educational institution’s share of gain
upon sale or other disposition of that
asset) is not less than the fair market
value of such asset on December 31,
2017, subject to all adjustments
provided in the proposed regulations
after December 31, 2017, and before the
date of disposition.
d. Reduction of Capital Gain Net Income
From a Partnership
Commenters stated that it would be
very difficult, if not impossible, for
institutions to obtain the basis
documentation that would have been
required under the proposed regulations
in order to apply the proposed
partnership asset basis step-up rule. As
an alternative, two commenters
recommended a method that would use
the difference between the fair market
value and outside basis of an applicable
educational institution’s partnership
interest on December 31, 2017, to
approximate the difference between the
fair market value and inside basis of,
and thus the amount of built-in gain in,
the applicable educational institution’s
share of partnership assets on such date.
The commenters stated that the
difference between fair market value
and tax basis of an applicable
educational institution’s partnership
interest on December 31, 2017, should
generally reflect the amount of the
applicable educational institution’s
built-in gain in its share of the
partnership’s assets on such date, and
that, because educational institutions
should know the fair market values and
tax bases of their partnership interests
on December 31, 2017, they should be
able to calculate the built-in gain in
their partnership interests as of
December 31, 2017.
Specifically, the commenters
recommended that an applicable
educational institution should be
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allowed to offset the distributive share
of partnership capital gain net income
after December 31, 2017, allocated by a
partnership by the amount of the builtin gain the applicable educational
institution had in its partnership
interest, determined as of December 31,
2017. Under this approach, an
applicable educational institution
would determine its built-in gain in a
partnership interest as of December 31,
2017, and then not report any capital
gain allocated from that partnership
after December 31, 2017, as being
subject to section 4968 until the
cumulative amount of such excluded
gain exceeds the amount of built-in gain
in the interest. The commenters
recommended that this rule be applied
on a partnership-by-partnership basis
and be available to reduce the amount
of an applicable educational
institution’s capital gain net income on
a first-recognized basis.
These final regulations adopt an
approach that is similar to the approach
recommended by the commenters.
These final regulations provide that, for
each partnership interest an applicable
educational institution held on
December 31, 2017, the applicable
educational institution may determine
an unadjusted step-up amount that is
equal to the excess, if any, of the fair
market value of such partnership
interest on December 31, 2017, over the
adjusted basis of such partnership
interest on December 31, 2017. For
purposes of computing net investment
income for taxable years beginning after
December 31, 2017, an applicable
educational institution will reduce its
distributive share of capital gain net
income from such partnership by the
least of: (A) The applicable educational
institution’s share of applicable capital
gain from such partnership (that is, both
short-term and long-term capital gain for
the first taxable year after December 31,
2017, but only long-term capital gain for
subsequent years because short-term
capital gains could not have been
included in the amount of outside builtin gain as of December 31, 2017); (B)
one-third of the applicable educational
institution’s unadjusted step-up for such
partnership; or (C) the applicable
educational institution’s adjusted stepup for such partnership (which, in
general, is its unadjusted step-up
reduced by any capital gain that
previously was excluded pursuant to
either this rule or the partnership
interest sale rule described in paragraph
6.d.iii. of the Summary of Comments
and Explanation of Revisions).
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e. Capital Loss Carryovers
A commenter represented that private
foundations and educational
institutions differ in their flexibility in
regards to the treatment of sales of
investments and operating budgets.
Specifically, a private grant-making
foundation, to the extent it has satisfied
its minimum distribution requirements,
can easily curtail its spending (and the
realization of capital gains while
converting investment assets to cash) by
issuing fewer or smaller grant awards to
manage its section 4940 tax liability.
The commenter contrasted such a
foundation with an educational
institution that typically has a large
operating budget with significant
nondiscretionary expenses related to
employees and infrastructure and must
find ways to meet its ongoing cash
needs, which may involve selling
investments at particular times that may
not be advantageous from an investment
or tax perspective.
The Treasury Department and the IRS
acknowledge the differences between
private foundations subject to section
4940(c) and educational institutions in
their missions, functions, and operating
expenses. Based on these differences,
these final regulations allow the use of
capital loss carryovers consistent with
the approach recommended by the
commenter.
C. Related Organizations for Purposes of
Net Investment Income and Assets
Section 4968(d)(1) provides that the
assets and net investment income of any
related organization with respect to an
educational institution are to be treated
as assets and net investment income,
respectively, of the educational
institution. The statute provides two
exceptions: (1) No such amount is to be
taken into account with respect to more
than one educational institution, and (2)
unless the related organization is
controlled by the institution or is a
supporting organization (as described in
section 509(a)(3)) with respect to the
institution for the taxable year, assets
and net investment income that are not
intended or available for the use or
benefit of the institution are not to be
taken into account by that educational
institution.
Under section 4968(d)(2), the term
‘‘related organization’’ means, with
respect to an educational institution,
any organization that (1) Controls the
educational institution; (2) is controlled
by the educational institution; (3) is
controlled by one or more persons that
also control the educational institution;
(4) is a supported organization (as
defined in section 509(f)(3)) with
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respect to the educational institution
during the taxable year; or (5) is a
supporting organization (as described in
section 509(a)(3)) with respect to the
educational institution during the
taxable year.
The first three categories of related
organizations require control of an
organization, but the statute does not
define the term ‘‘control.’’ Furthermore,
whether the educational institution is
the controlling or controlled entity
matters because, if the related
organization controls the educational
institution, or is controlled by one or
more persons that also control the
educational institution, then 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. In contrast, if a related
organization is controlled by an
educational institution, then all the
assets and net investment income of the
related organization are taken into
account by the educational institution.
Specifically, the proposed regulations
defined control as: (1) In the case of a
corporation, ownership (by vote or
value) of more than 50 percent of the
stock of the corporation; (2) in the case
of a partnership, ownership of more
than 50 percent 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
percent 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, (a) more than 50 percent of the
directors or trustees of the educational
institution or nonstock organization are
either representatives of, or are directly
or indirectly controlled by, the other
entity or (b) more than 50 percent 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 educational institution.
The commenters sought clarifications
and modifications of how related
organizations are treated based around
three major issues: (1) Control, (2)
potential double taxation of certain
types of related organizations, and (3)
treatment of the assets of certain related
organizations.
a. Control
Commenters stated generally that use
of the proposed definition of ‘‘control’’
would result in educational institutions’
being required to take into account
assets and net investment income that
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the educational institutions do not
actually control and that they will never
receive because the assets and income
actually belong to unrelated third
parties. The commenters also stated that
such a rule is inconsistent with
Congressional intent, and would not
address Congressional concerns that
educational institutions might attempt
to avoid the section 4968 excise tax by
holding assets in structures that, as
compared to direct ownership, represent
a difference in form but not substance.
The final regulations provide separate
rules for the different relationships that
may exist and separately define control
for organizations that (1) control an
educational institution, (2) are
controlled by an educational institution,
and (3) are controlled by one or more
persons that also control an educational
institution.
b. Double Taxation of Certain Related
Organizations
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Even if an educational institution
controls certain types of related
organizations, subjecting the assets or
net investment income of these
organizations to the section 4968 tax
might result in double or triple taxation.
In applying the related organization
provisions of section 4968(d),
commenters recommended disregarding
taxable corporations and trusts,
partnerships and pass-through entities,
and split-interest trusts.
Several types of entities that might be
related organizations are taxed and then
provide after-tax dollars to the
educational institution. Counting these
distributions toward the section 4968
tax might result in double taxation. The
Treasury Department and the IRS do not
consider it consistent with
Congressional intent to tax the income
again under section 4968. These final
regulations exclude from the definition
of ‘‘related organization’’ a taxable
corporation and certain taxable trusts, in
each case whether foreign or domestic.
To prevent double taxation of a
partnership’s net investment income
and overcounting of its assets, these
final regulations exclude from the
definition of ‘‘related organization’’ a
partnership, S corporation, or other
pass-through entity a portion of whose
income flows through to the educational
institution.
c. Treatment of Assets of Certain Related
Organizations
i. Trusts
With respect to trusts, commenters
raised issues concerning ‘‘control’’ and
whether charitable remainder trusts
should be counted as an asset of the
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educational institution, even if the
educational institution is deemed to
control the trust. Several commenters
stated that the proposed rule for control
of trusts, which provided that control of
a trust with beneficial interests means
ownership of more than 50 percent of
the beneficial interests in the trust,
would not lead an educational
institution to control the trust within
the generally accepted meaning of that
term. Commenters stated that the trustee
of a trust does not control a trust in a
way that is relevant for purposes of
section 4968, because the trustee is
required to administer the trust in
accordance with, and to the extent of
the trustee’s duties and powers as
determined by, the terms of the trust
and applicable law.
The Treasury Department and the IRS
acknowledge that the concept of control
does not mesh well with trusts. In
attempting to construct a replacement
for the control rule for trusts to be used
in the context of section 4968, the
Treasury Department and IRS identified
the circumstances under which a trust
should be deemed to have a relationship
with the educational institution that is
sufficiently similar to that generally
intended by the concept of control.
These final regulations provide that a
trust is a related organization, and an
educational institution is deemed to
control that trust, only: (1) If the
educational institution is substantially
the sole permissible trust beneficiary or
appointee of both income and principal,
whether or not the timing of
distributions is subject to the trustee’s
discretion; (2) if the trust is a pooled
income fund described in sections
642(c)(3) and 642(c)(5); (3) to the extent
that the assets of the trust were
contributed to the trust by the
educational institution (or by a person
controlled by the educational
institution, as determined under these
regulations); or (4) to the extent that the
educational institution (or a person
controlled by the educational
institution, as determined under these
regulations) has the right to demand (or
can otherwise cause) a distribution of
principal from the trust to the
educational institution (or a person
controlled by the educational
institution). The final regulations clarify
how to determine whether a person is
controlled by an educational institution.
With respect to split interest and
charitable remainder trusts, commenters
noted that an educational institution
generally is not able to receive any
benefit from, and cannot use assets in
the trust, until the termination of the
interests of the income beneficiaries
(which may be decades into the future).
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This is true even if the value of the
educational institution’s interest in the
trust exceeds 50 percent of the present
value of all beneficial interests in the
trust. Further, commenters noted it
would be difficult for an educational
institution to obtain information about
the income of a split-interest trust, as
there is currently no federal requirement
for a split-interest trust to report this
information to its remainder
beneficiary(ies).
With regard to charitable remainder
trusts and split-interest trusts, even
those that are administered by an
educational institution, the Treasury
Department and the IRS concluded that
the assets and net investment income of
such trusts should be included in the
educational institution’s assets and net
investment income only as they are
received by the educational institution.
Any income from such trusts already is
included in the educational institution’s
net investment income as it is received.
A remainder interest held by an
educational institution is deferred for a
sometimes lengthy and sometimes
indeterminate amount of time and is
subject to market fluctuations that will
affect (or could eliminate) the amount of
any eventual distribution of principal to
the educational institution.
In addition, because there are only
limited circumstances in which the
educational institution would have
sufficient control over a trust to justify
treating the trust as a related
organization, the final regulations also
exclude all other taxable trusts from the
definition of a related organization
except to the extent the educational
institution is deemed to control the
trust.
ii. Employee Benefit Funds
Commenters stated that various
retirement and benefit plans should be
excluded from the definition of related
organization for purposes of section
4968(d), stating that the beneficiaries of
these plans are employees of the
educational institutions and it was not
the intent of Congress to tax the
investment income of these entities.
Accordingly, these final regulations
provide that an employee benefit fund
is not a related organization for
purposes of section 4968(d).
iii. Nonstock Organizations
One commenter objected to the
proposed rule for control of nonstock
organizations, stating that the portion of
the rule that is based on directors or
trustees of the educational institution
being representatives of the other
organization often incorrectly
determines which entity controls the
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other, as the presence of common
directors or trustees alone is not
determinative of control.
The Treasury Department and the IRS
agree that a modified version of control
for nonstock organizations that is based
on the power of the educational
institution (or one or more of its
managers, directors, officers, trustees, or
employees, acting only in that capacity)
to cause (or prevent) a certain act would
more appropriately reflect control by the
educational institution over the
nonstock organization.
Thus, these final regulations provide
that an educational institution controls
a nonstock organization if the
educational institution (or one or more
of its managers, directors, officers,
trustees, or employees acting only in
that capacity) can (1) appoint or elect
(which must include the power to
remove and replace) more than 50
percent of the members of the nonstock
organization’s governing body (such as
directors, officers, or trustees), or
otherwise can appoint or elect that
majority with reasonable frequency; (2)
require the nonstock organization to
make an expenditure (or prevent the
organization from making an
expenditure); or (3) require the nonstock
organization to perform any act that
significantly affects its operations (or
prevent it from performing such an act).
Such control includes control by
aggregating votes or positions of
authority (including by veto power) but
applies regardless of the method by
which the control is exercised or
exercisable.
Paperwork Reduction Act
The collections of information
contained in the final regulations will
be submitted to the Office of
Management and Budget for review in
accordance with the Paperwork
Reduction Act of (1995) (44 U.S.C.
3507(d)). An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control
number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and return information are
confidential, as required by 26 U.S.C.
6103.
A. Collections of Information Imposed
by the Regulations
The collection of information in these
final regulations is in §§ 53.4968–
1(b)(2), (3), (4), and (5); 53.4968–
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2(d)(2)(ii) and (iii); and 53.4968–3(c)
and (d)(2). The collection of information
for § 53.4968–1 is required to determine
whether an educational institution is an
applicable educational institution, as
defined in section 4968(b). In particular,
this collection of information includes
definitions to enable educational
institutions to determine what
individuals constitute students of the
educational institution, which students
are tuition-paying, which students are
located in the United States, and which
assets of the educational institution are
used directly in carrying out an
institution’s exempt purpose. The
collection of information for § 53.4968–
2 is required to calculate net investment
income as defined in section 4968(c). In
particular, this collection of information
includes determining an applicable
educational institution’s share of gain
upon the sale or other disposition of a
partnership asset. The collection of
information for § 53.4968–3 is required
to determine the assets and net
investment income of related
organizations that are treated as assets
and net investment income of
applicable educational institutions, as
defined in section 4968(d). In particular,
this collection of information includes
whether an organization is a supporting
organization (as described in section
509(a)(3) of the Code) with respect to
such institution (including whether the
supporting organization is a Type I,
Type II, or Type III), whether the related
organization supports more than one
educational institution, and determining
the assets and net investment income of
a related organization that are attributed
to the educational institution.
The excise tax for section 4968 is
reported by timely filing a Form 990,
Return of Organization Exempt From
Income Tax, and Form 4720, Return of
Certain Excise Taxes Under Chapters 41
and 42 of the Internal Revenue Code,
Schedule O, Excise Tax on Net
Investment Income of Private Colleges
and Universities. In 2016, the IRS
released and invited comments on drafts
of an earlier version of Form 4720 in
order to give members of the public the
opportunity to benefit from certain
specific amendments made to the Code.
The IRS received no comments on Form
4720 during the comment period.
Consequently, the IRS made Form 4720
available on December 9, 2016, for use
by the public. The IRS is contemplating
making additional changes to Form
4720 to accommodate new provisions
provided for in the final regulations,
such as for the allowance of capital loss
carryovers. The IRS intends that the
burden of the collections of information
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will be reflected in the burden
associated with Form 4720, OMB
approval number 1545–0047.
B. Burden Estimates
The burden associated with Form
4720 is included in the aggregated
burden estimates for OMB control
number 1545–0047. The burden
estimates in 1545–0047 relate to all
filers associated with the Forms 990 and
4720, and will in the future include, but
not isolate, the estimated burden of the
information collections associated with
these final regulations.
The expected burden estimates for
this final rule are based on the
information that is available to the IRS,
and have been updated from the
proposed regulations to include new
provisions provided in the final
regulations that reduce the record
keeping burden for the private colleges
and universities that are subject to the
tax under section 4968. The final
regulations clarify that an educational
institution may use any reasonable
method for determining whether a
student is located in the United States
as long as that method is consistently
applied, and that the educational
institution may use any reasonable
method to determine the reasonable
cash balance necessary to cover current
operating expenses, providing an
example of a reasonable method. The
final regulations also exclude several
items of income from the definition of
gross investment income, such as
interest income from certain student
loans, rental income from the provision
of certain housing to students, faculty,
and staff, and certain royalty income.
The final regulations further disregard
from the calculation of capital gains any
gain from the sale or exchange of the
portion of property that is used by an
applicable educational institution for its
exempt purpose and any appreciation in
the value of donated property that
occurred prior to the date of its
donation. The final regulations provide
an easier method for applicable
educational institutions to substantiate
interests and assets in partnership
holdings. Finally, the final regulations
exclude several types of organizations
from the definition of ‘‘related’’ and
adjust the definition of control for
purposes of determining when an
organization is related for purposes of
section 4968.
The expected burden for private
colleges and universities that are subject
to this rule as described in section
4968(b) is listed below:
Estimated number of respondents: 40.
Estimated average annual burden
hours per response: 10 hours, 7 minutes.
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Estimated total annual burden:
$39,026 ($2017).
Estimated frequency of collection:
Annual.
Accordingly, the new provisions in
the final regulations reduced the
estimated average annual burden hours
per response by 22 hours, 20 min, and
the estimated total annual burden by
$84,310 from the burdens estimated in
the proposed regulations, which
provided for an estimated 40 number of
participants, 32 hours and 27 minutes
average burden hours per response, and
$123,336 (2017) total annual burden.
In the proposed regulations, the
Treasury Department and the IRS
requested comments on all aspects of
information collection burdens related
to the regulations, including estimates
for how much time it would take to
comply with the paperwork burdens
described above for each relevant form
and ways for the IRS to minimize the
paperwork burden. The Treasury
Department and the IRS did not receive
any comments on these issues. Proposed
revisions (if any) to the forms that
reflect the information collections
contained in these final regulations will
be made available for public comment at
https://apps.irs.gov/app/picklist/list/
draftTaxForms.html and will not be
finalized until after these forms have
been approved by OMB under the PRA.
Comments on these forms can be
submitted at https://www.irs.gov/formspubs/comment-on-tax-forms-andpublications.
Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby
certified that these final regulations will
not have a significant economic impact
on a substantial number of small
entities. In the proposed regulations, the
Treasury Department and the IRS
invited comments on the impact this
rule may have on small entities. The
Treasury Department and the IRS did
not receive any comments on this issue.
As discussed elsewhere in this
preamble, this rule merely provides
definitions regarding the applicability of
the section 4968 excise tax to certain
private colleges and universities and
rules for calculating any tax that might
be imposed. The requirements in this
regulation fall only on educational
institutions whose non-exempt assets
have an aggregate fair market value of at
least $500,000 per student of the
institution and that have at least 500
tuition-paying students (for a minimum
investment asset value of $250,000,000).
The threshold established by the
Small Business Administration for an
educational institution to be considered
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a small entity is income from all sources
exceeding $27.5 million. This final rule
will not affect a substantial number of
small entities. Only about 1.7 percent of
four-year colleges and universities (less
than 40 out of over 2,400 institutions in
the National Center for Education
Statistics’ Integrated Post-Secondary
Education System Data for 2016) are
expected to be affected by the tax. This
is because at a modest 4 percent rate of
return, the minimum endowment alone
would generate income of $10 million.
To generate another $17.5 million in
income would require receipts of
$35,000 per student if the institution
had only the minimum number of
students, compared to average tuition
and fees at a four-year private college or
university, which was $39,529 in 2015–
16. Accordingly, the Secretary certifies
that this rule will not affect a substantial
number of small entities.
Pursuant to section 7805(f), the notice
of proposed rulemaking was submitted
to the Chief Counsel for the Office of
Advocacy of the Small Business
Administration for comment on its
impact on small business (84 FR 31795,
July 3, 2019). No comments on the
notice were received from the Chief
Counsel for the Office of Advocacy of
the Small Business Administration.
Congressional Review Act
The Office of Management and Budget
has determined that the final rule is not
a ‘‘major rule’’ within the meaning of
the Congressional Review Act (5 U.S.C.
801, et seq.).
Unfunded Mandates Reform Act
Section 202 of the Unfunded
Mandates Reform Act of 1995 requires
that agencies assess anticipated costs
and benefits and take certain other
actions before issuing a final rule that
includes any Federal mandate that may
result in expenditures in any one year
by a state, local, or tribal government, in
the aggregate, or by the private sector, of
$100 million in 1995 dollars, updated
annually for inflation. The final
regulations do not include any Federal
mandate that may result in expenditures
by state, local, or tribal governments, or
by the private sector in excess of that
threshold.
Executive Order 13132: Federalism
Executive Order 13132 (entitled
‘‘Federalism’’) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the
consultation and funding requirements
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of section 6 of the Executive order. The
final regulations do not have federalism
implications and do not impose
substantial direct compliance costs on
state and local governments or preempt
state law within the meaning of the
Executive order.
Drafting Information
The principal authors of these
regulations are Melinda Williams and
Amber L. MacKenzie, Office of
Associate Chief Counsel (Employee
Benefits, Exempt Organizations, and
Employment Tax). However, other
personnel from the Treasury
Department and the IRS participated in
their development.
Statement of Availability of IRS
Documents
IRS Revenue Procedures, Revenue
Rulings, Notices, and other guidance
cited in this document are published in
the Internal Revenue Bulletin (or
Cumulative Bulletin) and are available
from the Superintendent of Documents,
U.S. Government Publishing Office,
Washington, DC 20402, or by visiting
the IRS website at https://www.irs.gov.
List of Subjects in 26 CFR Part 53
Excise taxes, Foundations,
Investments, Lobbying, Reporting and
recordkeeping requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 53 is
amended as follows:
PART 53—FOUNDATION AND SIMILAR
EXCISE TAXES
Paragraph 1. The authority citation
for part 53 continues to read, in part, as
follows:
■
Authority: 26 U.S.C. 7805.
*
*
*
*
*
Par. 2. Sections 53.4968–1 through
53.4968–4 are added to subpart K to
read as follows:
■
Sec.
53.4968–1 Excise tax based on investment
income of certain private colleges and
universities.
53.4968–2 Net investment income.
53.4968–3 Related organizations.
53.4968–4 Applicability date.
§ 53.4968–1 Excise tax based on
investment income of certain private
colleges and universities.
(a) Excise tax on the investment
income of certain private colleges and
universities. For taxable years beginning
after December 31, 2017, section 4968 of
the Internal Revenue Code (Code)
imposes a tax equal to 1.4 percent of the
net investment income (as defined in
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section 4968(c) and § 53.4968–2) of an
applicable educational institution (as
defined in section 4968(b)(1) and
paragraph (b)(1) of this section).
(b) Definitions. The definitions in this
paragraph (b) apply for purposes of
section 4968 and §§ 53.4968–1 through
53.4968–4.
(1) Applicable educational institution.
The term applicable educational
institution means any eligible
educational institution (as defined in
section 25A(f)(2) of the Code and
§ 1.25A–2(b) of this chapter)—
(i) That had at least 500 tuition-paying
students during the preceding taxable
year;
(ii) More than 50 percent of whose
tuition-paying students are located in
the United States;
(iii) That is not described in the first
sentence of section 511(a)(2)(B) of the
Code (relating to state colleges and
universities); and
(iv) The aggregate fair market value of
the assets of which at the end of such
preceding taxable year (other than those
assets that are used directly in carrying
out the institution’s exempt purpose) is
at least $500,000 per student.
(2) Student. The term student means
a person who is enrolled and attending
a course for academic credit from the
institution and who is being charged
tuition at a rate that is commensurate
with the tuition rate charged to students
enrolled for a degree. The number of
students of an educational institution
(including for purposes of determining
the number of students at a particular
location) is based on the daily average
number of full-time students (with parttime students taken into account on a
full-time student equivalent basis). The
standards for determining part-time
students, full-time students, full-time
equivalents, and daily average are
determined by each educational
institution. However, the standards may
not be lower than the minimum
applicable standards established by the
Department of Education under the
Higher Education Act of 1965 (20 U.S.C.
1088), as amended.
(3) Tuition-paying—(i) In general. The
term tuition-paying means the payment
of any tuition or fees required for the
enrollment or attendance of a student
for a course of instruction at an
educational institution. Tuition and fees
do not include payment for supplies or
equipment required during a specific
course once a student is enrolled in and
attending the course, or payment for
room and board or other personal living
expenses.
(ii) Treatment of a comprehensive or
bundled fee. If a student is required to
pay a fee (such as a comprehensive fee
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or a bundled fee) to an educational
institution that combines charges for
tuition with charges for personal
expenses such as room and board, the
student is a tuition-paying student.
(iii) Scholarships, grants, and work
study programs. Whether a student is
tuition-paying is determined after taking
into account any scholarships and
grants provided directly by the
educational institution or by the Federal
government or any state or local
government, and after application of any
work study programs operated directly
by the institution. Scholarships and
grants provided by non-governmental
third parties, even if administered by
the institution, are considered payments
of tuition on behalf of the student.
Accordingly, a student will be
considered a tuition-paying student if
payment of 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, any
work study program operated directly
by the institution, and any grants and
scholarships provided by the Federal
government or any state or local
government.
(4) Located in the United States. A
student is located in the United States
if the student resided in the United
States for at least a portion of the time
the student attended the educational
institution during the institution’s
preceding taxable year. Whether a
student resided in the United States in
any given year can be determined using
any reasonable method, as long as that
method is consistently applied.
(5) Assets used directly in carrying out
an institution’s exempt purpose—(i) In
general. Except as provided in
paragraph (b)(5)(iv) of this section, an
asset is used directly in carrying out an
educational institution’s exempt
purpose only if the asset is actually used
directly by the institution in carrying
out its exempt purpose. Whether an
asset is used directly by the institution
to carry out its exempt purpose is
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
percent 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 percent of the
total use, the institution must make a
reasonable allocation between such
exempt and nonexempt uses.
(ii) Illustrations. Examples of assets
that are used directly in carrying out an
institution’s exempt purpose include,
but are not limited to, the following—
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(A) Administrative assets, such as
office equipment and supplies used by
the institution directly in the
administration of its exempt activities;
(B) Real estate or the portion of any
building used by the institution directly
in its exempt activities;
(C) Physical property such as
paintings or other works of art owned by
the institution that are on public display
(or held for public display), fixtures and
equipment in classrooms, research
facilities and related equipment that
under the facts and circumstances serve
a useful purpose in the conduct of the
institution’s exempt activities;
(D) The reasonable cash balance,
determined using any reasonable
method, necessary to cover current
operating and administrative expenses
and other normal and current
disbursements directly connected with
the educational institution’s exempt
activities. For this purpose, a reasonable
method would include calculating an
amount equal to three months of
operating expenses allocable to program
services, calculated by dividing annual
functional expenses allocable to
program services by four. A larger
amount may be a reasonable cash
balance for this purpose if, under the
facts and circumstances, a larger amount
is established to be necessary to cover
administrative expenses and other
normal disbursements directly
connected with the institution’s exempt
activity.
(E) Any property the educational
institution leases to other persons at no
cost (or at a nominal rent) to the lessee
in furtherance of the institution’s
exempt purposes; and
(F) Patents, copyrights, and other
intellectual property and intangible
property to the extent that income from
those assets is excluded from net
investment income by § 53.4968–
2(b)(2)(iii).
(iii) Assets not used directly. The
following assets are examples of assets
not used directly in carrying out an
institution’s exempt purpose—
(A) Assets that are held for the
production of income or for investment
(for example, stocks, bonds, interestbearing notes, endowment funds, or
leased real estate not described in
paragraph (b)(5)(ii)(E) of this section),
even if the income from such assets is
used to carry out such exempt purpose;
and
(B) Property (such as offices and
equipment) used for the purpose of
managing the institution’s endowment
funds.
(iv) Assets of related organizations.
An asset of a related organization that is
treated as an asset of an educational
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institution by section 4968(d) and
§ 53.4968–3(c) and that is used directly
in carrying out an educational
institution’s exempt purpose, or that is
used directly in carrying out the exempt
purpose of a related organization that is
described in section 501(c)(3), is
considered used directly by the
educational institution in carrying out
its exempt purpose.
(v) Valuation of assets not used
directly in carrying out an institution’s
exempt purpose—(A) In general. The
values of assets not used directly in
carrying out an educational institution’s
exempt purpose are determined under
the rules of section 4942(e) and
§ 53.4942(a)–2(c)(4), as modified by
paragraph (b)(5)(v)(B) of this section.
(B) Modifications. In applying the
rules of § 53.4942(a)–2(c)(4), an
educational institution must—
(1) Substitute ‘‘educational
institution’’ for ‘‘private foundation’’ or
‘‘foundation’’ every place they appear;
and
(2) Make such adjustments as are
reasonable and necessary to obtain the
fair market value of any and all assets
as of the last day of the preceding
taxable year, rather than as of any other
times permitted or required by
§ 53.4942(a)–2(c)(4).
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§ 53.4968–2
Net investment income.
(a) Net investment income—(1) In
general. For taxable years beginning
after December 31, 2017, section 4968(a)
of the Internal Revenue Code (Code)
imposes a 1.4 percent excise tax on the
net investment income (as defined in
section 4968(c) and this section) of an
applicable educational institution and
on certain amounts of net investment
income of certain related organizations,
as described in section 4968(d) and
§ 53.4968–3. For purposes of this
section, net investment income is
determined under rules similar to the
rules of section 4940(c) of the Code.
Thus, net investment income generally
is the amount by which the sum of the
gross investment income (as defined in
paragraph (b) of this section) and the
capital gain net income (as defined in
paragraph (d) of this section) exceeds
the deductions allowed by paragraph (c)
of this section. Except to the extent
inconsistent with the provisions of this
section, net investment income is
determined under the principles of
subtitle A of the Code.
(2) Tax-exempt income. For purposes
of this section, net investment income is
determined by applying section 103 of
the Code (relating to State and local
bonds) and section 265 of the Code
(relating to expenses and interest
relating to tax-exempt income).
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(b) Gross investment income—(1) In
general. For purposes of this section and
except as provided in paragraph (b)(2) of
this section, the term gross investment
income means the gross amounts of
income from interest, dividends, rents,
payments with respect to securities
loans (as defined in section 512(a)(5) of
the Code), and royalties, but not
including any such income to the extent
included in computing the tax imposed
by section 511 of the Code. Such term
also includes income from sources
similar to those in the preceding
sentence. In general, gross investment
income includes the items of investment
income described in § 1.512(b)–1(a) of
this chapter.
(2) Exceptions. The following items of
income are excluded from the definition
of gross investment income:
(i) Interest income from a student loan
that was made by the applicable
educational institution or a related
organization to a student of the
applicable educational institution in
connection with the student’s
attendance at the institution;
(ii) Rental income from the provision
of housing by the applicable educational
institution or a related organization to
students of the applicable educational
institution and from housing for faculty
and staff if the housing is provided
contingent on their roles as faculty or
staff of the applicable educational
institution; and
(iii) Royalty income that is derived
from patents, copyrights, and other
intellectual property and intangible
property to the extent those assets
resulted from the work of student(s) or
faculty member(s) in their capacities as
such with the applicable educational
institution. However, neither royalty
income from trademarks on the
institution’s logo or name nor royalty
income from intellectual property
donated or sold to the institution is
excluded from gross investment income
under this rule.
(c) Deductions—(1) In general. For
purposes of computing net investment
income—
(i) There is allowed as a deduction
from gross investment income all the
ordinary and necessary expenses paid or
incurred for the production or collection
of gross investment income or for the
management, conservation, or
maintenance of property held for the
production of such income, determined
with the modifications set forth in
paragraph (c)(2) of this section. Taxes
paid or incurred under section 4968 are
not paid or incurred for the production
or collection of gross investment
income. Allowable expenses include
that portion of an applicable
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educational institution’s operating
expenses that is paid or incurred for the
production or collection of gross
investment income. An applicable
educational institution’s operating
expenses include compensation of
officers, other salaries and wages of
employees, outside professional fees,
interest, and rent and taxes on property
used in the applicable educational
institution’s operations. Where an
applicable educational institution’s
officers or employees engage in
activities on behalf of the institution for
both activities that generate net
investment income and for activities
that do not generate net investment
income, compensation and salaries paid
to such officers or employees must be
allocated between the activities that
generate net investment income and for
activities that do not generate net
investment income.
(ii) Where only a portion of property
produces, or is held for the production
of, income subject to the section 4968
excise tax, and the remainder of the
property is used for other purposes, the
deductions allowed by this paragraph
must be apportioned between the
taxable and other uses.
(iii) No amount is allowable as a
deduction under this section to the
extent it is paid or incurred for purposes
other than those described in paragraph
(c)(1)(i) of this section. Thus, for
example, the charitable deductions
prescribed under sections 170 and
642(c) of the Code; the net operating
loss deduction prescribed under section
172; and the special deductions
prescribed under part VIII of subchapter
B of chapter 1 of the Code are not
allowable.
(2) Deduction modifications. The
following modifications must be made
in determining deductions otherwise
allowable under this paragraph (c):
(i) The depreciation deduction is
allowed, but only on the basis of the
straight-line method provided in section
168(b)(3) and without regard to section
168(b)(1) and (2).
(ii) The depletion deduction is
allowed, but such deduction is
determined without regard to sections
613 and 613A of the Code, relating to
percentage depletion.
(iii) The basis to be used for purposes
of the deduction allowed for
depreciation or depletion is the basis
determined under the rules of part II of
subchapter O of chapter 1 of the Code
(part II of subchapter O), subject to the
modifications found in paragraphs
(c)(2)(i) and (ii) of this section (relating
to depreciation and depletion), and
without regard to § 53.4968–2(d)(2)
(relating to the basis for determining
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gain for property held on December 31,
2017, and continuously thereafter to the
date of disposition), or section 362(c) of
the Code (relating to certain special
basis rules regarding contributions of
capital to corporations). Thus, an
applicable educational institution must
reduce the cost or other substituted or
transferred basis by an amount equal to
the straight-line depreciation or cost
depletion, without regard to whether the
applicable educational institution
deducted such depreciation or depletion
during the period prior to its first
taxable year beginning after December
31, 2017. However, where an applicable
educational institution has previously
taken depreciation or depletion
deductions in excess of the amount
which would have been taken had the
straight-line or cost method been
employed, such excess depreciation or
depletion also is taken into account to
reduce basis. If the facts necessary to
determine the basis of property in the
hands of the donor or the last preceding
owner by whom it was not acquired by
gift are unknown to the applicable
educational institution, then the original
basis to the applicable educational
institution of such property is
determined under the rules of § 1.1015–
1(a)(3) of this chapter.
(iv) The deduction for expenses paid
or incurred in any taxable year for the
production of gross investment income
earned as an incident to a charitable
function can be no greater than the
income earned from such function
which is includible as gross investment
income for such year. For example,
where rental income incidentally is
realized in a year from historic
buildings held open to the public,
deductions for amounts paid or incurred
in that year for the production of such
income is limited to the amount of
rental income includible as gross
investment income for the year.
(d) Capital gains and losses—(1) In
general. In determining capital gain net
income for purposes of the tax imposed
by section 4968—
(i) Interaction with section 511. No
gain or loss from the sale or other
disposition of property is taken into
account to the extent that such gain or
loss is taken into account for purposes
of computing the tax imposed by section
511.
(ii) Sales or other dispositions of
exempt use property. To the extent that
property is used by the educational
institution for its exempt purposes,
capital gain from the sale or exchange of
the portion of that property that is used
by the educational institution for its
exempt purposes is disregarded;
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(iii) Sales of donated property—(A) In
general. Any appreciation in the value
of donated property that occurred prior
to the date of its donation to the
institution is disregarded.
(B) Date of donation. The date of
donation is determined under the
timing rules of § 1.170A–1(b) of this
chapter.
(C) Value on the date of donation. The
value of the donated property on the
date of donation is determined under
the valuation rules of § 1.170A–1(c) of
this chapter; and
(iv) Capital losses. Net losses from
sales or other dispositions of property
by one related organization (or by the
applicable educational institution)
reduce (but not below zero) net gains
from such sales or other dispositions by
other related organizations (or by the
applicable educational institution).
Should overall net losses from sales or
other dispositions of property exceed
gains from sales or other dispositions of
such property during the same taxable
year, such excess may not be deducted
from gross investment income in any
taxable year, nor may such excess be
used to reduce gains in prior taxable
years. However, capital loss carryovers
are allowed and may be deducted from
capital gains in a future year.
(2) Basis—(i) For purposes of
calculating gain from the sale or other
disposition of property other than a
partnership interest. Subject to the
modifications of paragraphs (c)(2)(i) and
(ii) of this section (referring to the
modifications relating to deductions
against gross investment income) and
without regard to section 362(c), the
basis for purposes of determining gain
from the sale or other disposition of
property (other than a partnership
interest) for purposes of determining
capital gain net income for purposes of
the tax imposed by section 4968 is the
greater of—
(A) Fair market value on December
31, 2017, plus or minus all adjustments
after December 31, 2017, and before the
date of disposition under the rules of
part II of subchapter O, provided that
the property was held by the applicable
educational institution on December 31,
2017, and continuously thereafter to the
date of disposition, or
(B) Basis as determined under the
rules of part II of subchapter O.
(ii) For purposes of determining a
distributive share of gain from the sale
or other disposition of a partnership
asset. For purposes of determining an
applicable educational institution’s
share of gain upon the sale or other
disposition of a partnership asset, the
applicable educational institution’s
basis in each such partnership asset
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generally is determined under the rules
of subchapter K of chapter 1 of the Code
(subchapter K). However, see paragraph
(d)(3) of this section.
(iii) For purposes of determining gain
on the sale or other disposition of a
partnership interest. For purposes of
determining an applicable educational
institution’s gain upon the sale or other
disposition of all or a portion of a
partnership interest, the applicable
educational institution’s basis in such
partnership interest is generally
determined under the rules of
subchapter K, subject to the special
rules in paragraph (d)(3) of this section.
(iv) For purposes of calculating loss.
Subject to the modifications of
paragraphs (c)(2)(i) and (ii) of this
section (referring to the modifications
relating to deductions against gross
investment income) and without regard
to section 362(c), basis as determined in
paragraph (d)(2)(i)(B) of this section
applies for purposes of determining
loss. For purposes of determining loss
from the sale or other disposition of a
partnership interest, basis is determined
under the rules of subchapter K.
(3) Special rules regarding
partnership interests and partnership
assets—(i) Reduction of distributive
share of capital gain net income from a
partnership. For purposes of computing
net investment income, an applicable
educational institution reduces the
amount of its distributive share of
capital gain net income from a
partnership by the least of—
(A) The applicable educational
institution’s share of applicable capital
gain (as defined in paragraph
(d)(3)(iii)(A) of this section) from such
partnership;
(B) One-third of the applicable
educational institution’s unadjusted
step-up (as defined in paragraph
(d)(3)(iii)(B) of this section) for such
partnership; or
(C) The applicable educational
institution’s adjusted step-up (as
defined in paragraph (d)(3)(iii)(C) of this
section) for such partnership.
(ii) Reduction of capital gain net
income from a sale or other disposition
of all or a portion of a partnership
interest. For purposes of computing net
investment income, an applicable
educational institution reduces the
amount of its capital gain net income
upon the sale or other disposition of all
or a portion of a partnership interest by
an amount that bears the same relation
to the applicable educational
institution’s adjusted step-up (as
defined in paragraph (d)(3)(iii)(C) of this
section) for such partnership as the fair
market value of the transferred portion
of the interest bears to the fair market
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value of the applicable educational
institution’s entire interest in such
partnership before the sale or other
disposition.
(iii) Definitions. For purposes of this
section—
(A) Applicable capital gain. For an
applicable educational institution’s first
taxable year beginning after December
31, 2017, the term applicable capital
gain means an applicable educational
institution’s share of both short-term
and long-term capital gains and losses
subject to section 4968 from a
partnership. For subsequent taxable
years, applicable capital gain does not
include an applicable educational
institution’s share of short-term capital
gains and losses subject to section 4968
from a partnership. For purposes of this
paragraph, applicable capital gain is not
less than zero.
(B) Unadjusted step-up. An applicable
educational institution computes an
unadjusted step-up for each partnership
interest it held on December 31, 2017.
The unadjusted step-up for a
partnership interest equals the excess, if
any, of the fair market value of such
partnership interest on December 31,
2017, over the adjusted basis of such
partnership interest on December 31,
2017.
(C) Adjusted step-up. An applicable
educational institution computes an
adjusted step-up for each partnership
interest it held on December 31, 2017.
The adjusted step-up for a partnership
interest equals the unadjusted step-up
for such partnership, reduced by the
amount of any capital gain net income
reduction pursuant to paragraphs
(d)(3)(i) and (ii) of this section for such
partnership.
(4) Examples. The following examples
illustrate paragraph (d)(3) of this
section. Unless stated otherwise in the
examples, partners have no tax items
other than those listed in the example.
With respect to partnerships, all
allocations are in accordance with
section 704(b) and the regulations under
section 704(b) in part 1 of this chapter
(Income Tax Regulations).
(i) Example 1—(A) Facts. University
(U), an applicable educational
institution, is a partner in partnership
PRS. On December 31, 2017, U’s PRS
interest had a fair market value of $130
and tax basis of $100. In 2018, U’s share
of capital gain net income from PRS is
$5, which is comprised of $20 of gain
from the sale of capital asset X and ($15)
of loss from the sale of capital asset Y.
Further, such $5 of capital gain net
income is applicable capital gain (as
defined in paragraph (d)(3)(iii)(A) of this
section).
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(B) Analysis. U has an unadjusted
step-up (as defined in paragraph
(d)(3)(iii)(B) of this section) for PRS of
$30 ($130 fair market value ¥ $100 tax
basis on December 31, 2017). Pursuant
to paragraph (d)(3)(i) of this section, for
purposes of computing its net
investment income, U reduces the
amount of its capital gain net income
from PRS by $5, which is the least of:
U’s share of applicable capital gain from
PRS ($5); or one-third of U’s unadjusted
step-up for PRS ($10); or U’s adjusted
step-up for PRS ($30). Thus, U reduces
its $5 of capital gain net income
allocated from PRS by $5, resulting in
U having $0 of capital gain net income
in 2018 for purposes of section 4968. As
a result, U’s adjusted step-up for PRS for
subsequent taxable years is reduced to
$25 ($30 ¥ $5) pursuant to paragraph
(d)(4)(iii)(C) of this section. Pursuant to
section 705, the $5 of gain allocated to
U increases U’s tax basis in its PRS
interest to $105.
(ii) Example 2—(A) Facts. The facts
are the same as in paragraph (d)(4)(i)(A)
of this section (Example 1). In 2019, U
sells its entire interest in PRS for $130,
which, immediately prior to the sale,
had a tax basis of $105. As a result, U
has $25 of capital gain from the sale of
its PRS interest.
(B) Analysis. Pursuant to paragraph
(d)(3)(iii) of this section, for purposes of
computing its net investment income, U
reduces its capital gain net income
resulting from the sale of its entire PRS
interest by $25, which is the amount
that bears the same relation to U’s
adjusted step-up for PRS ($25) as the
fair market value of the transferred
portion of PRS ($130) bears to the fair
market value of the U’s entire interest in
PRS before the sale or other disposition
($130). Thus, U reduces its $25 of
capital gain net income from the sale of
its PRS interest by $25, resulting in U
having $0 of capital gain net income in
2019 for purposes of section 4968.
(iii) Example 3—(A) Facts. The facts
are the same as in paragraph (d)(4)(i)(A)
of this section (Example 1). In 2019, U’s
share of capital gain net income from
PRS is $15, which is comprised of $15
of gain from the sale of capital asset Z.
Further, such $15 of capital gain net
income is applicable capital gain (as
defined in paragraph (d)(3)(iii)(A) of this
section).
(B) Analysis. Pursuant to paragraph
(d)(3)(i) of this section, for purposes of
computing its net investment income, U
reduces the amount of its capital gain
net income from PRS by $10, which is
the least of: U’s share of applicable
capital gain from PRS ($15); or one-third
of U’s unadjusted step-up for PRS ($10);
or U’s adjusted step-up for PRS ($25,
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computed as $30 of unadjusted step-up,
less $5 of capital gain net income
reduced in 2018 pursuant to paragraph
(d)(3)(i) of this section). Thus, U reduces
its $15 of capital gain net income
allocated from PRS by $10, resulting in
U having $5 of capital gain net income
in 2019 for purposes of section 4968. As
a result, U’s adjusted step-up for PRS is
reduced for subsequent taxable years to
$15 ($25 ¥ $10) pursuant to paragraph
(d)(3)(iii)(C) of this section. Pursuant to
section 705, the $15 of gain allocated to
U increases U’s tax basis in its PRS
interest to $120.
§ 53.4968–3
Related organizations.
(a) Definition of related
organization—(1) In general. For
purposes of section 4968(d) of the
Internal Revenue Code (Code) and
§§ 53.4968–1 through 53.4968–4, except
as provided in paragraph (a)(2) of this
section, the term related organization
means, with respect to an educational
institution, any organization that—
(i) Controls such institution;
(ii) Is controlled by such institution;
(iii) Is controlled by one or more
persons that also control such
institution;
(iv) Is a supported organization (as
defined in section 509(f)(3) of the Code)
with respect to such institution during
the taxable year; or
(v) Is a supporting organization (as
described in section 509(a)(3)) with
respect to such institution during the
taxable year.
(2) Organizations not considered
related organizations. For purposes of
section 4968(d) and §§ 53.4968–1
through 53.4968–4, the term related
organization does not include any
organization that is—
(i) A taxable corporation;
(ii) A taxable trust, including a nongrantor charitable lead trust (except to
the extent the trust is controlled by the
educational institution as described in
paragraph (b)(2)(ii) of this section);
(iii) A grantor charitable lead trust;
(iv) A charitable remainder trust;
(v) A partnership, S corporation (as
defined in section 1361(a)(1) of the
Code), or other pass-through entity that
is generally not subject to Federal
income tax, the income of which is
taxable to its partners or other interest
holders; or
(vi) A decedent’s estate.
(3) Employee benefit plans or
arrangements. A trust or similar funding
vehicle of an employee benefit plan or
arrangement, such as a section 501(a)
trust funding a section 401(a) qualified
retirement plan, or an annuity contract
funding a section 403(b) plan, or a
section 419(e) welfare benefit fund
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(including a voluntary employees’
beneficiary association under section
501(c)(9)) funding a welfare benefit
plan, will not be treated as a related
organization and its assets will not be
treated as the assets of the educational
institution or of a related organization.
A trust or other funding vehicle of an
unfunded employee benefit plan of an
educational institution or a related
organization, such as a grantor trust
described in section 671 et seq., used in
connection with a section 457(b) plan or
an arrangement subject to section 457(f),
will be treated as a related organization
for purposes of section 4968(d) and its
assets will be treated as the assets of the
educational institution or of a related
organization, but the assets are not
considered ‘‘used directly in carrying
out the institution’s exempt purpose’’
for purposes of section 4968(b)(1)(D).
For purposes of determining whether
the employee benefit plan of an
educational institution is funded or
unfunded, the educational institution
and all of its related organizations are
treated as a single sponsor and payor of
the benefits.
(b) Control—(1) Controls such
institution. For purposes of section
4968(d) and §§ 53.4968–1 through
53.4968–4, an organization controls an
educational institution if—
(i) The organization owns (by vote or
value) more than 50 percent of the
voting and non-voting stock or
membership interest of the educational
institution; or
(ii) The organization (or one or more
of its managers, directors, officers,
trustees, or employees, acting only in
those capacities) can—
(A) Appoint or elect (which must
include the power to remove and
replace) more than 50 percent of the
members of the educational institution’s
governing body (such as directors,
officers, or trustees), or otherwise has
the ongoing power to appoint or elect
more than 50 percent of such members
with reasonable frequency;
(B) Require the educational institution
to make an expenditure (or prevent the
educational institution from making an
expenditure); or
(C) Require the educational institution
to perform any act that significantly
affects its operations (or prevent it from
performing such an act).
(2) Is controlled by such institution.
For purposes of section 4968(d) and
§§ 53.4968–1 through 53.4968–4, an
organization is controlled by an
educational institution:
(i) Tax-exempt corporation. In the
case of a corporation recognized as
exempt from income tax under section
501(a), if the educational institution
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owns (by vote or value) more than 50
percent of the voting and nonvoting
stock or membership interest of the
corporation.
(ii) Trust—(A) In general. In the case
of a trust—
(1) If the educational institution is
substantially the sole permissible trust
beneficiary or appointee of both income
and principal, whether or not the timing
of the distribution is subject to the
trustee’s discretion;
(2) If the trust is a pooled income fund
described in sections 642(c)(3) and
642(c)(5);
(3) If, but only to the extent that, the
assets of the trust were contributed to
the trust by the educational institution
(or by a person controlled by the
educational institution); or
(4) If, but only to the extent that, the
educational institution (or person
controlled by the educational
institution) has the right to demand (or
can otherwise cause) a distribution of
principal from the trust to the
educational institution (or a person
controlled by the educational
institution).
(B) Person controlled by the
educational organization. For purposes
of this paragraph (b)(2)(ii), a person is
controlled by an educational institution
if the educational institution has the
power to remove and replace such
person or otherwise controls the person
under one of the tests described in
§ 53.4968–3(b)(2)(i), (ii), or (iii), with
similar principles applying for purposes
of determining control of any other form
of entity.
(iii) Nonstock organization. In the
case of a nonstock organization, if the
educational institution (or one or more
of its managers, directors, officers,
trustees, or employees, acting only in
those capacities) can—
(A) Appoint or elect (which must
include the power to remove and
replace) more than 50 percent of the
members of the organization’s governing
body (such as directors, officers, or
trustees), or otherwise has an ongoing
power to appoint or elect more than 50
percent of such members with
reasonable frequency);
(B) Require the organization to make
an expenditure (or prevent the
organization from making an
expenditure); or
(C) Require the organization to
perform any act that significantly affects
its operations (or prevent it from
performing such an act).
(3) Is controlled by one or more
persons that also control such
institution. For purposes of section
4968(d) and this section, an
organization (other than one described
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in paragraph (a)(2) of this section) is
controlled by one or more persons that
also control the educational institution
if more than 50 percent of the members
of the governing body of the other
organization are directly or indirectly
controlled by persons that comprise
more than 50 percent of the members of
the governing body of the educational
institution.
(4) Constructive ownership. The
principles of section 318(a)(2) (relating
to ownership attribution from
partnerships, estates, trusts, and
corporations) apply for purposes of
determining ownership of stock in a
corporation, and similar principles
apply for purposes of determining
ownership of an interest in any other
entity.
(5) Method of control. Control
includes control by aggregating votes or
positions of authority (including by veto
power), but applies regardless of the
method by which the control is
exercised or exercisable.
(c) Organization described in section
509(a)(3) during the taxable year with
respect to the educational institution. A
section 509(a)(3) organization is a
supporting organization with respect to
an educational institution only if the
supporting organization meets the
organizational, operational, and
relationship tests of section 509(a)(3)(B)
and § 1.509(a)–4 of this chapter with
respect to the educational institution.
(d) Assets and net investment income
of related organizations—(1) In general.
A related organization’s assets and net
investment income are taken into
account both in determining whether an
institution is an applicable educational
institution and in computing the net
investment income of an applicable
educational institution. For purposes of
determining the aggregate fair market
value of the assets and net investment
income of an educational institution,
the assets and net investment income of
all related organizations are treated as
the assets and net investment income,
respectively, of the institution, unless
an exception provided in paragraph
(d)(2) of this section or the exception
provided in § 53.4968–1(b)(5)(iv)
(relating to assets used directly in
carrying out an exempt purpose)
applies. In cases in which an
organization is a related organization
with respect to an educational
institution under more than one
definition of this § 53.4968–3, then the
rule that attributes the largest amount of
assets and net investment income of the
related organization to the educational
institution must be applied.
(2) Exceptions. For purposes of
section 4968 and this paragraph (d)(2)—
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(i) No amount is taken into account
with respect to more than one
educational institution. In determining
the aggregate fair market value of the
assets and net investment income of an
educational institution, assets and net
investment income of a related
organization are not taken into account
with respect to more than one
educational institution. Thus, 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 or among the
educational institutions as to which the
organization is a related organization,
subject to paragraph (d)(2)(ii) of this
section. The educational institution
must make such allocation in a
reasonable manner, taking into account
all facts and circumstances, that is
consistent across all related
organizations.
(ii) Assets and net investment income
that are not intended or available for the
use or benefit of the educational
institution—(A) In general. Unless a
related organization is controlled by the
educational institution or is a
supporting organization described in
section 509(a)(3) with respect to such
institution for the taxable year, assets
and net investment income of a related
organization that are not intended or
available for the use or benefit of the
educational institution are not taken
into account by that educational
institution.
(B) Determining whether assets and
net investment income of a related
organization are intended or available
for the use or benefit of an educational
institution. If a related organization
controls the educational institution, is
controlled by one or more persons that
also control such institution (but is not
described in section 509(a)(3) with
respect to the educational institution for
the taxable year), or is a supported
organization (as defined in section
509(f)(3)) during the taxable year with
respect to the educational institution,
then the related organization’s assets
and net investment income are taken
into account as assets and net
investment income of the educational
institution only to the extent the assets
and net investment income are intended
or available for the use or benefit of that
educational institution. Assets and net
investment income of a related
organization are intended or available
for the use or benefit of an educational
institution if such assets and net
investment income are specifically
earmarked or restricted for the benefit
of, or otherwise are fairly attributable to,
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the educational institution. For
example, assets are fairly attributable to
the educational institution if they have
been affirmatively designated or
appropriated for the educational
institution or made available for the
educational institution to draw upon at
will. Conversely, assets and net
investment income of a related
organization are not intended or
available for the use or benefit of an
educational institution if such assets
and net investment income are
specifically earmarked or restricted for
another entity or for unrelated purposes
or otherwise are not fairly attributable to
the educational institution. The assets
and net investment income of a related
organization must be allocated between
those intended or available for the use
or benefit of an educational institution
and those not intended or not available
for the use or benefit of that same
educational institution. The educational
institution must make such allocation in
a reasonable manner, taking into
account all facts and circumstances, that
is consistent across all related
organizations.
(C) Related organizations that are
controlled by the educational institution
or that are supporting organizations (as
described in section 509(a)(3)) with
respect to the educational institution
during the taxable year—(1) In general.
If a related organization is controlled, as
defined in paragraph (b)(2) of this
section, by an educational institution, or
is a supporting organization with
respect to the educational institution
during the taxable year, as defined in
paragraph (c) of this section, the assets
and net investment income of the
related organization are taken into
account as assets and net investment
income of the educational institution
regardless of whether those assets and
net investment income are earmarked or
restricted for the benefit of, or otherwise
are fairly attributable to, the educational
institution and even if they are
specifically earmarked or restricted for
another entity or for unrelated purposes
or otherwise are not fairly attributable to
the educational institution, subject to
paragraph (d)(2)(ii)(C)(2) of this section.
However, see §§ 53.4968–
1(b)(2)(ii)(A)(3) and (4) regarding trusts
that are controlled related organizations
only to the extent assets of the trust
were contributed to the trust by the
educational institution (or by a person
controlled by the educational
institution), or only to the extent the
educational institution (or person
controlled by the educational
institution) has the right to demand (or
can otherwise cause) a distribution of
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65563
principal from the trust to the
educational institution (or a person
controlled by the educational
institution). See also § 53.4968–
1(b)(5)(iv) for rules relating to when
assets of a related organization are
deemed to be used directly in carrying
out the institution’s exempt purpose.
(2) Special rule for Type III supporting
organizations with respect to an
educational institution as of December
31, 2017. An educational institution
with a related organization that was a
Type III supporting organization with
respect to the educational institution on
December 31, 2017, takes into account
only the assets and net investment
income of such Type III supporting
organization that are intended or
available for the use or benefit of, or
otherwise are fairly attributable to, the
educational institution, as described in
paragraph (d)(2)(ii)(B) of this section.
An educational institution may
determine whether the assets and net
investment income of such a Type III
supporting organization are intended or
available for the use or benefit of, or
otherwise are fairly attributable to, the
educational institution using any
reasonable method. A method that
attributes to an educational institution
assets and net investment income of a
supporting organization that specifically
are earmarked for the educational
institution, are restricted for the benefit
of the educational institution, or
otherwise are fairly attributable to the
educational institution (such as those
that have been affirmatively designated
or appropriated for the educational
institution or made available for the
educational institution to draw upon at
will) will be deemed to be reasonable.
(3) Determining assets of related
organizations. To determine which
assets of a related organization are
included by an educational institution
under section 4968(b)(1)(D) for a
particular year, an educational
institution determines which
organizations are related organizations,
as defined in section 4968(d)(2) and
§ 53.4968–3, as of the end of the
educational institution’s preceding
taxable year, and values the relevant
assets on that date.
(4) Determining net investment
income of related organizations. To
determine the amount of net investment
income of a related organization that is
included by the applicable educational
institution in calculating the tax
imposed by section 4968(a) for a
particular taxable year, an applicable
educational institution determines
which organizations are related
organizations, as defined in section
4968(d)(2) and § 53.4968–3, as of the
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end of that taxable year of the applicable
educational institution and includes the
net investment income from each
related organization’s taxable year that
ends with or within that same taxable
year of the applicable educational
institution. If an organization became a
related organization after the beginning
of the applicable educational
institution’s taxable year, then the
applicable educational institution
includes the organization’s net
investment income for the portion of the
year that the organization was a related
organization, using any reasonable
method.
§ 53.4968–4
Applicability date.
The rules of §§ 53.4968–1 through
53.4968–3 apply to taxable years of an
educational institution beginning after
October 15, 2020.
Sunita Lough,
Deputy Commissioner for Services and
Enforcement.
Approved: September 4, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 2020–20933 Filed 10–14–20; 8:45 am]
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]]>Agencies
[Federal Register Volume 85, Number 200 (Thursday, October 15, 2020)]
[Rules and Regulations]
[Pages 65526-65564]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-20933]
[[Page 65525]]
Vol. 85
Thursday,
No. 200
October 15, 2020
Part IV
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 53
Guidance on the Determination of the Section 4968 Excise Tax Applicable
to Certain Colleges and Universities; Final Rule
Federal Register / Vol. 85 , No. 200 / Thursday, October 15, 2020 /
Rules and Regulations
[[Page 65526]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 53
[TD 9917]
RIN 1545-BO75
Guidance on the Determination of the Section 4968 Excise Tax
Applicable to Certain Colleges and Universities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations for determining the
excise tax applicable to the net investment income of certain private
colleges and universities. The regulations affect certain private
colleges and universities.
DATES:
Effective Date: These regulations are effective on October 14,
2020.
Applicability Date: For date of applicability, see Sec. 53.4968-4.
FOR FURTHER INFORMATION CONTACT: Melinda Williams at (202) 317-6172 or
Amber Mackenzie at (202) 317-4086 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document amends the Foundation and Similar Excise Tax
Regulations (26 CFR part 53) by adding final regulations under section
4968 of the Internal Revenue Code (Code). Section 4968 was added to the
Code by section 13701 of Public Law 115-97 (131 Stat. 2054, 2167-68
(2017)), commonly referred to as the Tax Cuts and Jobs Act (TCJA).
Section 4968(a) imposes on each applicable educational institution, as
defined in section 4968(b)(1), an excise tax equal to 1.4 percent of
the institution's net investment income, determined under section
4968(c). Further, section 4968(d) treats a portion of certain assets
and net investment income of certain related organizations as assets
and net investment income of the educational institution.
Section 4968(b)(1) defines the term ``applicable educational
institution'' as an eligible educational institution (as defined in
section 25A(f)(2)) that, during the preceding taxable year, had at
least 500 tuition-paying students, more than 50 percent of whom were
located in the United States, that is not a state college or university
as described in the first sentence of section 511(a)(2)(B), and that
had assets (other than those assets used directly in carrying out the
institution's exempt purpose) the aggregate fair market value of which
was at least $500,000 per student of the institution.
Section 4968(b)(2) provides that, for purposes of section
4968(b)(1), the number of students of an institution (including for
purposes of determining the number of students at a particular
location) is based on the daily average number of full-time students
attending such institution, with part-time students taken into account
on a full-time student equivalent basis.
Section 4968(c) provides that, for purposes of section 4968, ``net
investment income'' is determined under rules similar to the rules of
section 4940(c).
Section 4968(d)(1) provides that, for purposes of determining the
aggregate fair market value of an educational institution's assets not
used directly in carrying out its exempt purpose,\1\ and for purposes
of determining an institution's net investment income, the assets and
net investment income of any related organization with respect to the
institution are treated as assets and net investment income,
respectively, of the educational institution, with two exceptions.
First, no such amount is to be taken into account with respect to more
than one educational institution. Second, unless such organization is
controlled by such institution or is a supporting organization
described in section 509(a)(3) with respect to such institution for the
taxable year, assets and net investment income that are not intended or
available for the use or benefit of the educational institution are not
taken into account.
---------------------------------------------------------------------------
\1\ Section 4968(d)(1) erroneously cross references section
4968(b)(1)(C). The correct cross reference should be to section
4968(b)(1)(D). See Joint Committee on Taxation, ``General
Explanation of Public Law 115-97'' (JCS-1-18), December 2018, at
290, n. 1357.
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Section 4968(d)(2) provides that the term ``related organization,''
with respect to an educational institution, means any organization
that: (1) Controls, or is controlled by, such institution; (2) is
controlled by one or more persons that also control such institution;
or (3) is a supported organization (as defined in section 509(f)(3)),
or a supporting organization (as described in section 509(a)(3)),
during the taxable year with respect to the educational institution.
The Conference Report for the TCJA, H. Rept. 115-466, 115th Cong.,
1st Sess., December 15, 2017 (Conference Report), at 555, 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 an 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 an educational institution.
In June 2018, the Department of the Treasury (Treasury Department)
and the IRS issued Notice 2018-55, 2018-26 I.R.B. 773, to provide
interim guidance on certain issues related to the application of the
tax imposed by section 4968. Specifically, Notice 2018-55 stated that,
in the case of property held on December 31, 2017, and continuously
thereafter to the date of its disposition, the Treasury Department and
the IRS intended to propose regulations stating that basis for purposes
of determining gain (but not loss) is deemed to be not less than the
fair market value of such property on December 31, 2017, plus or minus
all adjustments after December 31, 2017, and before the date of
disposition, consistent with the regulations under section 4940(c).
Notice 2018-55 additionally stated that the Treasury Department and the
IRS expected the proposed regulations to provide that losses from sales
or other dispositions of property generally would be allowed only to
the extent of gains, with no capital loss carryovers or carrybacks, and
that losses from sales or other dispositions of property by related
organizations will be allowed to offset overall net gains from other
related organizations or the applicable educational institution.
On July 3, 2019, the Treasury Department and the IRS published a
notice of proposed rulemaking in the Federal Register (REG-106877-18,
84 FR 31795) that contained proposed regulations regarding the
requirements of section 4968, including the manner for determining the
excise tax applicable to the net investment income of certain private
colleges and universities. The proposed regulations incorporated the
provisions set forth in Notice 2018-55. The proposed regulations also
provided definitions for several of the terms necessary for an
educational institution to determine whether the section 4968 excise
tax is applicable to it, including the terms ``student,'' ``tuition-
paying,'' ``located in the United States,'' and ``assets used directly
in carrying out an institution's exempt purpose.'' Eighteen comments
were received in response to the proposed regulations, one of which was
the collective comment of forty educational institutions likely to be
subject to this excise tax. No public hearing was requested or held.
After consideration of the comments received, the proposed
regulations
[[Page 65527]]
under section 4968 are adopted as final regulations as modified by this
Treasury Decision. The major areas of comment and the revisions to the
proposed regulations are discussed in the Summary of Comments and
Explanation of Revisions. Eight commenters voiced objections to the
Code section itself. No regulatory response to these comments is
appropriate. Accordingly, these comments are not discussed in the
Summary of Comments and Explanation of Revisions. All comments are
available for public inspection at www.regulations.gov or on request.
Summary of Comments and Explanation of Revisions
These final regulations provide guidance on the tax imposed by
section 4968 and the entities that are subject to the tax.
1. Applicable Educational Institution
Section 4968(b)(1) defines the term ``applicable educational
institution,'' in part, as an eligible educational institution defined
in section 25A(f)(2). Consistent with the statute, the proposed
regulations provided that the term ``applicable educational
institution'' means any eligible educational institution (as defined in
section 25A(f)(2) and Sec. 1.25A-2(b)): (1) That had at least 500
tuition-paying students attending the institution during the preceding
taxable year; (2) more than 50 percent of whose tuition-paying students
are located in the United States; (3) that is not described in the
first sentence of section 511(a)(2)(B) (relating to state colleges and
universities); and (4) the aggregate fair market value of the assets of
which at the end of such preceding taxable year (other than those
assets that are used directly in carrying out the institution's exempt
purpose) is at least $500,000 per student attending the institution.
Two commenters addressed the definition of applicable educational
institution. The first commenter recommended that the final regulations
provide additional guidance to clarify that separate, but affiliated,
educational institutions that are under common control (for example,
within the same university system) should be aggregated for purposes of
determining the number of students used in both the 500-student and the
$500,000-per-student tests. These final regulations do not adopt this
recommendation, because both section 4968(b)(1) and section 25A(f)(2)
refer to individual institutions and neither contains any provisions
for aggregating affiliated institutions for purposes of determining the
number of students at an institution. The only aggregation in section
4968 is the requirement to treat certain assets and net investment
income of related organizations as the assets and net investment
income, respectively, of the institution.
The second commenter stated that, for purposes of defining
``eligible educational institution,'' the final regulations should not
include a reference to the regulations at Sec. 1.25A-2(b) and should
use only the statutory definition contained in section 25A(f)(2).
Section 1.25A-2(b) provides that an eligible educational institution
means, in general, a college, university, vocational school, or other
postsecondary educational institution that is described in section 481
of the Higher Education Act of 1965 (20 U.S.C. 1088) as in effect on
August 5, 1997 (generally all accredited public, nonprofit, and
proprietary postsecondary institutions) that (1) is participating in a
Federal financial aid program under title IV of the Higher Education
Act of 1965 or (2) is certified by the Department of Education as
eligible to participate in such a program but chooses not to
participate.
The commenter explained that there are several educational
institutions whose organizational documents and mission prohibit them
from applying for or receiving Federal funds (including accepting funds
as part of a student Federal financial aid program under Title IV of
the Higher Education Act of 1965). The commenter asked that
applicability of section 4968 be determined based on the actions of an
institution rather than by a Department of Education certification that
is focused on whether the students of an institution can claim an
individual tax credit under section 25A for expenses to attend the
institution, which the commenter sees as being incompatible with both
the terms of section 25A and the mission of such institutions.
Although the Treasury Department and the IRS appreciate the
position of the commenter, section 4968 expressly defines applicable
educational institution by reference to section 25A(f)(2). Section
25A(f)(2) provides that the term ``eligible educational institution''
means an institution that is described in section 481 of the Higher
Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of the
enactment of section 25A, and that ``is eligible to participate in a
program under title IV of such Act.''
If the final section 4968 regulations did not include a reference
to Sec. 1.25A-2(b), an educational institution would still be
``eligible to participate in a program under title IV of such Act'' as
long as it satisfied all of the requirements of that Act even if it
chose not to participate in such a program and even if it was not
certified by the Department of Education as eligible to participate in
such a program. Thus, deleting the reference to Sec. 1.25A-2(b) would
not address the commenter's concerns. Further, Sec. 1.25A-2 was
adopted in 2002, and Congress is presumed to have been aware of the
regulations when section 4968 was enacted. Congress did not express any
intent in the legislative history of section 4968 for the regulations
under section 25A to be disregarded for purposes of defining eligible
educational institution. In addition, it would be very difficult for
the Treasury Department and the IRS to provide in the regulations under
section 4968 that the IRS is following a definition of eligible
educational institution that is consistent with the statutory language
of section 25A(f)(2) without also incorporating the regulations under
section 25A unless there was specific language in section 4968 with
which the regulations were in conflict, and that is not the case here.
Lastly, the Treasury Department and the IRS understand that the number
of educational institutions that do not participate in the Federal
programs provided in the Higher Education Act or that are not certified
as eligible to participate in the programs is very small, and it would
be burdensome for the IRS to follow one definition of eligible
educational institution for purposes of section 25A and another under
section 4968 when both provisions are dependent on section 25A(f)(2).
Thus, these final regulations adopt the definition of applicable
educational institution as proposed.
2. Student
The proposed regulations defined ``student,'' based in part on
section 25A(b)(3) and the Higher Education Act, as a person enrolled in
a degree, certification, or other program (including a program of study
abroad approved for credit by the eligible educational institution at
which such student is enrolled) leading to a recognized educational
credential at an eligible educational institution, and who is not
enrolled in an elementary or secondary school.
The proposed regulations also provided that the number of students
of an educational institution (including for purposes of determining
the number of students at a particular location) is based on the daily
average number of full-time students attending such institution (with
part-time students taken into account on a full-time
[[Page 65528]]
student equivalent basis). Under the proposed regulations, the
standards for determining part-time students, full-time students, full-
time equivalents, and daily average are determined by each educational
institution. However, the standards may not be lower than the
applicable standards established by the Department of Education under
the Higher Education Act of 1965 (20 U.S.C. 1088), as amended.
Three commenters addressed the proposed definition of ``student,''
stating that section 4968 does not define the term student but it does
provide that, for purposes of determining the number of students of an
institution, an educational institution must determine 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. Two of these commenters recommended that the definition should
include all students attending the institution even if not enrolled in
a degree, certification, or other program leading to a recognized
educational credential, stating that section 4968 includes students
that are taking a less-than half time load and that many of those
students are not seeking a degree. The commenters stated that the
definition of student for purposes of the Lifetime Learning Tax Credit
(LLTC) \2\ or the Family Educational Rights and Privacy Act (FERPA) \3\
is broader than the definition that applies for purposes of the Higher
Education Act and the American Opportunity Tax Credit,\4\ which defines
those eligible for student loans, and thus is more consistent with and
thus appropriate for purposes of section 4968. In addition, two
commenters recommended against a definition based on a recognized
educational credential, questioning who would decide what constitutes
such a credential and whether this would allow potential manipulation
by the educational institutions. One other commenter suggested
retaining the standard in the proposed regulations.
---------------------------------------------------------------------------
\2\ The Lifetime Learning Credit, found in section 25A(c),
provides a tax credit equal to 20 percent of up to $10,000 of
``qualified tuition and related expenses'' paid by the taxpayer
during the taxable year to acquire or improve job skills. Section
25A(f)(1) defines qualified tuition and related expenses as tuition
and fees required for enrollment or attendance at an eligible
educational institution for courses of instruction at such
institution.
\3\ The Family Educational Rights and Privacy Act (FERPA) (20
U.S.C. 1232g; 34 CFR part 99) is a Federal law that protects the
privacy of student education records. It defines the term
``student'' as any individual who is or has been in attendance at an
educational agency or institution, including at elementary and
secondary school levels, and regarding whom the agency or
institution maintains education records.
\4\ The American Opportunity Tax Credit, found in section
25A(b), provides a tax credit equal to the sum of 100 percent of so
much of the qualified tuition and related expenses paid by the
taxpayer during the taxable year (for education furnished to the
eligible student during any academic period beginning in such
taxable year) as does not exceed $2,000, plus 25 percent of such
expenses so paid as exceeds $2,000 but does not exceed $4,000.
Section 25A(b)(3) defines an eligible student for purposes of the
American Opportunity Tax Credit as a student who meets the
requirements of section 484(a)(1) of the Higher Education Act of
1965 (20 U.S.C. 1091(a)(1)), as in effect on the date of the
enactment of section 25A, and is carrying at least \1/2\ the normal
full-time work load for the course of study the student is pursuing.
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The Treasury Department and the IRS agree that section 4968 does
not expressly state that a person must be enrolled in a degree,
certification, or other program to be considered a student. However,
section 4968 does require that a student be attending the institution:
``. . . the number of students of an institution . . . shall be based
on the daily average number of full-time students attending such
institution (with part-time students taken into account on a full-time
student equivalent basis).''
The Treasury Department and the IRS have concluded that the
definition of student provided in FERPA is overly broad, as it
includes, for example, individuals who previously attended the
educational institution.
However, the LLTC, which provides a tax credit based on certain
tuition and fees required ``for the enrollment or attendance of'' an
individual at an eligible educational institution ``for courses of
instruction of such individual at such institution'' does provide a
useful analogy, as it refers to a person who is enrolled, attending,
and paying qualified tuition to an institution for courses of
instruction at such institution.
Whereas the LLTC includes a requirement that the purpose of the
course must be to acquire or improve job skills of the individual, the
Treasury Department and the IRS have determined that it would be more
appropriate and administrable instead to require that the course be
taken for academic credit. Whereas neither an applicable educational
institution nor the IRS is likely to know whether a course is taken to
acquire or improve job skills of the individual, it should be easy to
determine whether a course was taken for academic credit. Furthermore,
anyone taking a course for academic credit is using the school's
resources to receive the specific time and attention of the school's
faculty for his or her individual instruction. Thus, it is appropriate
to include taking a course for academic credit as a component of the
definition of student for purposes of section 4968.
However, under the definition, a student, whether full time or part
time, must be charged tuition at a rate that is commensurate with the
rate charged to students enrolled for a degree. The Treasury Department
and the IRS have concluded that this is necessary for a part-time
student to be considered as attending the institution on an
``equivalent basis'' to a full-time student.
Thus, these final regulations define the term ``student'' for
purposes of section 4968 as a person who is enrolled and attending a
course for academic credit from the institution and who is being
charged tuition at a rate that is commensurate with the tuition rate
charged to students enrolled for a degree. No inference is to be drawn
from this definition with regard to the definition of student for other
purposes, including for purposes of applying section 25A.
These final regulations also adopt the portion of the definition of
``student'' found in the proposed regulations providing that the number
of students of an educational institution (including for purposes of
determining the number of students at a particular location) is based
on the daily average number of full-time students (with part-time
students taken into account on a full-time student equivalent basis).
The standards for determining whether a student attends part-time or
full-time and for calculating full-time equivalents and the daily
average number of full-time students are determined by each educational
institution. However, the standards may not be lower than the minimum
applicable standards established by the Department of Education under
the Higher Education Act of 1965 (20 U.S.C. 1088), as amended.
3. Tuition-Paying
The proposed regulations provided that the term ``tuition-paying''
means the payment of any tuition or fees required for the enrollment or
attendance of a student for a course of instruction at an eligible
educational institution. The proposed regulations stated that this 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 or the payment of room and board or other personal living
expenses. In addition, the proposed regulations provided that whether a
student is ``tuition-paying'' is determined after taking into account
any scholarships provided directly by the educational institution and
any work study programs operated directly by the
[[Page 65529]]
educational institution; however, scholarship payments provided by
third parties, even if administered by the institution, are considered
payments of tuition on behalf of the student.
Three commenters discussed the meaning of ``tuition-paying.'' One
commenter expressed a concern that smaller educational institutions
might modify their financial aid programs to offer fewer partial
scholarships and more full scholarships to fall under the threshold of
having 500 tuition-paying students. The Treasury Department and the IRS
have determined that a modification to the regulations for this purpose
is not necessary because any definition of tuition-paying may lead to
this result and because the same definition of tuition-paying should
apply regardless of the size of the institution.
Another commenter recommended that a student should be considered
``tuition-paying'' regardless of the source of tuition funds, except
that an eligible educational institution that does not charge tuition
to any student would not be considered to have any tuition-paying
students. These final regulations do not adopt this suggestion because
the statute does not refer to tuition ``charged,'' rather it refers to
tuition ``paid.''
The third commenter asked whether the term ``scholarships'' in the
proposed regulations was intended to include Pell Grants and other
forms of Federal and state student financial aid as well as non-
governmental grants made on behalf of students, recommending that these
grants from government and non-government sources not be treated as the
payment of tuition on behalf of students. The Treasury Department and
the IRS agree that grants or scholarships made by Federal, state, and
local governments should be disregarded when determining whether a
student is tuition-paying. Grants or scholarships made by Federal,
state, and local governments generally are governed by legislation, are
intended to make a college education more affordable for all potential
students, and generally are based on criteria that the government sets
(such as a determination of financial need), applied without regard to
which educational institution the student attends or the cost of the
education. Pell Grants and other Federal grants are awarded and
administered by the Department of Education, which determines each
student's financial need and eligibility for the grant. Finally, almost
all educational institutions, whether private or public, use Federal
and state grants to offset the cost of tuition, and therefore it would
be fundamentally unfair to include these government grants as payment
of tuition by or on behalf of a student in determining whether an
educational institution is liable for the excise tax imposed by section
4968.
Thus, these final regulations adopt the definition of ``tuition-
paying'' found in the proposed regulations, which concluded that
scholarships awarded by the institution are not tuition ``paid'' on
behalf of the student, whereas scholarships from third parties
essentially are payments of the student's tuition, but add that whether
a student is tuition-paying is also determined after taking into
account grants made by the Federal government or any state or local
government.
4. Located in the United States
The proposed regulations provided that the term ``located in the
United States'' refers to the location of a student, and that a student
is considered to have been located in the United States if the student
resided in the United States for at least a portion of the time the
student attended the institution during the educational institution's
preceding taxable year.
The preamble to the proposed regulations provided three examples
relating to whether a student is considered to have been located in the
United States. In the first example, a student who attended an
educational institution in the preceding taxable year and who is a
citizen of a foreign country is considered to have been a student
located in the United States if the student resided in the United
States for at least a portion of the time the student attended the
educational institution in the preceding taxable year. In the second
example, a student attending the educational institution in the
preceding taxable year who was studying abroad in a foreign country is
considered to have been a student located in the United States if the
student resided in the United States for at least a portion of the time
the student attended the educational institution. The third example
illustrates that, if a student did not reside in the United States for
any portion of the time the student attended the educational
institution during the preceding taxable year, then that student would
not be considered to have been located in the United States for
purposes of section 4968(b)(1)(B). The proposed regulations asked for
comments on whether further guidance is needed relating to whether a
student is considered to have been located in the United States in a
preceding taxable year.
One commenter addressed the definition of ``located in the United
States.'' This commenter recommended that each institution be permitted
to determine whether a student is located in the United States using
any reasonable approach, as long as it was consistently used. However,
the commenter said that the approach would have to consider students
who spend substantial time in the United States attending classes as
located in the United States.
The proposed rule contemplated that educational institutions could
determine whether a student resided in the United States for at least a
portion of the time that the student attended the institution during
the institution's preceding taxable year using any reasonable method,
but these final regulations make that explicit. The final regulations
otherwise maintain the rule as proposed.
5. Assets Used Directly in Carrying Out an Institution's Exempt Purpose
a. In General
To be included in the definition of applicable educational
institution under section 4968(b)(1), an institution must have assets
(other than those assets that are used directly in carrying out the
institution's exempt purpose) the aggregate fair market value of which
is at least $500,000 per student. The phrase ``assets that are used
directly in carrying out the institution's exempt purpose'' is not
defined in section 4968, but a similar phrase is used in section 4942.
For purposes of section 4942, a private foundation must determine
its minimum investment return as part of its calculation of its
distributable amount for any taxable year. Minimum investment return is
defined in section 4942(e) as five percent of the excess of the
aggregate fair market value of all assets of the foundation ``other
than those which are used (or held for use) directly in carrying out
the foundation's exempt purpose,'' over the acquisition indebtedness
with respect to such assets.
Because section 4968 contains a phrase similar to the language used
in section 4942 (other than the omission of the parenthetical ``(or
held for use)''), the proposed regulations generally followed Sec.
53.4942(a)-2(c) for purposes of determining whether an educational
institution's assets are used directly in carrying out the
institution's exempt purpose, but not including any assets that would
be considered ``held for use'' for section 4942 purposes.
[[Page 65530]]
More specifically, the proposed regulations provided that an asset
is used directly in carrying out an 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 must 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 percent 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 percent of the total use, the institution must make a reasonable
allocation between exempt and nonexempt uses.
The proposed regulations included examples of assets that are used
directly in carrying out an institution's exempt purpose, stating that
they include, but are not limited to: (1) Administrative assets, such
as office equipment and supplies used by the institution directly in
the administration of its exempt activities; (2) real estate or the
portion of any building used by the institution directly in its exempt
activities; (3) physical property such as paintings or other works of
art owned by the institution that are on public display, fixtures and
equipment in classrooms, research facilities and related equipment
that, under the facts and circumstances, serve a useful purpose in the
conduct of the institution's exempt activities; (4) the reasonable cash
balances necessary to cover current administrative expenses and other
normal and current disbursements directly connected with the
educational institution's exempt activities (and, for this purpose, the
proposed regulations provided a safe harbor for determining a
reasonable cash balance: The portion of an educational institution's
actual cash balances at the end of a year that does not exceed 1.5
percent of the fair market value of the institution's non-charitable
use assets, determined without regard to any reduction for reasonable
cash balances); and (5) any property the educational institution leases
to other persons at no cost (or at a nominal rent) to the lessee in
furtherance of the institution's exempt purposes.
The proposed regulations also provided the following examples of
assets not considered to be used directly in carrying out an
institution's exempt purpose: (1) Assets that are held for the
production of income or for investment (for example, stocks, bonds,
interest-bearing notes, endowment funds, or leased real estate), even
if the income from such assets is used to carry out such exempt
purpose; and (2) property (such as offices) used for the purpose of
managing the institution's endowment funds.
The proposed regulations asked for comments on whether the use of
the principles of the section 4942 regulations creates any concerns.
Commenters asked that the final regulations expand the list of assets
considered used directly in carrying out an institution's exempt
purpose to include those that are ``held for use'' as well as including
certain intangible assets and certain assets of functionally related
businesses. Commenters also addressed how to calculate a reasonable
cash balance that would be considered used directly in carrying out an
institution's exempt purpose. In addition, commenters asked whether an
asset of a related organization that is treated as an asset of an
educational institution by section 4968(d) can be considered used
directly by the institution in carrying out its exempt purpose.
b. Assets That Are Held for Use
One commenter asked that the proposed regulations be expanded to
include as assets ``used directly in carrying out the institution's
exempt purpose'' assets that are ``held for use'' to carry out such
purposes, stating that there is no legislative history suggesting that
Congress specifically intended to not include the ``held for use''
language contained in section 4942.
Because assets held for use could include a much broader category
of assets, such as portions of an endowment fund set aside in some
formal or informal way for an exempt purpose, the Treasury Department
and the IRS have concluded that the category of assets used directly
for an institution's exempt purposes should not be so expanded,
especially because the statutory language of section 4968 does not
include the ``(or held for use)'' parenthetical language that appears
in section 4942. Accordingly, these final regulations do not adopt the
commenter's suggestion.
c. Intangible Assets
One commenter requested that the final regulations permit
intangible assets, in appropriate cases, to be treated as used directly
in carrying out an institution's exempt purpose. The Treasury
Department and the IRS agree that, in certain circumstances, intangible
assets may be treated as used directly in carrying out an institution's
exempt purpose. Thus, these final regulations provide that, to the
extent that royalty income would be excluded from net investment income
as described in part 6.a.iii. of this Summary of Comments and
Explanation of Revisions, the patents, copyrights, and other
intellectual property and other intangible property generating such
royalty income are treated as assets used directly by the institution
in furtherance of its exempt purposes. These final regulations also
provide that trademarks on an institution's logo or name and
intellectual property donated or sold to the institution are not assets
used directly for the institution's exempt purposes.
d. Certain Assets of Functionally Related Businesses
The preamble to the proposed regulations asked for comments on
whether and how educational institutions use functionally related
businesses in conducting their operations and whether functionally
related businesses should be explicitly included or excluded as
examples of exempt use assets in the final regulations. One commenter
requested that the final regulations provide that non-financial assets
used in a functionally related business be considered assets used
directly in carrying out an educational institution's exempt purpose.
The commenter stated that university theatres that produce plays,
student newspapers with circulation revenue or ad sales income, or
similar activities that operate as legally separate businesses while
buttressing the educational mission of an educational institution are
examples of functionally related businesses. The commenter recommended
that assets, including intangible assets, of such a functionally
related business be considered to be used directly in furthering the
educational institution's exempt purpose. The commenter further
recommended, however, that working capital or other financial resources
relating to such a functionally related business should be considered
assets not used directly in furthering the educational institution's
exempt purpose.
The Treasury Department and the IRS agree that, in certain
circumstances, certain assets of functionally related businesses may be
treated as used directly in carrying out an institution's exempt
purpose. However, the Treasury Department and the IRS note that the
concept of a functionally related business is relevant only for private
foundations with respect to the excise taxes imposed under sections
4942 and 4943. Thus, instead of providing a special rule for a non-
financial asset of
[[Page 65531]]
an activity of an educational institution, or of a related organization
with respect to the educational institution, that meets the definition
of a functionally related business found in Sec. 53.4942(a)-
2(c)(3)(iii), the general rule is that an educational institution
evaluates each asset based on all the facts and circumstances to
determine whether the asset is used directly in furthering the
institution's exempt purpose applies.
e. Reasonable Cash Balance
The proposed regulations recognized that, for section 4942
purposes, an amount equal to 1.5 percent of the fair market value of a
private foundation's non-charitable use assets (i.e., assets not
actually used by an institution in carrying out its exempt purpose),
determined without regard to the reduction for the reasonable cash
balance, is deemed to be a ``reasonable cash balance'' that is excluded
from the asset base used in calculating a private foundation's minimum
investment return under section 4942(e). For consistency with the
section 4942 rules, the proposed regulations proposed to adopt the same
definition as a safe harbor and asked for comments on whether, in light
of the differences between the exempt activities and valuation date(s)
of a private foundation and an educational institution, a different
percentage or other measurement should be used as a reasonable cash
balance at the end of the taxable year.
Two commenters stated that the 1.5 percent safe harbor should not
be included in the final regulations, because there is a significant
difference between the activities, and thus the need for cash for
operating expenses, of a private foundation and an educational
institution. The commenters indicated that the operating expenses of a
private foundation whose exempt activity is awarding grants, and even
of an operating private foundation, generally are substantially less
than the salaries, maintenance, and other operating expenses of an
educational institution with expansive physical facilities and human
resources for conducting education and research.
One commenter stated that educational institutions affected by the
excise tax under section 4968 vary widely in size and focus, and that
their methods for the delivery of educational services--which are the
drivers of operating expenses and corresponding cash outflow and
timing--vary widely. This commenter also mentioned that some
institutions have a summer session with a lower attendance (therefore
requiring fewer resources) as compared to their traditional fall or
spring sessions, and thus may have a lower cash balance at the end of
their taxable year, which generally falls in the middle of summer on
June 30th or July 31st. This commenter also stated that ratings
agencies might downgrade the credit rating of some institutions based
on their having cash on hand of only 1.5 percent of the value of non-
exempt use assets, and that bond proceeds for exempt projects must be
held in liquid assets. One commenter also stated that the amount
required for the reasonable cash needs of the institution should
include funds for the expenses of its educational and research
functions as well as cash reserves for special projects and bond
covenants. Both commenters recommended that the final regulations
instead permit educational institutions to determine their own
reasonable cash needs as of the end of the taxable year, based on the
particular facts and circumstances of that institution.
The Treasury Department and the IRS note that the 1.5 percent safe
harbor in proposed Sec. 53.4968-1(a)(4)(ii)(D) was merely a safe
harbor and did not prevent an educational institution from establishing
under the general facts and circumstance rule of proposed Sec.
53.4968-1(a)(4)(i) that another cash balance was reasonably necessary
to cover its current administrative expenses and other normal and
current disbursements directly connected with its exempt purposes.
However, in recognition that commenters did not find the safe harbor
useful, these final regulations instead provide a different safe harbor
that is based on the specific expenses incurred by each educational
institution. Specifically, these final regulations provide that a
reasonable cash balance may be determined by any reasonable method, and
that one such method would be to calculate an amount equal to three
months of operating expenses allocable to program services, calculated
by dividing annual functional expenses allocable to program services
(2019 Form 990, Part IX, line 25, column (B), or the corresponding line
provision of any successor Form 990) by four. Alternatively, a larger
amount may be a reasonable cash balance for this purpose if, under the
facts and circumstances, a larger amount is established to be necessary
to cover administrative expenses and other normal disbursements
directly connected with the institution's exempt activity.
f. Assets of Related Organizations
One commenter noted that section 4968(d) treats certain assets of
related organizations with respect to an educational institution as
assets of the educational institution, and that section 4968(b)(1)(D)
requires the educational institution to determine whether, at the end
of the preceding taxable year, the aggregate fair market value of its
assets (other than those assets that are used directly in carrying out
the institution's exempt purpose) is at least $500,000 per student of
the institution. This commenter suggested that, in counting the assets
of a related organization for this purpose, any asset of the related
organization that is used directly in carrying out the educational
institution's exempt purpose should be excluded from section
4968(b)(1)(D). In addition, the commenter asked how to apply the ``used
directly in carrying out the institution's exempt purpose'' test in the
case of a related organization with exempt purposes differing from
those of the educational institution.
The Treasury Department and the IRS agree with these comments.
Therefore, these final regulations provide that an asset of a related
organization that is treated as an asset of the educational institution
(in accordance with section 4968(d) and Sec. 53.4968-3(c)) and is used
directly in carrying out the educational institution's exempt purpose
is considered used directly by the institution in carrying out its
exempt purpose. These final regulations further provide that an asset
of a related organization that is treated as an asset of the
educational institution is considered to be used directly in carrying
out the educational institution's exempt purpose if (1) the related
organization is described in section 501(c)(3) and (2) the asset is
being used directly in carrying out the related organization's exempt
purpose.
For example, under this rule, if an educational institution
controls (as described in part 7.b.ii of this Summary of Comments and
Explanation of Revisions) a nonprofit nonstock organization that is a
museum, then section 4968(d)(1)(B) would treat all of the museum's
assets as assets of the educational institution, regardless of whether
the assets are earmarked or restricted for the benefit of, or otherwise
fairly attributable to, the educational institution, and even if they
are specifically earmarked or restricted for another entity or for
unrelated purposes or are otherwise not fairly attributable to the
educational institution. However, when for purposes of section
4968(d)(1)(D) the educational institution values its assets (other than
those used directly in carrying out the institution's exempt purpose)
at the end of the preceding taxable year, the educational institution
could exclude any museum
[[Page 65532]]
asset, such as artwork, that is being used directly in carrying out the
museum's exempt purpose, even if such use does not directly carry out
the educational institution's exempt purpose. (The Treasury Department
and the IRS note that the general rule found in Sec. 53.4968-
1(b)(5)(iii) that neither assets that are held for the production of
income or for investment nor property (such as offices and equipment)
used for the purpose of managing funds are considered used directly in
carrying out an exempt purpose. Thus, a related organization whose
exempt purpose is grantmaking generally will have few assets considered
to be used directly in carrying out the educational institution's
exempt purpose.)
g. Valuation of Assets Not Used Directly in Carrying Out an
Institution's Exempt Purpose
The proposed regulations provided that, for purposes of valuing an
educational institution's non-exempt use assets, the institution should
use rules similar to the rules of section 4942(e) and Sec. 53.4942(a)-
2(c)(4), with two modifications. First, the phrase ``educational
institution'' is substituted for ``private foundation'' or
``foundation'' every place they appear. Second, an institution will
have to make such adjustments as are reasonable and necessary to obtain
the fair market value of non-exempt use assets as of the last day of
the valuation taxable year, rather than any other time(s) required by
the section 4942 regulations. The proposed regulations also requested
comments on valuing assets using the principles of section 4942, as
modified by this special timing rule. No comments were received.
Accordingly, the proposed rule is adopted without substantive changes.
6. Net Investment Income
For taxable years beginning after December 31, 2017, section
4968(a) imposes a 1.4 percent excise tax on the net investment income
of an applicable educational institution (as defined in section
4968(c)), and on certain amounts of net investment income of certain
related organizations, as described in section 4968(d) and Sec.
53.4968-3. Section 4968(c) provides that net investment income is
determined under rules similar to the rules of section 4940(c).
Accordingly, the proposed regulations provided that an applicable
educational institution generally must calculate net investment income
under the rules of section 4940(c) and Sec. 53.4940-1(c) through (f),
with certain modifications.
Specifically, Sec. 53.4968-1(b)(3) of the proposed regulations (1)
substituted ``applicable educational institution'' for ``private
foundation'' or ``foundation'' each place they appear; (2) did not
apply the rule in Sec. 53.4940-1(d)(3), because it is narrowly focused
on section 302 stock redemptions by corporations that are disqualified
persons and is not applicable to colleges and universities; (3)
substituted ``December 31, 2017'' for ``December 31, 1969'' every place
that it occurs to determine the basis of assets held on December 31,
2017, for purposes of determining gain upon the sale or exchange of an
asset held on December 31, 2017 in calculating the excise tax; (4)
applied the special basis rule to assets held in partnerships as of
December 31, 2017, as well; and (5) allowed overall net losses from
sales or other dispositions of property by one related organization or
by the applicable educational institution to reduce (but not below
zero) overall net gains from such sales or other dispositions by other
related organizations or by the applicable educational institution.
Several commenters requested that the final regulations further
tailor those rules to take into account differences between a private
foundation subject to section 4940 and an educational institution,
including differences in funding sources, use of funds, structure,
governance, and oversight. In response, as discussed further in the
following paragraphs of this part 6, these final regulations omit the
use of a cross reference to the regulations under section 4940(c) to
define net investment income for purposes of section 4968. Instead,
these final regulations prescribe specific rules under section 4968
that are similar to the rules of section 4940(c) but that are more
tailored to educational institutions.
In particular, following the regulations under section 4940(c), the
final regulations provide, as further described in this part 6, that
net investment income generally is the amount by which the sum of the
gross investment income and the capital gain net income exceeds the
allowable deductions. Also consistent with section 4940(c)(5) and Sec.
53.4940-1(c)(2), net investment income is determined by applying
section 103 (relating to interest on certain governmental obligations)
and section 265 (relating to expenses and interest relating to tax-
exempt income). Finally, consistent with section 4940(c)(1) and Sec.
53.4940-1(c)(1), net investment income is determined under the
principles of subtitle A of the Code except to the extent inconsistent
with the Code or regulations.
a. Gross Investment Income
The proposed regulations noted that section 4968 does not expressly
provide that the tax on net investment income is limited to net
investment income derived from assets that are not used directly in
carrying out an applicable educational institution's exempt purpose.
This lack of a limitation is in contrast to the specific language in
section 4968(b)(1)(D) that excludes assets used directly in carrying
out an institution's exempt purpose in determining whether the
educational institution is an applicable educational institution.
Instead, section 4968(c) provides that net investment income is
determined under rules similar to the rules of section 4940(c).
To implement this provision, the proposed regulations proposed to
adopt by cross reference the rules provided in section 4940(c) and the
regulations thereunder, including Sec. 53.4940-1(d)(1), which
specifies that ``gross investment income'' means the gross amounts of
income from interest, dividends, rents, royalties (including overriding
royalties), and capital gain net income received by a private
foundation from all sources, but does not include such income to the
extent included in computing the tax on unrelated business taxable
income imposed by section 511. Under this definition, consistent with
specific language in Sec. 53.4940-1(d), interest, dividends, rents,
and royalties derived from assets devoted to an educational
institution's exempt activities would be includible in gross investment
income. Therefore, for example, under the proposed regulations,
interest received on a student loan would have been includible in
income for purposes of section 4968.
The proposed regulations requested comments on whether specific
types of income should be excluded from gross investment income under
section 4968 because taxing those types of income would not achieve the
congressional intent in enacting section 4968. Commenters recommended
excluding interest from student and faculty loans, rental income from
student and faculty housing, royalty income from exempt functions,
income from programmatic activities, and income from endowment funds if
the income is used as a tuition replacement fund.
These final regulations adopt most of these recommendations. These
final regulations specify that, consistent with section 4940(c), gross
investment income generally means the gross amounts of income from
interest, dividends, rents, payments with respect
[[Page 65533]]
to securities loans (as defined in section 512(a)(5)), and royalties,
but not including any such income to the extent it is included in
computing the tax imposed by section 511. Gross investment income also
includes income from sources similar to those in the preceding
sentence. In general, gross investment income includes the items of
investment income described in Sec. 1.512(b)-1(a).
However, in response to comments and consistent with the overall
purpose of section 4968, these final regulations exclude from the
definition of gross investment income (1) interest income from a
student loan that was made by the applicable educational institution or
a related organization to a student of the applicable educational
institution in connection with the student's attendance at the
institution; (2) rental income from the provision of housing by the
applicable educational institution or a related organization to
students of the applicable educational institution and from housing for
faculty and staff if the housing is provided contingent on their roles
as faculty or staff of the applicable educational institution; and (3)
royalty income that is derived from patents, copyrights, and other
intellectual property and intangible property to the extent those
assets resulted from the work of student(s) or faculty member(s) in
their capacities as such with the applicable educational institution.
However, neither royalty income from trademarks on the institution's
logo or name nor royalty income from intellectual property donated or
sold to the institution is excluded from gross investment income under
this rule).
i. Interest From Student Loans
The proposed regulations noted that the regulations under section
4940(c) specifically include student loan interest as gross investment
income. However, recognizing that student loans provided directly by an
applicable educational institution to its students can be seen as
helping the applicable educational institution fulfill its mission of
educating its students, and that, unlike private foundations, colleges
and universities educate students and charge tuition as part of their
primary exempt activities, the preamble to the proposed regulations
asked whether student loans provided by an applicable educational
institution to its students arguably can be viewed as a form of
deferred tuition which will be paid when the student enters the
workforce.
The preamble to the proposed regulations suggested distinguishing
the interest on a student loan from investment interest by reference to
the interest rate. If the interest is at a market (or higher) rate, it
would be difficult to distinguish the interest on the student loan and
interest on assets acquired for investment purposes. However, if the
interest rate is set at a substantially below-market rate, the
difference between the market interest rate and the interest rate on
the student loan might be viewed as similar to a scholarship from the
educational institution to the student. Under these circumstances, the
remaining, below-market rate interest income might be considered
distinguishable from income derived from assets acquired primarily for
investment purposes. Finally, the preamble to the proposed regulations
asked for comments on how a rule based on interest rates could be
addressed to avoid 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.
Four commenters recommended excluding all interest income from
loans to students from gross investment income, stating that loans made
by colleges and universities to students are not offered with the
intent of earning investment income for the institution, but are
instead made to assist students who have gaps in funding and need
financial assistance to complete their educations. Many of these
student loans are need-based loans to low-income students who would not
qualify for other programs or commercial loans. In addition, most of
the student loans made by educational institutions are made on terms,
taken as a whole, that are more favorable than similar commercial
student loans. These better terms include lower interest rates, fixed
interest rates, deferred or delayed repayment periods, low or no
origination fees, relaxed eligibility requirements, and more flexible
repayment plans than loans that are offered on the open market.
In response to these comments, these final regulations exclude from
gross investment income interest income from a student loan that was
made by the applicable educational institution (or a related
organization of the institution) to a student of the institution in
connection with the student's attendance at the institution.
While most of the student loans made by educational institutions
(or their related organizations) may be made on terms, taken as a
whole, that are more favorable than similar commercial student loans,
many of those favorable terms are not centered on interest rates. For
example, unlike commercial loans, no collateral or demonstrations
regarding future income are required. Therefore, an exception based on
whether terms are more favorable than commercial loans would be unduly
burdensome to administer and these final regulations do not include
such a requirement.
One commenter recommended extending this reasoning to faculty
loans, which in many circumstances are provided in order to give an
educational institution a competitive edge in attracting talented
educational professionals. In most cases, this type of financing is an
alternative to providing housing directly, the income or loss from
which the commenter also recommended excluding. However, the commenter
noted that there are nuances with respect to the types of faculty loans
that may be provided by an educational institution that may warrant
disparate treatment, and that an examination of all of the facts and
circumstances (such as the resources of the borrowers, interest rate
charged, availability of credit in the local area, and scope and extent
of the program) would be necessary to determine whether a particular
loan was effectively a substitute for bank financing and thus really an
investment vehicle that should be considered to produce gross
investment income.
These final regulations do not exclude interest on loans to faculty
from gross investment income. Although loans to faculty might
indirectly benefit students by attracting better faculty, so does
paying faculty higher salaries. Some loans provide a substitute for
bank financing for a faculty member to purchase a residence that then
becomes an asset of the faculty member. All loans to faculty, even if
on favorable terms as part of a compensation package in order to
attract such faculty, are substantially different from loans to
students which may be viewed as effectively representing deferred
tuition. Furthermore, interest income received on loans to faculty is
more difficult to distinguish from other interest income that is
includible under section 4940(c), such as interest income at the
applicable Federal rate on a loan to acquire a luxury home. While
certain loans, such as one to allow faculty to secure appropriate
housing that otherwise would not be attainable by faculty, might
qualify as supporting the institution's exempt purposes, a similar loan
in other circumstances might not. The difference would be heavily
dependent upon interest rates, the local real estate market, and other
facts and circumstances. Thus, in accord with the
[[Page 65534]]
language in section 4968(c) that net investment income for section 4968
purposes should be similar to the rules of section 4940(c), the final
regulations under section 4968 do not exclude interest income on loans
other than loans to students in connection with their attendance at the
educational institution.
ii. Rental Income From Student, Faculty, and Staff Housing
The proposed regulations also noted that colleges and universities
offer various types of housing (such as dormitories or apartments) for
use by students, non-students (for example, during the summer), and
faculty. The preamble to the proposed regulations requested comments on
the differences, if any, among the housing arrangements, whether any of
the arrangements include the signing of leases, the various amounts
charged by a college or university related to provision of housing and
meals, and particular factors that distinguish room and board payments
from students living in a dormitory from rental income that
institutions receive.
Five commenters recommended excluding income from student housing
from gross investment income. These commenters stated that student
housing is provided by educational institutions to their students for
the purpose of furthering the students' education, rather than to
create an investment return to the institution. On-campus housing
provides a sense of community and creates non-classroom opportunities
for students to engage with individuals with a similar academic focus
as well as those with diverse perspectives and backgrounds, which
promotes informal learning and development of social skills. It also
facilitates studying and attending classes on campus, provides students
with the full breadth of campus security services, and provides
convenient access to campus dining halls. Many educational institutions
require students to live in on-campus housing for one or more years.
Further, several factors distinguish student housing from other rental
properties that institutions may own. For example, typical residential
rental agreements provide secure and exclusive access to a specific
property for the tenant's use, and the tenant has the right to
continuous occupancy and use of the specified space over the term of
the lease. In contrast, students sign a contract for housing, but
typically do not sign leases. They are assigned a space, within a room
often shared by at least one other individual, frequently a stranger.
Residence halls and student apartments or houses are typically not
available year-round, but only during academic terms. For example, that
housing might close over certain holidays and during breaks between
semesters. Housing space normally is contingent on enrollment at the
educational institution, and students that withdraw from the
institution must vacate their rooms. Students are subject to specific
housing rules and codes of conduct while in student housing, often
including a prohibition on cooking. Residence halls also typically
include the presence of a resident advisor, who is available 24 hours a
day and may monitor the students' behavior. Guest access to student
residences often is monitored or restricted.
The Treasury Department and the IRS agree that income received from
the housing of current students of an educational institution is
distinguishable from other types of traditional rental income, and
these final regulations exclude such income from gross investment
income, whether the housing is provided to the educational
institution's students by the institution or a related organization of
the institution.
Two commenters further recommended that rental income from faculty
and staff housing also should be excluded from net investment income,
stating that faculty and staff housing is a critical strategic resource
used by universities to recruit and retain exceptional personnel. The
commenters note that the provision of faculty and staff housing allows
faculty and staff to live closer to campus, which not only is a
convenience for such individuals but also allows them to more fully
participate in the campus experience, contributing to a vibrant and
dynamic residential and academic campus. Two commenters mentioned that
housing rental prices generally are not set based on market rates but
on actual cost, and many institutions operate housing at a loss,
although it would be administratively burdensome to determine a
theoretical market rate for each housing unit as well as to break out
the income and expenses related to each housing unit.
The Treasury Department and the IRS agree that rental income from
housing provided to an institution's faculty and staff can be
distinguished from other types of rental income if the housing is
provided contingent on their capacities as faculty or staff (for
example, if the rental agreement contains a provision that the person
must be currently employed as faculty or staff of the applicable
educational institution). Thus, these final regulations exclude such
income from gross investment income, whether the housing is provided to
the educational institution's faculty or staff by the institution or a
related organization of the institution. These final regulations do
not, however, exclude rental income from other persons, or from former
faculty or staff.
Two commenters recommended that rental income from dormitories and
other student housing that is made available to students and
nonstudents alike for educational programs and camps open to the public
that are outside of the institution's academic year, particularly
during the summer months, also be excluded from gross investment
income. These final regulations do not adopt this suggestion. Such
income may, depending on the circumstances, constitute unrelated
business taxable income and be excluded from section 4968 for that
reason. For example, if the income is from leasing to third parties
that conduct summer camps and programs at the institution and the
institution provides substantial personal services with respect to the
rented facilities, it likely is unrelated business taxable income.
Furthermore, the leasing of student housing to third parties for the
operation of camps and programs run by third parties is not materially
distinguishable from typical rental income. Also, if the summer camp or
program is not operated by the educational institution, then the
educational institution does not control who is staying in the housing
and the housing is not necessarily provided for the benefit of the
institution's current students or to contribute directly to achieving
its educational purpose. However, the Treasury Department and IRS note
that rental income from dormitories and other housing provided to
current students that extends through the summer months (such as
graduate student housing) would meet the exception for housing provided
to students and would be excluded from gross investment income.
iii. Royalty Income From Exempt Functions
Two commenters asked that royalty income derived from educational
and research activities conducted by an applicable educational
institution be excluded from the institution's gross investment income.
The commenters stated that universities conduct research as part of the
pursuit of knowledge by faculty and students rather than for the
purpose of earning income. Both commenters stated that royalties
derived from research that is directly conducted by students, faculty,
and researchers is
[[Page 65535]]
distinguishable from the royalty income earned by most private
foundations because private foundations receiving royalty income
``normally'' have passive holdings in intellectual property that was
not developed by the private foundations. (One commenter clarified that
royalty income earned from ``passive investments'' was not intended to
be included in this proposed exception for purposes of section 4968.)
Both commenters represented that it would be a significant
administrative burden to capture all expenses and costs allocable to
such royalty income, including expenses incurred in applying for,
obtaining, and defending a patent and in developing and negotiating
license agreements during the life of the patent, and both commenters
estimated that such annual expenses would equal or exceed the annual
gross investment income from such royalties.
The Treasury Department and the IRS agree that applicable
educational institutions produce intellectual property as part of the
pursuit of knowledge by faculty and students. These activities
generally are not engaged in for profit and they are not passive
investment activity. Instead, these activities are integral to an
educational institution's exempt purposes. As a result, these final
regulations exclude certain royalties generated by such educational and
research activities from gross investment income for purposes of
section 4968.
Specifically, these final regulations exclude from gross income
royalty income that is derived from patents, copyrights, and other
intellectual property and intangible property to the extent those
assets resulted from the work of student(s) or faculty member(s) in
their capacities as such with the applicable educational institution.
However, neither royalty income from trademarks on the institution's
logo or name nor royalty income from intellectual property donated or
sold to the institution is excluded from gross investment income under
this rule.
iv. Income From Programmatic Activities
Two commenters recommended excluding any income derived by an
educational institution from the conduct of its core educational and
research activities (that is, programmatic activities) from gross
investment income. The commenters stated that taxing income that is
derived directly from a college or university's exempt purpose is
inconsistent with the intent of section 4968, which is intended to tax
investment income. However, one commenter did not include any specific
examples of types of income that would be gross investment income
derived from the conduct of an applicable educational institution's
core educational and research activities, and the other commenter gave
as examples tuition, museum or gym admission fees, and income from a
related business, such as a campus bookstore--none of which would be
included in the definition of gross investment income under the
proposed regulations.
The Treasury Department and the IRS note that private foundations
may earn gross investment income in the conduct of their exempt
activities, but that such income is explicitly considered gross
investment income by section 4940(c) and Sec. 53.4940-1(d). The
preamble to the proposed regulations specifically asked commenters,
when commenting on whether specific types of income should be excluded
from gross investment income under section 4968 because taxing those
types of income would not achieve the congressional intent in enacting
section 4968, to state specifically how any such proposed exclusion
would still be ``similar to'' the rules of section 4940(c) and the
specific characteristics of each type of such income that would warrant
deviating from the rules provided in section 4940 and the regulations
thereunder. Furthermore, it is unclear what types of income, other than
student loan interest, rental income from certain housing, and certain
royalty income, otherwise would be gross investment income earned in
the conduct of an applicable educational institution's exempt
activities. Accordingly, other than the exclusions listed in part
6.a.i., ii., and iii., these final regulations do not include an
exclusion from gross investment income for income earned in the conduct
of an applicable educational institution's exempt activities.
v. Excluding Income on Endowment Funds if the Income Is Used as a
Tuition Replacement Fund
One commenter recommended excluding income from endowment funds
from gross investment income if the income is used as a tuition
replacement fund for all of the applicable educational institution's
students.
Section 4968(c) provides that, for purposes of section 4968, net
investment income is determined under rules similar to the rules of
section 4940(c). Neither section 4968(c) nor 4940(c) provide an
exclusion from net investment income for the income from an
institution's endowment fund, regardless of what the income is
ultimately used for. Thus, these final regulations do not exclude the
income from an institution's endowment fund (however defined) from
gross investment income, even if the income from the endowment fund is
used as a tuition replacement fund.
b. Deductions
i. In General
As stated in part 6.a of this Summary of Comments and Explanation
of Revisions, the proposed regulations provided that an institution
generally must calculate net investment income under rules similar to
the rules of section 4940(c). The proposed regulations proposed to
adopt this approach, incorporating by cross reference the provisions of
Sec. 53.4940-1(c) through (f), with certain modifications. These final
regulations delete the use of a cross reference to the regulations
under section 4940(c) and instead prescribe specific rules that are
similar to the rules of section 4940.
Thus, consistent with section 4940(c) and Sec. 53.4940-1(e)(1)(i),
Sec. 53.4968-2(c)(1)(i) of these final regulations explicitly states
that there is allowed as a deduction from gross investment income all
the ordinary and necessary expenses, including operating expenses, paid
or incurred for the production or collection of gross investment income
or for the management, conservation, or maintenance of property held
for the production of such income, determined with the modifications
described in part 6.b.ii of this Summary of Comments and Explanation of
Revisions.
An applicable educational institution's operating expenses related
to its gross investment income may include compensation of officers,
other salaries and wages of employees, outside professional fees,
interest, and rental payments and taxes upon property used in the
applicable educational institution's operations other than in its
exempt activities. An applicable educational institution's operating
expenses that are incurred both for investment and exempt purposes,
such as salaries for officers or other employees, must be allocated
between the investment and exempt activities of that institution on
some reasonable basis. Similarly, consistent with Sec. 53.4940-
1(e)(1)(iii), in cases in which only a portion of property produces, or
is held for the production of, income subject to the section 4968
excise tax, and the remainder of the property is used for other
purposes, the expenses are apportioned between the taxable and other
uses. Furthermore, to
[[Page 65536]]
the extent an applicable educational institution's expenses are taken
into account in computing the tax imposed by section 511, they are not
deductible for purposes of computing the tax imposed by section 4968.
Consistent with Sec. 53.4940-1(e)(1)(iii), no amount is allowable
as a deduction to the extent it is paid or incurred for purposes other
than the production or collection of gross investment income as
determined for section 4968 purposes, or for the management,
conservation, or maintenance of property held for the production of
such income. Thus, for example, the charitable deduction prescribed
under section 170 or 642(c), the net operating loss deduction
prescribed under section 172, and certain special deductions for
corporations under sections 241 through 250 prescribed under part VIII
of subchapter B of chapter 1 of the Code (part VIII of subchapter B)
are not allowable as a deduction in determining section 4968 net
investment income. Taxes imposed under section 4968 are not paid or
incurred for the production or collection of gross investment income.
ii. Modifications
Consistent with section 4940(c) and Sec. 53.4940-1(e)(2), these
final regulations provide that the following modifications must be made
in determining deductions otherwise allowable under these final
regulations, as explained in part 6.b.i of this Summary of Comments and
Explanation of Revisions.
First, consistent with section 4940(c)(3)(B)(i) and Sec. 53.4940-
1(e)(2)(i), a depreciation deduction is allowed, but only on the basis
of the straight line method provided in section 168(b)(3) and without
regard to paragraphs (1) and (2) of section 168(b).
Second, consistent with section 4940(c)(3)(B)(ii) and Sec.
53.4940-1(e)(2)(ii), a depletion deduction is allowed, but such
deduction is determined without regard to sections 613 and 613A,
relating to percentage depletion.
Third, consistent with Sec. 53.4940-1(e)(2)(iii), basis to be used
for purposes of calculating the deduction allowed for depreciation or
depletion is the basis determined under the rules of part II of
subchapter O of chapter 1 of the Code (part II of subchapter O),
subject to the previously described modifications for calculating
depreciation and depletion, and without regard to Sec. 53.4968-2(d)(2)
(relating to the basis for determining gain for property held on
December 31, 2017, and continuously thereafter to the date of
disposition, discussed in part 6.c of this Summary of Comments and
Explanation of Revisions) or section 362(c) (relating to certain
contributions to capital). Thus, an applicable educational institution
must reduce the cost or other substituted or transferred basis by an
amount equal to the straight-line depreciation or cost depletion,
without regard to whether the institution deducted such depreciation or
depletion during the period prior to its first taxable year beginning
after December 31, 2017. However, in cases in which an applicable
educational institution has previously taken depreciation or depletion
deductions in excess of the amount which would have been taken had the
straight line or cost method been employed, such excess depreciation or
depletion also is taken into account to reduce basis. If the facts
necessary to determine the basis of property in the hands of the donor
or the last preceding owner by whom it was not acquired by gift are
unknown to a donee applicable educational institution, then the
institution's original basis in such property is determined under the
rules of Sec. 1.1015-1(a)(3).
One commenter requested that the step-up rule for calculating gain
upon the disposition of assets held on December 31, 2017 (discussed
later in this Summary of Comments and Explanation of Revisions) also
apply for purposes of calculating depreciation and depletion, stating
that educational institutions, which are more likely than private
foundations to hold on to depreciable assets, otherwise may be
motivated to engage in self-help by selling assets they own and
purchasing similar use assets in order to obtain depreciation
deductions based on the current fair market value basis. These final
regulations do not adopt such a rule because it would be contrary to
section 4940(c) and applicable educational institutions do not seem to
be distinguishable from private foundations on this issue.
Fourth, consistent with Sec. 53.4940-1(e)(2)(iv), the deduction
for expenses paid or incurred in any taxable year for the production of
gross investment income, as determined for section 4968 purposes,
earned as an incident to a charitable function can be no greater than
the income earned from such function which is includible as gross
investment income for such year. For example, where rental income is
incidentally realized in a year from historic buildings held open to
the public, deductions for amounts paid or incurred in that year for
the production of such income is limited to the amount of rental income
includible as gross investment income for the year.
c. Capital Gains and Losses
The proposed regulations contained three special rules relating to
capital gains and losses. First, consistent with Notice 2018-55, the
proposed regulations substituted ``December 31, 2017'' for ``December
31, 1969'' each place it appears in Sec. 53.4940-1(c)-(f), to provide
a step-up in basis (if any) for purposes of calculating gain upon the
sale or other disposition of assets held on December 31, 2017, and
continuously thereafter to the date of disposition.
Second, in response to a comment received in response to Notice
2018-55, the proposed regulations provided that, if an applicable
educational institution held an interest in a partnership (including
through one or more tiers of partnerships) on December 31, 2017, and
continuously thereafter, and the partnership held assets on December
31, 2017, and continuously thereafter to the date of disposition, the
partnership's basis in its assets with respect to the applicable
educational institution for purposes of determining the applicable
educational institution's share of gain upon sale or other disposition
of the assets by the partnership will not be less than the fair market
value of such asset on December 31, 2017, plus or minus all adjustments
as provided under Sec. 53.4940-1(f)(2)(i) after December 31, 2017, and
before the date of disposition. The proposed regulations stated that,
to avail itself of this special partnership basis rule, an institution
must obtain documentation from the partnership to substantiate the
basis used.
Third, the proposed regulations provided that, for purposes of
Sec. 53.4940-1(f), overall net losses from sales or other dispositions
of property by one related organization (or by the applicable
educational institution) reduce (but not below zero) overall net gains
from such sales or other dispositions by other related organizations
(or by the applicable educational institution).
The preamble to the proposed regulations stated that, consistent
with the requirement in section 4968(c) to calculate net investment
income under rules similar to the rules under section 4940(c), the
proposed regulations generally followed the rules for determining gain
upon the sale or other disposition of property that have been used for
section 4940(c) purposes since 1969. The preamble further stated that
section 4940(c)(1) provides that, except to the extent inconsistent
with the provisions of section 4940, net investment income is
determined under the principles of subtitle A. Subtitle A
[[Page 65537]]
encompasses all of the income tax provisions (sections 1 through 1564)
of the Code, including the basis rules in section 1015 (basis of
property acquired by gift generally is the donor's basis). Accordingly,
under the proposed regulations, an applicable educational institution
generally must calculate gain on the sale or other disposition of a
lifetime gift of property using the donor's basis. However, the
preamble to the proposed regulations requested comments on whether a
special rule excluding from capital gain net income any appreciation in
a gift of donated property that occurred before the date of receipt by
the applicable educational institution should be included under the
final regulations and how a special rule excluding from gain such pre-
donation appreciation would be consistent with the statutory language
of section 4968.
Commenters addressed several aspects of the proposed rules for
capital gain net income, including the taxation of capital gain net
income on the sale of exempt use property; capital gain net income on
the sale of donated property; the step-up rule for assets held in a
partnership on December 31, 2017; and whether capital loss carryovers
should be allowed.
In response to these public comments and as discussed in in more
detail in part 6.c.i through iii of this Summary of Comments and
Explanation of Revisions, these final regulations provide that (1)
capital gain net income from the sale or exchange of property used by
an institution for its exempt purpose is disregarded for the portion of
the property that is used for the exempt purpose; (2) any appreciation
in the value of donated property that occurred prior to the date of its
donation to the institution is disregarded; and (3) capital loss
carryovers are allowed but not capital loss carrybacks.
Consistent with section 4940(c)(4)(A) and (D) and the proposed
regulations, these final regulations also provide that in determining
capital gain net income for purposes of the tax imposed by section
4968, no gain or loss from the sale or other disposition of property is
taken into account to the extent that such gain or loss is taken into
account for purposes of computing the tax imposed by section 511.
i. Capital Gain Net Income on Sale of Exempt Use Property
Two commenters recommended excluding from capital gain net income
gain from the sale of exempt use property. One of the commenters stated
that exempt use property is excluded from section 4968(b)(1)(D)'s
calculation for determining the applicability of section 4968, and that
it would thus be inconsistent to tax the educational institution on the
sale of such property. This commenter also stated that taxing income
that is derived directly from a college or university's exempt purpose
assets is inconsistent with the intent of section 4968, which is aimed
at investment income. The other commenter said that the proposed
regulation's reference to Sec. 53.4940-1(f)(1) suggested such a
result, but asked that the final regulations clarify this reading.
Section 4940(c)(4)(A) was amended in 2006 \5\ to provide that
``there shall not be taken into account any gain or loss from the sale
or other disposition of property to the extent that such gain or loss
is taken into account for purposes of computing the tax imposed by
section 511.'' By implication, section 4940(c)(4)(A) thus provides that
all gain or loss from the sale or other disposition of any and all
property, other than any gain or loss that is taken into account for
purposes of computing the tax imposed by section 511, is taken into
account for purposes of section 4940(c).\6\
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\5\ The amendments to section 4940(c)(4)(A) were made by the
Pension Protection Act of 2006, Public Law 109-280, and the Tax
Technical Corrections Act of 2007, Public Law 110-172 (which
conformed the language of section 4940(c)(4)(A) to the 2006 JCT
Technical explanation).
\6\ According to the JCT Technical explanation (JCX-38-06), the
reason for amending section 4940(d)(4)(A) in 2006 and 2007 was that
section 4940(c) does not provide for the blanket exclusion of gain
or loss from the sale or other disposition of assets used for exempt
purposes that was provided in the section 4940 regulations. Section
53.4940-1(f)(1)), which has not been updated to reflect the
amendments made in 2006 and 2007, provides that ``there shall be
taken into account only capital gains and losses from the sale or
other disposition of property held by a private foundation for
investment purposes'' and ``gains and losses from the sale or other
disposition of property used for the exempt purposes of the private
foundation are excluded.'' (Emphasis added.) Although the section
4940 regulations, which have not been revised since 1992, have not
been revised to reflect the changes to section 4940(c)(4)(A) made in
2006 and 2007, the current statute is clear that capital gain net
income includes (and is intended to include) gain from property used
by a private foundation for exempt purposes.
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Section 4968(c) provides that net investment income for purposes of
section 4968 is determined under rules similar to the rules of section
4940(c). Section 4940(c) was specifically amended in 2006 and 2007 to
provide that capital gain net income is no longer limited only to
property that was held for investment purposes and, instead, extends to
all property held by a private foundation, including property used for
exempt purposes. The only exceptions to this general rule are for ``any
gain or loss from the sale or other disposition of property to the
extent that such gain or loss is taken into account for purposes of
computing the tax imposed by section 511'' and for certain like-kind
exchange-type dispositions. See Section 4940(c)(4)(A) and (D).
However, educational institutions as a general matter own more
tangible property and more different types of tangible property used in
the performance of their exempt purposes than a typical private
foundation. Further, constantly changing and growing student
populations, as well as new developments and innovations and needs in
education and research, requires educational institutions to
continually reevaluate their needs for property and possibly to replace
or upgrade certain property. This process is likely to result in the
need to sell assets in order to best serve the educational
institution's exempt purposes. For instance, property such as
residential and educational buildings, libraries, laboratories, and
information technology assets often are sold as needs change. Income
from such sales generally is reinvested in acquiring upgrades or
replacements for that property, and therefore is integral to the
performance of the exempt function of the institution, rather than for
an investment purpose. Accordingly, these final regulations exclude
from capital gain net income the gain from the sale or exchange of
exempt use property for the portion of the property that is used for
the exempt purpose.
ii. Capital Gain Net Income From the Sale of Donated Property
Five commenters responded to the proposed regulations' request for
comments on the calculation of capital gain net income from the sale of
donated property, all recommending that any appreciation that occurred
prior to an institution's receipt of the donated property be excluded
from such gain. The commenters stated that the purpose of section 4968
is to tax institutions on their own net investment income, not to tax
donations, and that it would thus be inequitable to tax applicable
educational institutions on the appreciation in value that occurred
before the donee institution received the donation of a capital asset.
Commenters also stated that donated property normally is not actually
retained and held as an investment; instead, applicable educational
institutions typically sell donated property as soon as possible. Thus,
the gain upon sale of donated property often is attributable to the
appreciation that occurred before the institution received the
property.
[[Page 65538]]
Three commenters noted that, although a private foundation must use
the donor's transferred basis in computing any gain from the sale of
donated property, a private foundation has the option of making gifts
of appreciated property to section 501(c)(3) public charities by
funding their grants in kind, resulting in no excise or income tax
being imposed on either organization when the property eventually is
sold. These commenters stated that it would be difficult for applicable
educational institutions to take advantage of this strategy. One
commenter opined that private foundations generally are able to time
their sales to offset losses more efficiently than educational
institutions can. The commenter asserted that the substantially higher
operational expenses of an educational institution sometimes require
that institution to sell a donated asset upon receipt. The commenter
also opined that, because these donated assets are not retained for
investment purposes, they do not produce net investment income.
All commenters stated that the requirement to obtain a donor's
basis information will be administratively burdensome. Unlike private
foundations, which typically receive donations from a small number of
known donors, applicable educational institutions receive a large
number of donations from a wide variety of donors. In many cases,
institutions will be unable to determine (or verify) the transferred
basis under section 1015 of the donated property. Further, the
commenters stated, requesting donors to provide their basis information
could negatively affect an applicable educational institution's
relationships with donors.
One commenter stated that applicable educational institutions could
work around this issue by encouraging donors to donate any appreciated
property to a donor advised fund that then could sell the property and
contribute the cash proceeds to the institution.
The Treasury Department and the IRS agree that the differences
between applicable educational institutions and private foundations
with respect to donations of property justify a rule under section 4968
that is different from the treatment found in section 4940(c) for the
treatment of the capital gain net income of property donated to a
private foundation. In addition, such a rule will increase
administrability for both taxpayers and the IRS by removing the
requirement to determine the donor's basis of the donated property.
Furthermore, it will avoid placing different applicable educational
institutions receiving stock of equal value but with different bases in
different positions with regard to the computation of their respective
net investment income merely from receiving the donated property.
Accordingly, these final regulations provide that any appreciation
in the value of donated property that occurred prior to the date of
donation to the applicable educational institution is disregarded in
calculating gain for purposes of section 4968. This special rule does
not, however, change the transferred basis of the donated property;
thus, an applicable educational institution must obtain the transferred
basis of donated property under section 1015 for purposes of claiming a
loss upon its sale or other disposition or for purposes of calculating
depreciation or depletion.
One commenter requested that the final regulations recognize that a
college or university that disposes of contributed property at the
first reasonable opportunity is not holding such property for
investment purposes and, accordingly, exclude all of the proceeds from
the sale of such contributed property from capital gain. The same
commenter suggested a safe harbor under which property disposed of
within 30 days of receipt would be treated as having been disposed of
at the first reasonable opportunity. These final regulations do not
adopt either suggestion, because there is no analog in section 4940(c)
or in any other provision of the Code. Furthermore, any cut off would
be arbitrary and there is no justification for why one day versus
another day should not result in the recognition of gain. While these
final regulations disregard any appreciation that occurred prior to an
institution's receipt of the donated property, appreciation that occurs
after an institution's receipt of the donated property is included in
net investment income. For consistency with the rules applicable to
charitable deductions, the date of donation is determined under the
timing rules of Sec. 1.170A-1(b) and the value on the date of donation
is determined under the valuation rules of Sec. 1.170A-1.
iii. Capital Loss Carryovers
One commenter requested that capital loss carryovers be allowed.
This commenter represented that a private grant-making foundation, to
the extent it has satisfied its minimum distribution requirements, can
easily curtail its spending (and the realization of capital gains while
converting investment assets to cash) by issuing fewer or smaller grant
awards to manage its section 4940 tax liability. The commenter
contrasted such a foundation with an educational institution that
typically has a large operating budget with significant
nondiscretionary expenses related to employees and infrastructure and
must find ways to meet its ongoing cash needs, which may involve
selling investments at particular times that may not be advantageous
from an investment or tax perspective.
Although section 4940(c) explicitly allows losses from sales or
other dispositions of property only to the extent of gains from such
sales or other dispositions, and does not allow capital loss carryovers
or carrybacks, the commenter represented that, given the differences
between private foundations and educational institutions, the allowance
of capital loss carryovers is necessary to achieve outcomes for
educational institutions under section 4968 that are ``similar to'' the
outcomes for private foundations under section 4940(c).
The Treasury Department and the IRS acknowledge that there are
various and notable differences between private foundations subject to
section 4940(c) and educational institutions in their missions,
functions, and operating expenses. Therefore, based on a general
understanding, as further informed by commenters, of the way
educational institutions manage both their substantial,
nondiscretionary operating expenses in furthering their exempt purposes
and their investment activities, these final regulations allow the use
of capital loss carryovers.
Accordingly, these final regulations adopt the rule in the proposed
regulations that overall net losses from sales or other dispositions of
property by one related organization (or by the applicable educational
institution) reduce (but not below zero) overall net gains from such
sales or other dispositions by other related organizations (or by the
applicable educational institution). In addition, these final
regulations adopt the rule in the proposed regulations that, should
overall net losses from sales or other dispositions of property exceed
gains from sales or other dispositions of such property during the same
taxable year, such excess may not be deducted from gross investment
income in any taxable year, nor may such excess be used to reduce gains
in prior taxable years. However, the final regulations provide that
capital loss carryovers are allowed and may be deducted from capital
gains in a future year.
[[Page 65539]]
d. Basis
These final regulations provide rules for determining basis or a
substitute for basis (in the context of section 4968) for purposes of
determining (1) gain from the sale or other disposition of property
other than a partnership interest; (2) a distributive share of gain
from the sale or other disposition of an asset held in a partnership;
(3) gain on the sale of a partnership interest; and (4) loss.
i. Basis for Purposes of Determining Gain From the Sale or Other
Disposition of Property Other Than a Partnership Interest
Consistent with the proposed regulations and with section 4940(c),
these final regulations provide that the basis for purposes of
determining gain from the sale or other disposition of property (other
than a partnership interest) is generally the greater of (1) fair
market value of the property on December 31, 2017, plus or minus all
adjustments after December 31, 2017, and before the date of its
disposition under the rules of part II of subchapter O, provided that
the property was held by the applicable educational institution on
December 31, 2017, and continuously thereafter to the date of its
disposition, or (2) basis as determined under the rules of part II of
subchapter O, subject to the three modifications described at the
beginning of part 6.b.ii. of this Summary of Comments and Explanation
of Revisions (referring to the modifications relating to deductions
against gross investment income). See parts 6.d.ii. and 6.e. of this
Summary of Comments and Explanation of Revisions for special rules
regarding determining a distributive share of capital gain from the
sale or other disposition of an asset held in a partnership and on the
sale of a partnership interest.
ii. Basis for Purposes of Determining a Partner's Distributive Share of
Gain From the Sale or Other Disposition of an Asset Held in a
Partnership and Gain From the Sale or Other Disposition of a
Partnership Interest
The proposed regulations provided that if an applicable educational
institution held an interest in a partnership (including through one or
more tiers of partnerships) on December 31, 2017, and continuously
thereafter, and the partnership held an asset on December 31, 2017, and
continuously thereafter to the date of disposition by the partnership,
the partnership's basis in such asset (for purposes of determining the
applicable educational institution's share of gain upon sale or other
disposition of that asset) is not less than the fair market value of
such asset on December 31, 2017, plus or minus all adjustments as
provided under Sec. 53.4940-1(f)(2)(i) after December 31, 2017, and
before the date of disposition.
Four commenters addressed the requirement in the proposed
regulations that, for purposes of applying this rule, an applicable
educational institution must obtain documentation from the partnership
to substantiate the basis used. The commenters stated that, while an
applicable educational institution can obtain documentation to
establish its basis in its partnership interest (outside basis) as of
December 31, 2017, obtaining documentation to establish its share of
the basis of each partnership asset (inside basis) would be extremely
burdensome and that an asset-by-asset determination of gain might,
therefore, not be possible.
The commenters stated that applicable educational institutions
often hold interests in hundreds of partnerships, many with numerous
investors, that may involve multiple tiers of flow-through entities,
and that applicable educational institutions generally are passive
investors in these partnerships. Commenters stated that it would be
very difficult, if not impossible, for applicable educational
institutions to obtain the required basis documentation from all the
partnerships, especially because there is no requirement for
partnerships to provide such documentation and because reporting from
partnerships generally is done on an aggregate basis and not on an
asset-by-asset basis. Commenters added that many partnerships may not
even be aware that their partners include an applicable educational
institution.
The commenters recommended that the substantiation rule in the
proposed regulations be removed and that an applicable educational
institution instead be allowed to determine the amount of built-in gain
in the applicable educational institution's share of partnership assets
using any reasonable method. Two commenters recommended a method,
described in part 6.e. of this Summary of Comments and Explanation of
Revisions, that would use the difference between fair market value and
outside basis of a partnership interest on December 31, 2017, to
approximate the amount of cumulative built-in gain in an applicable
educational institution's share of partnership assets on such date.
The Treasury Department and the IRS recognize the problem described
by commenters with regard to the proposed substantiation rule and agree
that another approach for determining the amount of built-in gain in
partnership assets solely for purposes of applying section 4968 would
be appropriate in alleviating the problem. Accordingly, these final
regulations remove the proposed substantiation rule and eliminate the
need to determine a step-up in a partner's share of bases in
partnership assets for purposes of section 4968. As a result, the bases
of partnership assets on December 31, 2017, are not stepped up for
purposes of section 4968. Rather, for purposes of determining an
applicable educational institution's share of gain upon the sale or
other disposition of an asset held in a partnership, these final
regulations provide that the applicable educational institution's basis
in each partnership asset generally is determined under the rules of
subchapter K of chapter 1 of the Code (subchapter K), but also provide
a method, more fully described in part 6.e. of this Summary of Comments
and Explanation of Revisions, which generally enables an applicable
educational institution to offset its distributive share of capital
gain net income from partnership asset dispositions by a portion of the
built-in gain in the applicable educational institution's interest in
the partnership as of December 31, 2017.
These final regulations provide a similar rule for determining an
applicable educational institution's gain upon the sale or other
disposition of all or a portion of a partnership interest.
iii. Basis for Purposes of Calculating Loss
Consistent with the proposed regulations and with section 4940(c),
for purposes of determining loss from the sale or other disposition of
property, basis is determined under the rules of part II of subchapter
O, subject to the modifications of part 6.b.ii. of this Summary of
Comments and Explanation of Revisions (referring to the modifications
relating to depreciation and depletion deductions against gross
investment income). For purposes of determining loss from the sale or
other disposition of a partnership interest, basis is determined under
the rules of subchapter K.
e. Special Rules Regarding Partnership Interests and Partnership Assets
As described in part 6.d.ii. of this Summary of Comments and
Explanation of Revisions, commenters stated that it would be very
difficult, if not impossible, for institutions to obtain the basis
documentation necessary to apply the partnership asset basis step-up
rule provided in the proposed regulations.
[[Page 65540]]
As an alternative, two commenters recommended a method that would use
the difference between the fair market value and outside basis of an
applicable educational institution's partnership interest on December
31, 2017, to approximate the difference between the fair market value
and inside basis of, and thus the amount of built-in gain in, the
applicable educational institution's share of partnership assets on
such date. The commenters stated that the difference between fair
market value and tax basis of an applicable educational institution's
partnership interest on December 31, 2017, generally should reflect the
amount of the applicable educational institution's built-in gain in its
share of the partnership's assets on such date, and that, because
educational institutions should know the fair market values and tax
bases of their partnership interests on December 31, 2017, they should
be able to calculate the built-in gain in their partnership interests
as of December 31, 2017.
Specifically, the commenters recommended that an applicable
educational institution should be allowed to offset the distributive
share of partnership capital gain net income after December 31, 2017,
allocated by a partnership by the amount of the built-in gain the
applicable educational institution had in its partnership interest,
determined as of December 31, 2017. Under the commenters' approach, an
applicable educational institution would determine its built-in gain in
a partnership interest as of December 31, 2017, and then not report any
capital gain allocated from that partnership after December 31, 2017,
as being subject to section 4968 until the cumulative amount of such
excluded gain equals the amount of built-in gain in the interest. The
commenters recommended that this rule be applied on a partnership-by-
partnership basis and be available to reduce the amount of an
applicable educational institution's capital gain net income on a
first-recognized basis.
For the reasons described in part d.ii of this Summary of Comments
and Explanation of Revisions, these final regulations adopt an approach
that is similar to the approach recommended by the commenters in regard
to determining an applicable educational institution's distributive
share of gain allocated from a partnership (partnership asset
disposition rule), as well as adding a partnership interest disposition
rule. These final regulations provide that, for each partnership
interest an applicable educational institution held on December 31,
2017, the applicable educational institution may determine an
unadjusted step-up amount that is equal to the excess, if any, of the
fair market value of such partnership interest on December 31, 2017,
over the adjusted basis of such partnership interest on December 31,
2017. Then, for purposes of computing net investment income for taxable
years beginning after December 31, 2017, an applicable educational
institution will reduce its distributive share of capital gain net
income from such partnership by the least of (1) the applicable
educational institution's share of applicable capital gain from such
partnership (that is, both short-term and long-term capital gain for
the first taxable year after December 31, 2017, but only long-term
capital gains and losses for subsequent years because short-term
capital gains and losses in such years could not have been included in
the amount of outside built-in gain as of December 31, 2017); (2) one-
third of the applicable educational institution's unadjusted step-up
for such partnership; or (3) the applicable educational institution's
adjusted step-up for such partnership (which, in general, is its
unadjusted step-up reduced by any capital gain that was previously
excluded pursuant to the partnership asset disposition rule or the
partnership interest disposition rule described in this paragraph).
These final regulations do not apply the capital gain net income
reduction rule on a first-recognized basis, as recommended by the
commenters. The excess of fair market value over tax basis of a
partnership interest on December 31, 2017, may reflect built-in gain in
partnership assets that would not be included in net investment income
for purposes of section 4968--for example, ordinary income property.
Additionally, application of the rule to offset all first-recognized
capital gain net income in determining the educational institution's
net investment income could provide a benefit to applicable educational
institutions that would be inconsistent with the purpose of section
4968 by permitting a reduction in capital gain net income subject to
section 4968 that is attributable to a partnership asset both acquired,
and disposed of, after December 31, 2017. Accordingly, these final
regulations adopt a middle ground position that spreads the exclusion
without burdensome asset-by-asset matching by providing that the
maximum amount of an applicable educational institution's capital gain
net income from a partnership that may be excluded in any given year
cannot exceed one-third of the applicable educational institution's
unadjusted step-up for such partnership.
Commenters did not provide a recommendation for coordinating the
partnership asset disposition rule with a partnership interest
disposition rule. However, consistent with permitting an applicable
educational institution to offset its distributive share of capital
gain net income from partnership asset dispositions, these final
regulations also provide a capital gain net income reduction rule in
the context of a sale or other disposition of all or a portion of a
partnership interest. These final regulations provide that, for
purposes of computing net investment income, an applicable educational
institution reduces the amount of its capital gain net income upon the
sale or other disposition of all or a portion of a partnership interest
by an amount that bears the same relation to the applicable educational
institution's adjusted step-up for such partnership as the fair market
value of the transferred portion of the interest bears to the fair
market value of the applicable educational institution's entire
interest in such partnership before the sale or other disposition.
7. Related Organizations
Section 4968(d)(1) provides, in part, that the assets and net
investment income of any related organization with respect to an
educational institution are to be treated as assets and net investment
income, respectively, of the educational institution. To determine
which assets of a related organization are included by section
4968(b)(1)(D) for a particular year, an educational institution
determines which organizations are related organizations, as defined in
section 4968(d)(2), as of the end of the educational institution's
preceding taxable year, and values the relevant assets on that date. To
determine the amount of net investment income of a related organization
that is included by the applicable educational institution in
calculating the tax imposed by section 4968(a) for a particular taxable
year, an applicable educational institution determines which
organizations are related organizations, as defined in section
4968(d)(2), as of the end of that taxable year of the applicable
educational institution and includes the net investment income from
each related organization's tax year that ends with or within that same
taxable year of the applicable educational institution. If an
organization becomes a related organization within the applicable
educational institution's taxable year
[[Page 65541]]
and remains a related organization as of the end of the taxable year,
then the applicable educational institution includes the organization's
net investment income for the portion of the year that it was a related
organization, using any reasonable method.
The statute provides two exceptions to the rules for including
assets and net investment income of a related organization as assets
and net investment income of the educational institution: (1) No such
amount is to be taken into account with respect to more than one
educational institution, and (2) unless the related organization is
controlled by the institution or is described in section 509(a)(3)
(relating to supporting organizations) with respect to the institution
for the taxable year, assets and net investment income that are not
intended or available for the use or benefit of the institution are not
to be taken into account by it. Section 53.4968-3 of these final
regulations provides definitions and special rules relating to related
organizations.
a. Definition of Related Organization
Under section 4968(d)(2), the term ``related organization'' means,
with respect to an educational institution, any organization that (1)
controls the educational institution; (2) is controlled by the
educational institution; (3) is controlled by one or more persons that
also control the educational institution; (4) is a supported
organization (as defined in section 509(f)(3)) with respect to the
educational institution during the taxable year; or (5) is a supporting
organization (as described in section 509(a)(3)) with respect to the
educational institution during the taxable year.
The first three categories of related organizations require control
of an organization, but the statute does not define the term
``control.'' Furthermore, whether the educational institution is the
controlling or controlled entity matters because if the related
organization controls the educational institution, or is controlled by
one or more persons that also control the educational institution, then
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. In contrast, if a related
organization is controlled by an educational institution, then all the
assets and net investment income of the related organization are taken
into account by the educational institution, with the exception that
the same assets are not taken into account by more than one educational
institution.
The proposed regulations provided a definition of control derived
from section 512(b)(13)(D) and the regulations thereunder, consistent
with the definition of control contained in Notice 2019-09, ``Interim
Guidance Under Section 4960'' (2019-04 I.R.B. 403), and requested
comments on whether there were any circumstances in which this proposed
definition of control should be modified in the context of section
4968.
Specifically, the proposed regulations defined control as: (1) In
the case of a corporation, ownership (by vote or value) of more than 50
percent of the stock of the corporation; (2) in the case of a
partnership, ownership of more than 50 percent 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 percent 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, (a) more than 50 percent of the directors or trustees of the
educational institution or nonstock organization are either
representatives of, or are directly or indirectly controlled by, the
other entity or (b) more than 50 percent 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 educational institution. For this purpose, a ``representative''
means a trustee, director, agent, or employee, and ``control'' includes
the power to remove a trustee or director and designate a new trustee
or director. Finally, the proposed regulations stated that section 318,
which contains rules for determining constructive ownership of stock,
applies for purposes of determining ownership of stock in a
corporation, and similar principles apply for purposes of determining
ownership of an interest in any other entity.
Commenters stated generally that use of the proposed definition of
``control'' would result in educational institutions' being required to
take into account assets and net investment income that the educational
institutions do not actually control and that they will never receive
because the assets and income actually belong to unrelated third
parties. The commenters also stated that such a rule is inconsistent
with Congressional intent to include assets and income of related
organizations only when the educational institution actually has
control over the use of the related organization's assets and net
investment income, and would not address Congressional concerns that
educational institutions might attempt to avoid the section 4968 excise
tax by holding assets in structures that, as compared to direct
ownership, represent a difference in form but not substance.
More specifically, commenters stated that entities under common
control with an educational institution could be deemed to be
controlled by the educational institution, contrary to reality and thus
inappropriately inflating the net investment income of the educational
institution. In addition, the commenters stated that including
controlled taxable entities, partnerships, split interest trusts, and
employee benefit plans as related organizations for purposes of section
4968 would lead to double or triple taxation.
Parts 7.a.i. through v. of this Summary of Comments and Explanation
of Revisions address entities that commenters recommended disregarding
in applying the related organization provisions of section 4968(d):
Taxable corporations; partnerships and other pass-through entities;
certain trusts; employee benefit plans; and decedent's estates. Part
7.b of this Summary of Comments and Explanation of Revisions describes
the rules for determining whether an educational institution will be
considered to ``control'' an entity that is not disregarded for
purposes of section 4968(d). Part 7.c of this Summary of Comments and
Explanation of Revisions addresses the application of the rule that
assets and net income of a controlled entity will be treated as the
assets and net income of only one educational institution. Part 7.d of
this Summary of Comments and Explanation of Revisions addresses the
application of the rule that assets and net investment income of
certain related organizations that are not intended or available for
the use or benefit of an educational institution are not taken into
account by the institution.
i. Taxable Corporations
The preamble to the proposed regulations stated that, because the
net investment income that a taxable entity distributes or transfers to
an educational institution has already been taxed, the Treasury
Department and the IRS did not consider it consistent with
Congressional intent to tax the income again under section 4968.
Furthermore, with regard to the assets of a taxable corporation that is
a related organization, the educational institution likely already has
included the value of the shares of the corporation's stock that it
owns in its non-exempt use assets; however, the stock value may differ
[[Page 65542]]
from the value of the taxable corporation's underlying assets. The
proposed regulations requested comments on how to account for this
difference without double-counting the assets, as well as more general
comments on the treatment of taxable entities that may be related
organizations for purposes of section 4968.
Commenters agreed that educational institutions should not be
required to take into account the net investment income of a related
organization that is a taxable entity, stating that this would result
in double, and sometimes triple, taxation (U.S. Federal income tax at
the entity level on the taxable entity's income; section 4968 tax on
any payments of net investment income by a taxable entity to the
educational institution; and section 4968 tax on the net investment
income of the controlled taxable entity that is treated as the
institution's income under section 4968(d)). Furthermore, the
commenters said that the value of the educational institution's
holdings in the taxable entity would already be reflected on the
educational institution's books, and, if the educational institution
owned more than 50 percent, but less than 100 percent, of the taxable
entity, the proposed definition would attribute to the institution
income and assets that actually belong to unrelated third parties.
To prevent this multiple taxation of a taxable entity's net
investment income and to prevent overcounting of a taxable entity's
assets, these final regulations exclude from the definition of
``related organization'' a taxable corporation and, as described in
part 7.a.iii. of this Summary of Comments and Explanation of Revisions,
taxable trusts, in each case whether foreign or domestic.
The Treasury Department and the IRS note that any investment-type
income that is paid to an educational institution by a taxable entity
(such as interest on money loaned by the institution to the taxable
entity) is included in net investment income for purposes of section
4968(c) in the same manner as any other such investment-type income
received by an institution from any other entity, regardless of whether
the other entity is or is not controlled by the institution. In
addition, for purposes of section 4968(b)(1)(D), the value of the
educational institution's interest in a taxable entity is based on the
fair market value of the interest on the last day of the preceding
taxable year, rather than on the book value of the interest reflected
on the educational institution's books and records.
ii. Partnerships and Other Pass-Through Entities
Commenters stated that the proposed regulations' definition of
control of partnerships (i.e., that ownership of more than 50 percent
of the profits interest or capital interest in a partnership would
result in the educational institution's being deemed to control the
partnership), likewise would result in double taxation (section 4968
tax on the net investment income that is allocated to the educational
institution by the partnership and section 4968 tax on the net
investment income of the partnership that is treated as the
institution's income under section 4968(d)), which is inconsistent with
the principles of subchapter K. Furthermore, the value of the
educational institution's interest in the partnership already would be
reflected on the educational institution's books, and, if the
educational institution owns more than 50 percent, but less than 100
percent, of the profits interest or capital interest in such
partnership, the proposed definition would attribute to the institution
income and assets that actually belong to other partners, including
unrelated third parties.
One commenter stated that an educational institution often is a
limited partner in an investment partnership and asked that the final
regulations provide that an educational institution that is a limited
partner in a partnership not be treated as controlling the partnership
for purposes of section 4968. This commenter added that, even if an
educational institution served as the general partner of a partnership,
it would have limited powers to change equity holders' entitlements to
the partnership income and thus would not control all of the income or
assets of the partnership.
To prevent double taxation of a partnership's net investment income
and overcounting of its assets, these final regulations exclude from
the definition of ``related organization'' a partnership, S
corporation, or other pass-through entity a portion of whose income
flows through to the educational institution.
The Treasury Department and the IRS note that any net investment
income that flows through to an educational institution is included in
that institution's net investment income for purposes of section
4968(c). In addition, for purposes of section 4968(b)(1)(D), the value
of an educational institution's partnership interest is the fair market
value of the institution's partnership interest on the last day of the
preceding taxable year, rather than the book value of that interest
carried on the educational institution's books and records.
iii. Certain Trusts
Multiple commenters stated that the proposed regulations'
definition of control of trusts, which provided that ownership of more
than 50 percent of the beneficial interests in a trust results in an
educational institution being deemed to control the trust, would lead
to inequitable results. In particular, commenters recommended excluding
split-interest trusts described in section 4947(a)(2) from the
definition of related organization, stating that, with respect to
charitable remainder trusts, an educational institution generally is
not able to receive any benefit, and cannot use assets in the trust,
until the termination of the interests of the income beneficiaries
(which may be decades into the future). This is true even if the value
of the educational institution's interest in the trust exceeds 50
percent of the present value of all beneficial interests in the trust.
In addition, even though it is unlikely that an educational institution
would receive any income from such a trust while the grantor is alive,
income paid from a split-interest trust is not considered net
investment income for purposes of section 4940(c) (see Notice 2004-35),
and it seems inconsistent to treat income that would not be net
investment income if it were received directly from the trust to be
treated as net investment income when not received from the trust.
Further, it seems inequitable and contrary to Congressional intent to
tax an educational institution on income that is paid to the grantor or
other non-charitable beneficiary during the grantor's lifetime.
Finally, it would be difficult for an educational institution to obtain
information about the income of a split-interest trust, as there is
currently no Federal requirement for a split-interest trust to report
this information to its remainder beneficiary(ies).
One commenter recommended that the final regulations provide that a
charitable remainder trust is within the control of the institution
only if the institution (1) has a vested remainder interest of at least
50 percent of all actuarial interests in the trust, (2) serves as the
trustee of the trust, and (3) under the terms of the trust document,
has the right as trustee to make distributions from the trust to itself
as a charitable organization.
The Treasury Department and the IRS considered whether the present
value of an educational institution's share of the remainder assets of
a charitable
[[Page 65543]]
remainder trust should be included as assets of the institution for
purposes of the $500,000-of-assets-per-student test in section
4968(b)(1)(D), given that such assets can demonstrate creditworthiness
and because money is fungible. However, the Treasury Department and the
IRS have determined that, for ease of administrability for both
educational institutions and the IRS, and in view of the risk that, as
a result of market forces, the remainder eventually received by the
educational institution could be significantly less than its present
value each year, an educational institution will not count the assets
of a charitable remainder trust as its own assets until the educational
institution actually becomes entitled to those assets at the
termination of the interest of the income beneficiary. If this were not
the rule, an educational institution would have to determine annually
its share of the fair market value of the assets of each charitable
remainder trust for which the educational institution is a remainder
beneficiary, even though the educational institution might not know it
had a remainder interest in all cases, the educational institution's
remainder interest could be given to another charity in some instances,
and the educational institution might not receive its remainder
interest if the trust's investment returns turn out to be insufficient
for the trust to possess any assets at the termination of the interests
of the income beneficiaries. An educational institution similarly would
have difficulty determining such a trust's net investment income.
Therefore, these final regulations provide that a charitable remainder
trust is not considered to be a related organization for purposes of
section 4968(d).
An educational institution will not be a remainder beneficiary of a
charitable lead trust. Instead, some portion of the trust's income is
payable currently to one or more charities for a term, after which the
remaining assets of the trust will be payable to noncharitable
beneficiaries. Thus, an educational institution does not have any right
to or interest in the principal or remainder of such a trust. As an
income beneficiary of a charitable lead trust, any income payable
currently to an educational institution will be included in the
institution's net investment income for the current year. (This is true
whether the trust is a grantor trust (whose income is taxed to the
deemed owner of the trust and for which there is no current income tax
deduction for the current distribution to charity) or a nongrantor
trust (whose income is taxed to the trust itself, subject to a
charitable deduction).) Thus, because the assets of a charitable lead
trust are not available to the educational institution, and its net
investment income is already included in the educational institution's
assets and net investment income as received, the final regulations
exclude charitable lead trusts from the definition of a related
organization.
In addition, because there are only limited circumstances in which
the educational institution would have sufficient control over a trust
to justify treating the trust as a related organization, the final
regulations also exclude all other taxable trusts from the definition
of a related organization except to the extent the educational
institution is deemed to control the trust, as provided in part
7.b.ii.B of this Summary of Comments and Explanation of Revisions.
iv. Employee Benefit Plans
Commenters stated that various retirement and benefit plans
(including but not limited to section 403(b), section 457, voluntary
employees' beneficiary associations (VEBAs) under section 501(c)(9),
and defined benefit plans), should be excluded from the definition of
related organization for purposes of section 4968(d), stating that the
beneficiaries of these plans are employees of the educational
institutions and it was not the intent of Congress to tax the
investment income of these entities. One commenter also asked that
other assets that are set aside or dedicated by an educational
institution to pay for the institution's commitment to provide certain
employee benefits be excluded from the definition of related
organization.
These final regulations base the determination of whether assets
held by or related to an employee benefit plan of an educational
institution are considered assets of the educational institution on
whether the arrangement is considered to be a funded or nonfunded plan.
An employer's obligation to pay an employee benefit generally is
considered to be ``funded'' when the assets are set aside from the
employer exclusively to provide for the employees' benefits in a manner
that the assets are no longer subject to claims of the employer's
general creditors and may not revert back to the employer's general
assets for use by the employer. See Sproull v. Commissioner, 16 T.C.
244 (1951), aff'd per curiam, 194 F.2d 541 (6th Cir. 1952). For
example, contributions to the section 501(a) trust of a section 401(a)
qualified retirement plan are considered to fund the obligation to
provide employees' future retirement benefits. Similarly, a section
403(b)(1) annuity contract or amounts held in a section 403(b)(7)
custodial account are considered to ``fund'' the obligation to pay
employees' section 403(b) retirement benefits. In each of these cases,
the assets held in the trust, contract, or account are considered to be
set aside to ``fund'' the employer's benefit obligation and are not
treated as assets of the employer. Further, amounts held in a section
419(e) welfare benefit fund (including a VEBA) are set aside to provide
welfare benefits for employees, are not subject to the claims of
general creditors, and would not be treated as assets of the employer
or as assets of a related organization.
In contrast, plans under section 457 are unfunded because funds are
not set aside for the purpose of providing benefits to plan
participants in a manner that would result in a ``funded'' obligation
to provide benefits under the plan. Under section 457(b)(6), assets
held pursuant to an eligible deferred compensation plan, including
amounts held in a grantor trust, must remain solely the property and
rights of the employer and would be subject to the claims of the
employer's general creditors. See Sec. 1.457-8(b)(2). Similarly,
amounts set aside by an eligible employer intended to pay for benefits
under an ineligible section 457(f) plan, including assets set aside in
a grantor trust, are treated as assets of the employer and subject to
the claims of the employer's general creditors. Accordingly, assets set
aside and held by an educational institution, including in a grantor
trust, to be used to pay the employees' benefits under an educational
institution's section 457(b) or section 457(f) plan are considered
assets of the educational institution. As a result, these final
regulations provide that a grantor trust or other financing vehicle
used in connection with these unfunded plans is a ``related
organization'' for purposes of section 4968(d), and its assets will be
treated as the assets of the educational institution. The Treasury
Department and the IRS note that, because assets in an unfunded plan
are available to the employer just like any other assets, they are not
considered ``used directly in carrying out the institution's exempt
purpose'' for purposes of section 4968(b)(1)(D).
Other unfunded employee benefits, such as a typical health flexible
spending arrangement (health FSA) or accrued leave cashout program,
have no related grantor trust or other financing vehicle but instead
use the employer's general assets as a source of payment. Any general
assets that are used to satisfy benefit obligations are
[[Page 65544]]
considered assets of the employer. Thus, if the employer is an
educational institution or is a related organization with regard to an
educational institution, such assets are considered to be assets of the
educational institution, and no special rule is needed in the
regulations.
Solely for purposes of determining the status of an employee
benefit plan as a funded or unfunded arrangement, an educational
institution and all of its related organizations are treated as a
single sponsor and payor of the benefits.
v. Decedents' Estates
A few commenters asked that the final regulations clarify that
decedents' estates are not ``related organizations'' under section
4968(d). Commenters stated that, because a decedent's estate is a
separate legal entity created at a person's death, it should not be
considered a related organization under section 4968(d), and, in any
case, an educational institution would not be in a position to control
a decedent's estate. The Treasury Department and the IRS agree, and to
eliminate any question for purposes of section 4968, these final
regulations provide that a decedent's estate is not a related
organization. However, the Treasury Department and the IRS note that
any assets of an estate that ultimately are transferred to an
educational institution will be considered the educational
institution's assets upon receipt by the institution.
b. Control
As stated in part 7.a of this Summary of Comments and Explanation
of Revisions, the first three categories of related organizations
described in section 4968(d)(2) require the presence of an element of
control to exist for an organization to be considered to be ``related''
to an educational organization, but the statute does not define the
term ``control.'' The proposed regulations provided a definition of
control based on section 512(b)(13)(D) and the regulations thereunder
and requested comments on whether there are any circumstances in which
this definition of control should be modified in the context of section
4968.
Commenters asserted that the proposed definition of control would
lead to unintended and undesirable results. For example, commenters
stated that the downward attribution rules of section 318 would cause
all brother/sister organizations of an educational institution to be
considered to be controlling each other and that an educational
institution controlled by a church could be deemed to own all the
assets of the church or the assets of another, unrelated church just
because the two churches were invested in the same investment
partnership.
The proposed regulation's definition of control did not
differentiate between an educational institution's control of another
organization or another organization's control of an educational
institution. The Treasury Department and the IRS recognize that the
types of entities that would be deemed to control an educational
institution under the proposed rule are likely to be very different
from those that would be controlled by an educational institution. In
addition, the direction of control matters for purposes of determining
whether all the assets and net investment income of a related
organization are attributable to the educational institution or whether
only the assets and net investment income that are intended or
available for the use or benefit of the educational institution are
attributable to the educational institution. Accordingly, these final
regulations provide separate rules for the different relationships that
may exist. Specifically, these final regulations, among other things,
separately define control for organizations that control an educational
institution, that are controlled by an educational institution, and
that are controlled by one or more persons that also control an
educational institution, and do not apply the downward attribution
rules of section 318.
i. Controls Such Institution
The Treasury Department and the IRS anticipate that most applicable
educational institutions are set up as nonstock organizations, but to
cover all circumstances, these final regulations set out rules for
control of various types of organizational forms.
Generally, an organization will be considered to control an
educational institution if the organization owns (by vote or value)
more than 50 percent of the stock or membership interest of the
educational institution.
In the case of any educational institution that does not have stock
or membership interests, the other organization will be considered to
control an educational organization if the other organization (or one
or more of its managers, directors, officers, trustees, or employees,
acting only in their capacities as representatives of the organization)
can (1) appoint or elect (which must include the power to remove and
replace) more than 50 percent of the members of the educational
institution's governing body (such as directors, officers, or
trustees), or otherwise has an ongoing power to appoint or elect more
than 50 percent of such members with reasonable frequency; (2) require
the educational institution to make an expenditure (or prevent the
educational institution from making an expenditure); or (3) require the
educational institution to perform any act that significantly affects
its operations (or prevent it from performing such an act). Such
control includes control by aggregating votes or positions of authority
(including by veto power) but applies regardless of the method by which
the control is exercised or exercisable.
As discussed in part 7.d of this Summary of Comments and
Explanation of Revisions, an educational institution generally does not
take into account assets and net investment income of a related
organization that controls the educational institution unless the
assets and net investment income of the related organization are
intended or available for the use or benefit of the educational
institution. However, if a related organization both controls the
educational institution as described in this paragraph and is also a
supporting organization described in section 509(a)(3) during the
taxable year with respect to the educational institution, as described
in part 7.b.iv of this Summary of Comments and Explanation of
Revisions, then the rule that attributes the largest amount of assets
and net investment income of the related organization to the
educational institution must be applied.
ii. Is Controlled by Such Institution
The Treasury Department and the IRS have determined that only tax-
exempt corporations, certain trusts, and nonstock organizations
controlled by an educational institution should be considered
controlled related organizations with respect to an educational
institution for purposes of determining an educational institution's
assets and net investment income under section 4968(d)(1).
As discussed in part 7.d of this Summary of Comments and
Explanation of Revisions, if an educational institution controls an
organization under this definition, then it must take into account all
the assets and net investment income of the controlled related
organization, except as provided in parts 7.b.ii.B (relating to certain
controlled trusts), 7.c (relating to no amount being taken into account
with respect to more than one educational institution), 7.d.iii
(relating to certain organizations that were Type III supporting
organizations with respect to an educational institution on December
[[Page 65545]]
31, 2017), and 7.d.iv (relating to when assets used directly in
carrying out a related organization's exempt purpose are considered to
be used directly in carrying out the educational institution's exempt
purpose) of this Summary of Comments and Explanation of Revisions.
A. Tax-Exempt Corporations
No comments were received relating to the proposed rule for control
of tax-exempt corporations. Thus, these final regulations retain the
proposed rule and provide that a tax-exempt corporation is controlled
by an educational institution if the educational institution owns (by
vote or value) more than 50 percent of the voting and nonvoting stock
or membership interest of the tax-exempt corporation.
B. Trusts
As discussed in part 7.a.iii of this Summary of Comments and
Explanation of Revisions, several commenters stated that the proposed
rule for control of trusts, which provided that control of a trust with
beneficial interests means ownership of more than 50 percent of the
beneficial interests in the trust, would not appropriately capture
trusts that are controlled by the educational institution within the
generally accepted meaning of that term. Commenters stated that the
trustee of a trust does not control a trust in a way that is relevant
for purposes of section 4968, because the trustee is required to
administer the trust in accordance with, and to the extent of the
trustee's duties and powers as determined by, the terms of the trust
and applicable law. One commenter suggested that, given the limited
roles of the trustee and the beneficiary, an educational institution
should be considered to control a trust only if the educational
institution is both a beneficiary and a trustee with the discretionary
power to make current distributions of the trust's income and/or
principal to itself, pursuant to the terms of the trust.
The Treasury Department and the IRS agree with commenters that a
control rule for trusts based on an educational institution having a
more than 50 percent beneficial interest leads to unintended results.
However, the Treasury Department and the IRS believe that the
commenter's recommended rule is too narrow and could allow an
educational institution to transfer endowment assets into a trust that
it would not be considered to control under the recommended rule, but
that it did control in substance.
The Treasury Department and the IRS acknowledge that the concept of
control does not comport well with trusts. Possibly the only person
with control over a trust is a person with the power to revoke the
trust; even the trustee's ``control'' is limited by the provisions of
the trust instrument and applicable law. In attempting to construct a
replacement for the control rule for trusts to be used in the context
of section 4968, the Treasury Department and IRS identified the four
specific circumstances under which a trust should be deemed to have a
relationship with the educational institution that is sufficiently
similar to that generally intended by the concept of control. However,
in two of these circumstances, these final regulations recognize that
the deemed control is only with regard to some of the assets of the
trust; consequently, in the third and fourth circumstances explained in
the subsequent paragraphs, only a portion of the trust is considered to
be a related organization and only some of the assets and net
investment income are attributed to the educational institution.
The first circumstance is where the educational institution is the
sole permissible trust beneficiary. In this circumstance, several
factors would be irrelevant, such as the identity of the trustee, the
timing and standards for making trust distributions, and the donors to
the trust. To prevent the existence of another trust beneficiary,
whether purely discretionary or with only a minimal interest in the
trust, from being used to avoid this rule, the test refers to the
educational institution being ``substantially'' the sole trust
beneficiary.
A second circumstance is where the trust is a pooled income fund
described in sections 642(c)(3) and 642(c)(5). Although a certain
portion of the net income of the fund is payable on a current basis to
the donors to the fund, the fund is managed by the educational
institution, the educational institution is the sole remainderman of
the fund, and a portion of the fund becomes payable to the educational
institution as each donor's interest expires. Given the different times
(generally based on the date of death of individual donors) when
portions of the trust principal will become payable to the educational
institution, and the control of the fund by the educational
institution, the Treasury Department and the IRS have determined that
it is appropriate to deem a pooled income fund described in sections
642(c)(3) and 642(c)(5) to be controlled by that institution.
A third circumstance is where the trust has been funded with assets
of the educational institution. If, and only to the extent that, the
trust's funding consisted of assets contributed to the trust by the
educational institution (or by a person controlled by the educational
institution), the Treasury Department and the IRS concluded that the
trust's assets and net income should be attributed to the educational
institution.
Finally, the Treasury Department and the IRS concluded that any
portion of a trust that the educational institution (or a person
controlled by the educational institution) can demand or cause to be
distributed to the educational institution (or a person controlled by
the educational institution) should be attributed to the educational
institution.
Therefore, these final regulations provide that a trust is a
related organization, and an educational institution is deemed to
control that trust, only: (1) If the educational institution is
substantially the sole permissible trust beneficiary or appointee of
both income and principal, whether or not the timing of distributions
is subject to the trustee's discretion; (2) if the trust is a pooled
income fund described in section 642(c)(3) and (5); (3) if, but only to
the extent that, the assets of the trust were contributed to the trust
by the educational institution (or by a person controlled by the
educational institution, as determined under these regulations); or (4)
if, but only to the extent that, the educational institution (or a
person controlled by the educational institution, as determined under
these regulations) has the right to demand (or can otherwise cause) a
distribution of principal from the trust to the educational institution
(or a person controlled by the educational institution).
For purposes of this definition, a person is controlled by an
educational institution if the educational institution has the power to
remove and replace such person or otherwise controls the person under
one of the tests in Sec. 53.4968-3(b)(2)(i), (ii), or (iii), with
similar principles applying for purposes of determining control of any
other form of entity.
C. Nonstock Organizations
One commenter objected to the proposed rule for control of nonstock
organizations, stating that the portion of the rule that is based on
directors or trustees of the educational institution being
representatives of the other organization often incorrectly determines
which entity controls the other, as the presence of common directors or
trustees alone is not determinative of control. The commenter stated
that the
[[Page 65546]]
representatives test from the proposed regulations could be especially
devastating to hierarchical religious organizations using corporation
sole or similar structures, which have neither directors nor trustees.
If one made a natural extension of the proposed rule by treating the
incumbent officer of a ``corporation sole'' as a sole director or
trustee, hierarchical religious organizations could be affected because
an ecclesiastical officeholder could not be on the board of any
educational institution without causing that religious organization to
be deemed to be controlled by that educational institution. The
commenter stated that control tests found in other sections of the Code
relating to tax-exempt organizations, such as the control tests found
in sections 507, 509, 4911, 4941, 4942, and 4943, would be more
relevant and appropriate for purposes of section 4968. For example,
these tests include the power to cause a certain act, often acting
solely in the capacity of foundation manager.
The Treasury Department and the IRS agree that a modified version
of control for nonstock organizations that is based on the power of the
educational institution (or one or more of its managers, directors,
officers, trustees, or employees acting only in the capacity as a
representative of the educational institution) to cause (or prevent) a
certain act would also appropriately reflect control by the educational
institution over the nonstock organization.
Thus, these final regulations provide that an educational
institution controls a nonstock organization if the educational
institution (or one or more of its managers, directors, officers,
trustees, or employees acting only in those capacities) can (1) appoint
or elect (which must include the power to remove and replace) more than
50 percent of the members of the nonstock organization's governing body
(such as directors, officers, or trustees), or otherwise has the
ongoing power to appoint or elect more than 50 percent of such members
with reasonable frequency; (2) require the nonstock organization to
make an expenditure (or prevent the organization from making an
expenditure); or (3) require the nonstock organization to perform any
act that significantly affects its operations (or prevent it from
performing such an act). Such control includes control by aggregating
votes or positions of authority (including by veto power) but applies
regardless of the method by which the control is exercised or
exercisable.
iii. Is Controlled by One or More Persons That Also Control Such
Institution
The proposed regulations provided a rule relating to control of a
nonstock organization by one or more persons that also control an
educational institution, finding control if more than 50 percent of the
directors or trustees of the nonstock organization are directly or
indirectly controlled by one or more persons that control the
educational institution.
In recognition that the other organization might be other than a
nonstock organization, these final regulations provide a separate rule
for organizations that are controlled by one or more persons that also
control such institution. Under these final regulations, an
organization is controlled by one or more persons that also control the
educational institution if more than 50 percent of the members of the
governing body of the other organization is directly or indirectly
controlled by persons that comprise more than 50 percent of the members
of the governing body of the educational institution.
As discussed in part 7.d of this Summary of Comments and
Explanation of Revisions, an educational institution does not take into
account assets and net investment income of a related organization that
is controlled by one or more persons that also control the educational
institution unless the assets and net investment income are intended or
available for the use or benefit of the educational institution.
However, if a related organization is both (1) controlled by one or
more persons that also control the educational institution, as
described in this part 7.b.iii, and also is (2) controlled by the
educational organization, as described in part 7.b.ii of this Summary
of Comments and Explanation of Revisions or is also a supporting
organization described in section 509(a)(3) during the taxable year
with respect to the educational institution, as described in part
7.b.iv of this Summary of Comments and Explanation of Revisions, then
the rule that attributes the largest amount of assets and net
investment income of the related organization to the educational
institution must be applied.
Nevertheless, the exceptions allowing certain assets and net
investment income to not be taken into account described in parts
7.b.ii.B (relating to certain controlled trusts), 7.c (relating to no
amount being taken into account with respect to more than one
educational institution), 7.d.iii (relating to certain organizations
that were Type III supporting organizations with respect to an
educational institution on December 31, 2017), and 7.d.iv (relating to
when assets used directly in carrying out a related organization's
exempt purpose are considered to be used directly in carrying out the
educational institution's exempt purpose) of this Summary of Comments
and Explanation of Revisions, continue to apply.
iv. Supporting Organizations Described in Section 509(a)(3)
Section 4968(d)(2)(C) includes within the definition of related
organization any supporting organization (as described in section
509(a)(3)) during the taxable year with respect to the educational
institution.
One commenter noted that a Type I supporting organization \7\
controlled by a community foundation that supports a class of entities
that includes an educational institution within the class should be
considered to be a Type I supporting organization only ``with respect
to'' the controlling community foundation and not ``with respect to''
an educational institution. The commenter suggested that an
organization be considered a supporting organization with respect to
the educational institution only if the supporting organization meets
the organizational, operational, and relationship tests with respect to
the educational institution, considered in isolation. The Treasury
Department and the IRS agree that a section 509(a)(3) organization is a
supporting organization ``with respect to'' an educational institution
only if the supporting organization meets the organizational,
operational, and relationship tests with respect to the educational
institution, and have clarified this point in these final regulations.
---------------------------------------------------------------------------
\7\ Organizations described in section 509(a)(3) are known as
``supporting organizations.'' Supporting organizations achieve their
public charity status by providing support to one or more
organizations described in section 509(a)(1) or (2), which, in this
context, are referred to as ``supported organizations.'' To be
described in section 509(a)(3), an organization must satisfy several
tests, including having one of three ``relationships'' with one or
more supported organizations. A supporting organization that is
operated, supervised or controlled by one or more supported
organizations is known as a ``Type I'' supporting organization. A
supporting organization that is supervised or controlled in
connection with one or more supported organizations is known as a
``Type II'' supporting organization. A supporting organization that
is operated in connection with one or more supported organizations
is known as a ``Type III'' supporting organization.
---------------------------------------------------------------------------
The commenter further suggested that an organization be deemed to
be described in section 509(a)(3) with respect to an educational
institution only if (1) it is described in section
[[Page 65547]]
509(a)(3); (2) it bears a Type I, Type II, or Type III relationship to
the educational institution; and (3) substantially all, or at least a
majority, of its activities are for the benefit of, perform the
functions of, or carry out the purposes of the educational institution
or other public charities controlled by the educational institution.
The Treasury Department and the IRS disagree with this reading because
a supporting organization may be a supporting organization (as
described in section 509(a)(3) and the regulations under section
509(a)(3)) with respect to the educational institution, despite the
fact that less than a majority of its activities are for the benefit
of, perform the functions of, or carry out the purposes of the
educational institution or other public charities controlled by the
educational institution. Thus, these final regulations do not adopt
this recommendation.
The commenter noted that a supporting organization that is not a
supporting organization ``with respect to'' an educational institution
may still be related to the institution under one of the other tests,
and that a Type I or Type II supporting organization with respect to
the educational institution may be considered both a supporting
organization with respect to the educational institution described in
section 4968(d)(2)(C) and an organization controlled by the educational
institution described in section 4968(d)(2)(A) or an organization
controlled by one or more persons that also control the educational
institution described in section 4968(d)(2)(B). The Treasury Department
and the IRS agree, but in cases in which an organization is a related
organization with respect to an educational institution on more than
one basis, if one of the bases is that the organization is either
controlled by the educational institution as described in part 7.b.ii
of this Summary of Comments and Explanation of Revisions, or is a
supporting organization (as described in section 509(a)(3)) with
respect to the educational institution during the taxable year, then
the rule that attributes the largest amount of assets and net
investment income of the related organization to the educational
institution must be applied.
v. Constructive Ownership
The proposed regulations provided that the principles of section
318 apply for purposes of determining ownership of stock in a
corporation and that similar principles apply for purposes of
determining ownership in any other entity.
Commenters noted that section 318 provides rules for attribution
from entities under section 318(a)(2) (upward attribution) and to
entities under section 318(a)(3) (downward attribution). In general,
under upward attribution, (1) partners in a partnership are each
considered to own a proportionate share of stock owned by or for the
partnership; (2) beneficiaries of a trust are each considered to own a
proportionate share of stock owned by or for the trust based on their
actuarial interests in the trust; and (3) a person that owns stock
representing 50 percent or more of the value of a corporation is
considered to own a proportionate share of the stock owned by or for
such corporation. In general, under downward attribution, partnerships
and trusts are considered to own stock owned by or for their partners
and beneficiaries, respectively, and corporations are considered to own
stock owned by or for a person that owns stock representing 50 percent
or more of the value of the corporation. Commenters noted that
application of the downward attribution rules can lead to an
institution being deemed to control an organization that it does not
actually control.
The Treasury Department and the IRS agree with commenters that
application of the principles of section 318(a)(3) may lead to
unintended results. Thus, these final regulations provide that the
principles of section 318(a)(2) apply for purposes of determining
ownership of stock in a corporation, and similar principles apply for
purposes of determining ownership of interests in any other entity.
c. Assets and Net Income Treated as Assets and Net Income of Only One
Educational Institution
As noted at the beginning of this part 7, section 4968(d)(1)
provides, in part, that for purposes of determining the aggregate fair
market value of an institution's assets and its net investment income,
the assets and net investment income of all related organizations with
respect to the educational institution are treated as assets and net
investment income, respectively, of the educational institution.
However, section 4968(d)(1)(A) provides an exception under which no
such amount is taken into account with respect to more than one
educational institution.
In order to effectuate the exception contained in section
4968(d)(1)(A), the proposed regulations provided 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 among the educational
institutions as to which the organization is a related organization.
The proposed regulations provided that such 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
Treasury Department and the IRS requested comments on whether more
specific guidance is required concerning the allocation of a related
organization's assets and net investment income among multiple
educational institutions being supported by the same related
organization, and if so, what such additional guidance should be
provided. One commenter agreed with the proposed regulation, saying
that any reasonable methodology that takes into account all facts and
circumstances and is applied consistently across all related
organizations is appropriate for purposes of avoiding double-counting
of related organizations' assets and income. Thus, these final
regulations adopt the proposed rule and add that the allocation must be
consistently applied.
d. Assets and Net Investment Income of Related Organizations
For purposes of attributing assets and net investment income of
related organizations to educational institutions, section
4968(d)(1)(B) provides that, unless a related organization is
controlled by the educational institution or is a supporting
organization described in section 509(a)(3) with respect to such
institution for the taxable year, 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.
Put another way, if a related organization (1) controls the
educational institution (but is not described in section 509(a)(3) with
respect to the educational institution for the taxable year as
described in part 7.b.iv of this Summary of Comments and Explanation of
Revisions), (2) is controlled by one or more persons that also control
such institution (but is neither controlled by the educational
institution as described in part 7.b.ii of this Summary of Comments and
Explanation of Revisions nor is described in section 509(a)(3) with
respect to the educational institution), or (3) is a supported
organization (as defined in section 509(f)(3)) with respect to the
educational institution during the
[[Page 65548]]
taxable year, then the related organization's assets and net investment
income are taken into account as assets and net investment income of
the educational institution only to the extent the assets and net
investment income are intended or available for the use and benefit of
the educational institution.
However, if a related organization either (1) is controlled by the
educational institution or (2) is a supporting organization described
in section 509(a)(3) with respect to such institution for the taxable
year, then all the assets and net investment income of the related
organization are considered assets and net investment income of the
educational institution, except as provided in parts 7.b.ii.B (relating
to certain controlled trusts), 7.c (relating to an exception under
which no such amount is taken into account with respect to more than
one educational institution), 7.d.iii (relating to certain
organizations that were Type III supporting organizations with respect
to an educational institution on December 31, 2017), and 7.d.iv
(relating to when assets used directly in carrying out a related
organization's exempt purpose are considered to be used directly in
carrying out the institution's exempt purpose) of this Summary of
Comments and Explanation of Revisions.
i. Related Organizations That Control the Educational Institution, Are
Controlled by One or More Persons That Also Control the Educational
Institution, or Are Supported Organizations (as Defined in Section
509(f)(3)) With Respect to the Educational Institution During the
Taxable Year
As discussed in part 7.d of this Summary of Comments and
Explanation of Revisions, the assets and net investment income of
certain related organizations are taken into account only to the extent
that they are intended or available for the use and benefit of the
educational institution. In determining which assets and net investment
income are considered ``intended or available for the use and benefit
of'' the educational institution, the Conference Report states, ``[f]or
example, assets of a related organization that are earmarked or
restricted for (or fairly attributable to) the educational institution
would be treated as assets of the educational institution, whereas
assets of a related organization that are held for unrelated purposes
(and are not fairly attributable to the educational institution) would
be disregarded.'' H. Rept. 115-466, 115th Cong., 1st sess., at 555
(December 15, 2017).
The proposed regulations provided that when an educational
institution is determining which assets and net investment income are
``intended or available for the use or benefit of'' the educational
institution, the educational institution must make an allocation
between those assets and net investment income that are intended or
available for the use and benefit of the educational institution and
those not intended or not available for the use and benefit of that
educational institution. Such allocation must be made in a reasonable
manner, taking into account all facts and circumstances, and must be
consistently applied across all related organizations.
One commenter agreed with this approach, stating that it is
reasonable to permit an educational institution to take into account
its own unique facts and circumstances and use any reasonable method to
allocate the assets and net investment income.
The preamble to the proposed regulations further explained that
assets and net investment income of such a related organization are
intended or available for the use and benefit of an educational
institution if such 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 such
assets and net investment income are specifically earmarked or
restricted for another entity or for unrelated purposes or otherwise
are not fairly attributable to that educational institution.
The preamble to the proposed regulations requested comments on
situations in which an organization's assets or net investment income
is not specifically earmarked or restricted for the benefit of any
particular organization but otherwise is fairly attributable to the
educational institution or to another organization. For example, the
proposed regulations asked whether, absent any earmarking or
restriction, total distributions from a related organization to an
educational institution in one taxable year should establish a
presumption for section 4968 purposes that at least an equal amount is
fairly attributable to that educational institution for the following
taxable year, absent demonstrated facts and circumstances supporting
attribution of a lesser amount.
One commenter stated that, because earmarked and restricted funds
are subject to legally binding requirements that the assets must be
used solely for the designated recipient, such funds are a clear
example of assets ``intended for'' a particular organization. In
contrast, internal board decisions to allocate funds to certain
purposes do not typically convert funds into restricted funds because
the board still has authority to reverse its previous decision without
obtaining any outside consent. However, the commenter noted that
certain assets that have been affirmatively designated for use by an
educational institution could be ``intended for'' the institution, and
thus ``fairly attributable,'' even if not subject to a binding
restriction. This commenter recommended that the unrestricted,
undesignated assets of a related organization will not be treated as
intended or available for the educational institution unless they have
been affirmatively designated or appropriated for the educational
institution or made available for the educational institution to draw
upon at will; in other words, if they have been approved and directed
by the related organization for use by the educational institution.
These final regulations adopt this recommendation.
A few commenters said that total distributions from a related
organization to an educational institution in one taxable year should
not establish a presumption for section 4968 purposes that at least an
equal amount is fairly attributable to the educational institution for
the following taxable year. One commenter recommended creating a
rebuttable presumption based upon an average of distributions from the
related organization over a number of years. Another commenter noted
that there is no need to estimate possible future distributions because
the excise tax under section 4968 is based on data that is known at the
time the annual return is being prepared, so the exact amount of
distributions do not have to be estimated. This commenter stated that
if such a presumption did apply, it should be rebuttable based on facts
showing that the previous year's amounts distributed were for special
projects and not ``intended or available for'' the educational
institution the following year. In response to the comments, these
final regulations do not include a presumption based on previous
distributions.
[[Page 65549]]
ii. Related Organizations That Are Controlled by the Educational
Institution or That Are Supporting Organizations (as Described in
Section 509(a)(3)) With Respect to the Educational Institution During
the Taxable Year
If a related organization (1) is controlled by an educational
institution, as described in part 7.b.ii of this Summary of Comments
and Explanation of Revisions, or (2) is a supporting organization (as
defined in section 509(a)(3) and described in part 7.b.iv of this
Summary of Comments and Explanation of Revisions) with respect to the
educational institution during the taxable year, then the assets and
net investment income of the related organization must be taken into
account as assets and net investment income of the educational
institution, regardless of whether the assets and net investment income
are earmarked, restricted for the benefit of, or otherwise are fairly
attributable to that educational institution, and even if they are
specifically earmarked or restricted for another entity or for
unrelated purposes or otherwise are not fairly attributable to that
educational institution. However, the special rule in section
4968(d)(1)(A) continues to apply, preventing the assets and net
investment income of the related organization from being taken into
account by more than one educational institution. See part 7.c of this
Summary of Comments and Explanation of Revisions. In addition, assets
that are used directly for the related organization's exempt purpose
are considered used directly in carrying out the educational
institution's exempt purpose for purposes of section 4968(b)(1)(D), as
described in parts 5.e and 7.d.iv of this Summary of Comments and
Explanation of Revisions. There also is a special rule for related
organizations that were Type III supporting organizations with respect
to the educational institution on December 31, 2017, as described in
part 7.d.iii of this Summary of Comments and Explanation of Revisions.
iii. Special Rule for Related Organizations That Were Type III
Supporting Organizations With Respect to an Educational Institution on
December 31, 2017
In recognition that section 509(a)(3) Type III supporting
organizations, unlike section 509(a)(3) Type I and Type II supporting
organizations, are not directly or indirectly controlled by their
supported organizations,\8\ and because educational institutions may
not be able to get the needed information from their Type III
supporting organizations on a timely basis, the proposed regulations
provided a special rule for related organizations of an educational
institution that were Type III supporting organizations with respect to
an educational institution on December 31, 2017.
---------------------------------------------------------------------------
\8\ As mentioned in footnote 9 of this preamble, there are three
types of supporting organizations: Type I, Type II, and Type III.
The relationship of a Type III supporting organization with its
supported organization(s) is much more attenuated than the other two
types.
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That special rule allowed an educational institution with a related
organization that was a Type III supporting organization with respect
to the educational institution on December 31, 2017, to take into
account only the assets and net investment income of the related Type
III supporting organization that are intended or available for the use
and benefit of the educational institution, rather than the value of
all of that organization's assets or amount of net investment income.
The proposed regulations provided that an educational institution can
determine whether the assets and net investment income of such a Type
III supporting organization are intended or available for the use and
benefit of the educational institution using any reasonable method. The
proposed regulations set out one method for determining the amount of
net investment income available to the educational institution that
would be considered to be reasonable (i.e., using all the distributions
received from a Type III supporting organization subject to this
special rule as net investment income of the educational institution
each year) and one method for determining assets available to the
educational institution that would be considered to be reasonable
(i.e., using the distributions received from a Type III supporting
organization to calculate the percentage of the Type III supporting
organization's total net income that was distributed to the educational
institution, and using the same percentage to calculate the value of
the underlying assets of the Type III supporting organization that are
intended or available for the use and benefit of the educational
institution each year). The proposed regulations requested comments on
whether additional guidance pertaining to Type III supporting
organizations was needed.
One commenter stated that the safe harbor methods in the proposed
regulations would in many cases lead to strange results, stating that
the fact that a particular subsidiary makes a distribution to an
educational institution in one year in no way implies that the
educational institution has similar amounts available to it in future
years, let alone to a corresponding portion of the related
organization's entire asset base. The commenter suggested that only the
amounts actually distributed or appropriated to the educational
institution should be treated as intended or available for the
educational institution.
For consistency with the general rule for determining which assets
and net investment income are considered ``intended or available for
the use and benefit of'' an educational institution, and in response to
the comment, these final regulations do not include the safe harbor
method in the proposed regulations. Instead, these final regulations
provide that a method using assets and net investment income of the
Type III supporting organization (with respect to the educational
institution as of December 31, 2017), that are specifically earmarked
for an educational institution, are restricted for the benefit of an
educational institution, and are otherwise fairly attributable to an
educational institution (such as those that have been affirmatively
designated or appropriated for the educational institution or made
available for the educational institution to draw upon at will) will be
deemed to be reasonable.
Several commenters asked that the special rule for related
organizations that were Type III supporting organizations with respect
to the educational institution on December 31, 2017, be extended to
cover all Type III supporting organizations. One asked that the special
rule be extended to Type I and Type II supporting organizations, one
asked that it be extended to split-interest trusts, and one asked that
it cover all related organizations for which the educational
institution lacks ``effective control.''
Although the Treasury Department and the IRS have concluded that a
transition rule with respect to entities that were Type III supporting
organizations with respect to an educational institution on December
31, 2017, is appropriate, extending this rule to other organizations
would be contrary to the statute. In addition, the Treasury Department
and the IRS have concluded that excluding certain categories of
organizations from the definition of related organization, as described
in part 7.a of this Summary of Comments and Explanation of Revisions,
and explaining that a supporting organization must be described in
section 509(a)(3) ``with respect to'' an educational institution during
the
[[Page 65550]]
taxable year, as described in part 7.b.iv of this Summary of Comments
and Explanation of Revisions, address most of the commenters' concerns.
iv. Interaction With Section 4968(b)(1)(D)
As described in part 5.f of this Summary of Comments and
Explanation of Revisions, these final regulations provide that an asset
of a related organization that is treated as an asset of an educational
institution by section 4968(d) and that is used directly in carrying
out an educational institution's exempt purpose is considered to be
used directly by the educational institution in carrying out its exempt
purpose for purposes of section 4968(b)(1)(D). In addition, an asset of
a related organization described in section 501(c)(3) that is treated
as an asset of an educational institution by section 4968(d) and that
is used directly in carrying out the related organization's exempt
purpose is considered to be used directly by the educational
institution in carrying out its exempt purpose for purposes of section
4968(b)(1)(D).
8. Penalty Waiver
One commenter asked that any penalties arising from underpayment of
the excise tax for tax years prior to and including tax years in which
final guidance is issued be waived. A waiver of penalties is beyond the
scope of these regulations. In addition, these final regulations are
not effective until the taxable year beginning after publication of the
final regulations. Thus, applicable educational institutions will have
up to a year to comply with the final regulations, and for prior
taxable years applicable educational institutions can comply with the
statute using a reasonable good faith interpretation.
Applicability Date
These final regulations apply to taxable years of an educational
institution beginning after October 15, 2020.
Special Analyses
Executive Orders 12866, 13563, and 13771 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects, distributive impacts, and equity). Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, of reducing costs, of harmonizing rules, and of promoting
flexibility. The Executive Order 13771 designation for this regulation
is regulatory.
The final regulations have been designated by the Office of
Management and Budget's (OMB) Office of Information and Regulatory
Affairs (OIRA) as subject to review under Executive Order 12866
pursuant to the Memorandum of Agreement (April 11, 2018) between the
Treasury Department and OMB regarding review of tax regulations. OIRA
has determined that the final rulemaking is significant and subject to
review under Executive Order 12866 and section 1(b) of the Memorandum
of Agreement. Accordingly, the final regulations have been reviewed by
OMB.
I. Need for Regulation
The Conference Report, at 555, states that Congress intended that
the Secretary promulgate regulations to carry out the intent of section
4968. These final regulations are in response to this congressional
intent. The final regulations provide guidance for determining the
excise tax applicable to the net investment income of certain private
colleges and universities, as provided by the TCJA. The regulations are
intended to clarify which educational institutions are subject to the
excise tax under section 4968 (excise tax) and how net investment
income is calculated for purposes of this excise tax.
The Treasury Department and the IRS received 18 formal comments
regarding these proposed definitions and rules, and there was a degree
of taxpayer uncertainty as to whether the definitions of the various
terms and whether the rules for computing net investment income would
remain the same as those provided in the notice of proposed rulemaking.
Pursuant to section 6(a)(3)(B) of Executive Order 12866, the
following qualitative analysis provides further details regarding the
anticipated impacts of the final regulations. The statute and the final
regulations are briefly described in Part II of this Special Analyses
section. The baseline used for the analysis is described in Part III.
Part IV describes the types of entities affected by the proposed
regulations. Part V provides a qualitative assessment of the potential
economic effects, including the benefits and costs, of the proposed
regulations compared to the baseline.
II. The Statute and the Final Regulations
Section 4968 imposes a 1.4 percent excise tax on the net investment
income of applicable educational institutions. Under the statute, an
``applicable educational institution'' is an eligible educational
institution (which is described in section 25A(f)(2)) that has at least
500 tuition-paying students during the preceding taxable year, more
than 50 percent of whom are located in the United States, that is not a
state college or university, and the fair market value of the assets of
which (other than those assets that are used directly in carrying out
the institution's exempt purpose) is at least $500,000 per student at
the end of the preceding taxable year. Under section 4968, net
investment income is determined under rules ``similar to'' the rules of
section 4940(c) (the rules for the calculation of the net investment
income of private foundations). In addition, the statute contains a
rule under which the assets and net investment income of related
organizations generally are treated as the assets and net investment
income of the educational institution.
Section 4968 does not define the terms ``student,'' ``tuition-
paying student,'' or ``assets used directly in carrying out the
institution's exempt purpose.'' Section 4968(c) states that, for the
purposes of the excise tax in section 4968, net investment income is
determined under rules ``similar to'' the rules of section 4940(c) but
does not define what is meant by ``similar to.'' Section 4968 does not
define the term ``control'' as it relates to the definition of a
``related organization with respect to an educational institution.''
The final regulations provide general definitional guidance with
respect to these and other terms and rules relevant to the
implementation of the statute.
III. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the final regulations relative to a no-action baseline
reflecting anticipated Federal income tax-related behavior in the
absence of these final regulations.
IV. Affected Entities
One researcher used data from the Integrated Post-Secondary
Education Data System (IPEDS) on endowment values at the end of the
2015-2016 academic year and enrollment data to estimate the number of
institutions at risk of having liability under this excise tax.\9\
Under the assumption that none of the assets in the endowment are for
[[Page 65551]]
exempt purposes, he estimates that 23 institutions are likely to be
currently subject to tax. Using the same IPEDS data, another researcher
estimated that in 2016, among four-year public and not-for-profit
private institutions located in the United States with at least 500
full-time equivalent students, and excluding endowments held at the
university system level, there were 27 endowments worth at least
$500,000 per student.\10\ These estimates do not take into account all
of the provisions of the statute and regulations. For example, limiting
this set of institutions to the not-for-profit private institutions
subject to tax and excluding assets that are used for the institutions'
exempt purpose would reduce the number of affected institutions. On the
other hand, as both authors note, because the $500,000 per student
threshold for the aggregate fair market value of assets (other than
those assets which are used directly in carrying out the institution's
exempt purpose) that in part determines whether the excise tax in
section 4968 applies to an educational institution is not indexed for
inflation, the number of institutions to which the excise tax in
section 4968 applies is expected to increase over time. In addition,
these studies did not consider assets held by related organizations;
including such assets could increase the number of affected
institutions.
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\9\ Levine, Phillip. ``The University Endowment Income Tax: Who
Will Pay it and Why Was it Implemented?'', Econofact, January 25,
2018, available at https://econofact.org/the-university-endowment-tax-who-will-pay-it-and-why-was-it-implemented, accessed April 29,
2019.
\10\ Hinrichs, Peter. ``College Endowments.'' Economic
Commentary 2018-04 (May 17, 2018), Federal Reserve Bank of
Cleveland, Table 1.
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V. Economic Effects of the Final Regulations
The Treasury Department and the IRS anticipate that the issuance of
guidance pertaining to section 4968 will provide a marginal net
economic benefit to the overall U.S. economy.
The final regulations clarify a number of definitions related to
the excise tax in section 4968. In the absence of guidance, affected
taxpayers would have to calculate their tax liability without the
definitions and clarifications provided by the final regulations, a
situation that is generally considered more burdensome and could lead
to greater conflicts with tax administrators. The final regulations
make use of a number of existing statutory and regulatory provisions in
defining students, tuition, exempt purpose, fair market value, net
investment income and related organizations. Many taxpayers already
will be familiar with these definitions. Thus, the Treasury Department
and the IRS project that the final regulations will reduce taxpayer
compliance burden relative to the no-action baseline, including in
determining whether the excise tax applies to the institution and the
computation of the excise tax. However, it is possible that the final
regulations will have other economic effects based on the time needed
to file the return as well as the costs of tax administration,
including monitoring the compliance of taxpayers with the excise tax.
The guidance provided in the final regulations also ensures that
the excise tax liability is calculated similarly across taxpayers,
avoiding situations where one taxpayer receives preferential treatment
over another taxpayer for fundamentally similar economic activity. For
example, in the absence of these final regulations, an educational
institution may have uncertainty over whether it is subject to the
excise tax under section 4968 and what assets are used in determining
the net investment income for purposes of the excise tax under section
4968. As a result, in the absence of guidance, similar institutions
might take different positions and pay different amounts of tax,
introducing economic inefficiency and inequity.
Based on this analysis, the Treasury Department and the IRS
anticipate the net economic contribution of the final regulations will
be modest and will be positive relative to not issuing any such
guidance and conditional on the relevant statutes. In the proposed
regulations, the Treasury Department and the IRS requested comments on
a number of aspects of the proposed regulations, which included
comments on the economic effects, any behavioral changes caused, or the
unintended costs and benefits of the regulations. The Treasury
Department and the IRS did not receive any comments on these issues.
VI. Economic Analysis of Specific Provisions
The regulations embody certain regulatory decisions that reflect
the necessary exercise of regulatory discretion. These decisions
specify more fully how section 4968 is to be implemented.
A. Clarifications of Definitions
Consistent with the statute, the final regulations provide that the
term ``applicable educational institution'' means any eligible
educational institution: (1) That had at least 500 tuition-paying
students attending the institution during the preceding taxable year;
(2) with more than 50 percent of whose tuition-paying students are
located in the United States; (3) that is not described in the first
sentence of section 511(a)(2)(B) (relating to state colleges and
universities); and (4) the aggregate fair market value of the assets of
which at the end of such preceding taxable year (other than those
assets that are used directly in carrying out the institution's exempt
purpose) is at least $500,000 per student attending the institution.
Many provisions of the final regulations clarify definitions
related to the tax imposed by section 4968, minimizing the burdens
entities bear to comply with the tax, and have little other economic
impact. Clarifications reduce uncertainty, lower the effort required to
infer which institutions are subject to the section 4968 tax and the
potential for conflict if entities and tax administrators interpret
provisions differently. Examples of clarifications include the
definition of ``applicable educational institution,'' ``student,''
``tuition-paying,'' ``located in the United States,'' and ``assets.''
i. Definition of ``Student''
The definition of ``applicable education institution'' relies on
the definition of ``student.'' In section 25A(b)(3) and the Higher
Education Act, a ``student'' is defined as a person enrolled in a
degree, certification, or other program (including a program of study
abroad approved for credit by the eligible educational institution at
which such student is enrolled) leading to a recognized educational
credential at an eligible educational institution, and who is not
enrolled in an elementary or secondary school.
The proposed regulations provided that the number of students of an
educational institution (including for purposes of determining the
number of students at a particular location) is based on the daily
average number of full-time students attending such institution (with
part-time students taken into account on a full-time student equivalent
basis). Under the proposed regulations, the standards for determining
part-time students, full-time students, full-time equivalents, and
daily average are generally determined by each educational institution.
Two commenters recommended that the definition of ``student'' be
expanded to include all students attending the institution even if not
enrolled in a degree, certification, or other program leading to a
recognized educational credential. One concern was that the term
``recognized educational credential'' was ambiguous.
The final regulations define the term ``student'' as a person who
is enrolled and attending a course for academic credit from the
institution and who is being charged tuition at a rate that is
[[Page 65552]]
commensurate with the tuition rate charged to students enrolled for a
degree.
ii. Definition of ``Tuition-Paying''
The proposed regulations provided that the term ``tuition-paying''
means the payment of any tuition or fees required for the enrollment or
attendance of a student for a course of instruction at an eligible
educational institution. The proposed regulations stated that this 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, or the payment of room and board or other personal living
expenses. In addition, the proposed regulations provided that whether a
student is ``tuition-paying'' is determined after taking into account
any scholarships provided directly by the educational institution and
any work study programs operated directly by the educational
institution; however, scholarship payments provided by third parties,
even if administered by the institution, are considered payments of
tuition on behalf of the student.
Commenters sought clarification on how scholarships from different
sources counted toward tuition, given that the proposed regulations
considered tuition after taking into account scholarships and work-
study programs offered directly from the institution. One commenter was
specifically concerned with Federal and state financial aid and non-
governmental scholarships not paid by the institution. The final
regulations do not count Federal, state, and local grants or financial
aid as ``tuition,'' but do count grants and scholarships provided by a
non-governmental party other than the particular educational
institution as ``tuition.''
In summary, ``tuition'' excludes payments made by or on behalf of
the student by the institution or from any Federal, state, and local
governmental sources. These clarifications in the final regulations
will more easily allow institutions to determine the applicability of
the statute.
iii. Definition of ``Located in the United States''
The proposed regulations provided that the term ``located in the
United States'' refers to the location of a student, and that a student
is considered to have been located in the United States if the student
resided in the United States for at least a portion of the time the
student attended the institution during the educational institution's
preceding taxable year.
One commenter sought clarification on this definition, recommending
that each institution be able to use any reasonable approach to
consider which students are located in the United States, as long as it
is consistently applied. The final regulations make explicit the
commenter's suggestion.
iv. Clarifications of ``Assets Used Directly in Carrying Out an
Institution's Exempt Purpose''
The final regulations also provide clarification of ``assets used
directly in carrying out an institution's exempt purpose.'' The
definition of an asset counted for purposes of section 4968 rests on
whether the asset is used for an exempt purpose. If an asset is used
for both an exempt purpose and for other purposes, and the exempt use
represents 95 percent 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 percent of the total use,
the institution must make a reasonable allocation between exempt and
nonexempt uses. Non-exempt assets generally include assets held for the
production of income or for investment and property used to manage the
institution's endowment.
A commenter recommended expanding the definition of exempt assets
to include intangible assets and non-financial assets used in a
functionally related business. Such functionally related businesses
would be things like a school newspaper that generated ad revenue. The
Treasury Department and IRS agreed that in certain circumstances these
types of assets may be included in exempt assets.
Another aspect of what is considered as assets held directly for an
exempt purpose is a reasonable cash balance to carry out the
institution's purpose. The proposed regulations recognized that an
amount equal to 1.5 percent of the fair market value of the educational
institution's non-charitable use assets (i.e., assets not actually used
by an institution in carrying out its exempt purpose), determined
without regard to the reduction for the reasonable cash balance, is
deemed to be a ``reasonable cash balance'' that is excluded from the
educational institution's asset base. These final regulations provide
that a reasonable cash balance may be determined by any reasonable
method and provide one example that would be deemed to be reasonable.
The final regulations therefore increase the flexibility of educational
institutions in establishing an appropriate reasonable cash balance.
Commenters also requested clarification of the treatment of assets
of organizations related to the educational institution. The final
regulations provide that an asset of a related organization that is
treated as an asset of the educational institution (in accordance with
section 4968(d) and Sec. 53.4968-3(c)) and is used directly in
carrying out the educational institution's exempt purpose is considered
used directly by the institution in carrying out its exempt purpose.
These final regulations further provide that an asset of a related
organization that is treated as an asset of the educational institution
is considered to be used directly in carrying out the educational
institution's exempt purpose as long as (1) the related organization is
described in section 501(c)(3) and (2) the asset is being used directly
in carrying out the related organization's exempt purpose. Further
discussion of ``related'' organizations is below.
B. Differences in Definition of ``Net Investment Income'' for
Educational Institutions Versus Private Foundations
Section 4968(a) imposes a 1.4 percent excise tax on the net
investment income of an applicable educational institution and on
certain amounts of net investment income of certain related
organizations. Section 4968(c) provides that net investment income is
determined under rules similar to the rules of section 4940(c). Section
4940(c) defines net investment income for an excise tax on private
foundations' net investment income.
Several commenters requested that the Treasury Department and IRS
further tailor these rules to take into account differences between a
private foundation subject to section 4940 and an educational
institution subject to section 4968, including differences in funding
sources, use of funds, structure, governance, and oversight. The
Treasury Department and IRS responded by tailoring the final
regulations to define net investment income more specifically for
educational institutions.
Following the regulations under section 4940(c), the final 4968
regulations provide that net investment income generally is the amount
by which the sum of the gross investment income and the capital gain
net income exceeds the allowable deductions. Commenters sought
clarification and modification of what is included as ``gross
investment income'' and ``capital gain net income.''
[[Page 65553]]
i. Gross Investment Income
Commenters recommended clarifications and modification to what is
included in gross investment income for purposes of section 4968. The
final regulations specify that, consistent with section 4940(c), gross
investment income generally means the gross amounts of income from
interest, dividends, rents, payments with respect to securities loans,
and royalties, but not including any such income to the extent it is
included in computing the tax imposed by section 511.
In response to commenters, the final regulations exclude from the
definition of gross investment income interest income from a student
loan made by an educational institution (or a related organization) to
a student of the institution in connection with the student's
attendance at the institution. Section 4940(c) specifically includes
student loan interest as gross investment income. Commenters noted that
loans made by colleges and universities to students are not offered
with the intent of earning investment income for the institution.
The final regulations also exclude from the definition of gross
investment income rental income from the provision of housing to
current students of the educational institution and from housing for
faculty and staff if the housing is provided contingent on their roles
as faculty or staff of the educational institution. The final
regulations exclude from the definition of gross investment income
royalty income that is derived from patents, copyrights, and other
intellectual property and intangible property to the extent those
assets were created by the institution's current students or faculty in
their capacities as such. Commenters represented that it would be a
significant administrative burden to capture all expenses and costs
allocable to such royalty income. The Treasury Department and the IRS
agree that applicable educational institutions produce intellectual
property as part of the pursuit of knowledge by faculty and students.
However, royalties from trademarks on the institution's logo or name,
as well as royalties on property donated or sold to the educational
institution, are not excluded from gross investment income under this
rule.
ii. Capital Gains and Losses
Commenters addressed several aspects of the proposed rules for
capital gain net income, including the taxation of capital gain net
income on the sale of exempt use property; capital gain net income on
the sale of donated property; the step-up rule for assets held in a
partnership on December 31, 2017; and whether capital loss carryovers
should be allowed.
a. Capital Gain Net Income on Sale of Exempt Use Property
In response to public comments, these final regulations provide
that capital gain net income from the sale or exchange of property used
by an institution for its exempt purpose is disregarded for the portion
of the property that is used for the exempt purpose.
b. Capital Gain Net Income From the Sale of Donated Property
Commenters recommended that any appreciation that occurred prior to
an institution's receipt of the donated property be excluded from the
calculation of capital gain net income from the sale of donated
property. Private foundations subject to section 4940 are generally
passive grant-making organizations that have the ability to dispose of
appreciated property by making a grant of the property instead of
selling the appreciated property and making a grant in cash.
Educational institutions, on the other hand, nearly always immediately
liquidate the gifts and use the proceeds to fund the institution's
activities; they therefore cannot avoid the net investment income from
the sale of appreciated property like private foundations. In response,
these final regulations provide that any appreciation in the value of
donated property that occurred prior to the date of donation to the
applicable educational institution is disregarded in calculating gain
for purposes of section 4968.
c. Basis for Purposes of Determining a Distributive Share of Gain From
the Sale or Other Disposition of an Asset Held in a Partnership
Commenters expressed concern with the proposed section 4968 rules
proposing calculation of the basis of assets held in partnerships in
which an educational institution owns an interest. Four commenters
noted that it would be extremely burdensome for institutions to obtain
documentation to establish their share of the basis of a particular
partnership asset and that an asset-by-asset determination of gain,
therefore, might not be possible.
The Treasury Department and the IRS acknowledge the problem
described by commenters. These final regulations provide a method,
described in paragraph 6.e. of the Summary of Comments and Explanation
of Revisions, which generally enables an applicable educational
institution to offset its distributive share of capital gain net income
from partnership asset dispositions by using the applicable educational
institution's adjusted step-up for such partnership (described in
paragraph 6.e of the Summary of Comments and Explanation of Revisions),
if any, at the time of such partnership asset disposition.
Specifically, the proposed regulations provided that, if an
applicable educational institution held an interest in a partnership on
December 31, 2017, and continuously thereafter, and the partnership
held an asset on December 31, 2017, and continuously thereafter to the
date of its disposition by the partnership, the applicable educational
institution's basis in such asset (for purposes of determining the
applicable educational institution's share of gain upon sale or other
disposition of that asset) is not less than the fair market value of
such asset on December 31, 2017, subject to all adjustments provided in
the proposed regulations after December 31, 2017, and before the date
of disposition.
d. Reduction of Capital Gain Net Income From a Partnership
Commenters stated that it would be very difficult, if not
impossible, for institutions to obtain the basis documentation that
would have been required under the proposed regulations in order to
apply the proposed partnership asset basis step-up rule. As an
alternative, two commenters recommended a method that would use the
difference between the fair market value and outside basis of an
applicable educational institution's partnership interest on December
31, 2017, to approximate the difference between the fair market value
and inside basis of, and thus the amount of built-in gain in, the
applicable educational institution's share of partnership assets on
such date. The commenters stated that the difference between fair
market value and tax basis of an applicable educational institution's
partnership interest on December 31, 2017, should generally reflect the
amount of the applicable educational institution's built-in gain in its
share of the partnership's assets on such date, and that, because
educational institutions should know the fair market values and tax
bases of their partnership interests on December 31, 2017, they should
be able to calculate the built-in gain in their partnership interests
as of December 31, 2017.
Specifically, the commenters recommended that an applicable
educational institution should be
[[Page 65554]]
allowed to offset the distributive share of partnership capital gain
net income after December 31, 2017, allocated by a partnership by the
amount of the built-in gain the applicable educational institution had
in its partnership interest, determined as of December 31, 2017. Under
this approach, an applicable educational institution would determine
its built-in gain in a partnership interest as of December 31, 2017,
and then not report any capital gain allocated from that partnership
after December 31, 2017, as being subject to section 4968 until the
cumulative amount of such excluded gain exceeds the amount of built-in
gain in the interest. The commenters recommended that this rule be
applied on a partnership-by-partnership basis and be available to
reduce the amount of an applicable educational institution's capital
gain net income on a first-recognized basis.
These final regulations adopt an approach that is similar to the
approach recommended by the commenters. These final regulations provide
that, for each partnership interest an applicable educational
institution held on December 31, 2017, the applicable educational
institution may determine an unadjusted step-up amount that is equal to
the excess, if any, of the fair market value of such partnership
interest on December 31, 2017, over the adjusted basis of such
partnership interest on December 31, 2017. For purposes of computing
net investment income for taxable years beginning after December 31,
2017, an applicable educational institution will reduce its
distributive share of capital gain net income from such partnership by
the least of: (A) The applicable educational institution's share of
applicable capital gain from such partnership (that is, both short-term
and long-term capital gain for the first taxable year after December
31, 2017, but only long-term capital gain for subsequent years because
short-term capital gains could not have been included in the amount of
outside built-in gain as of December 31, 2017); (B) one-third of the
applicable educational institution's unadjusted step-up for such
partnership; or (C) the applicable educational institution's adjusted
step-up for such partnership (which, in general, is its unadjusted
step-up reduced by any capital gain that previously was excluded
pursuant to either this rule or the partnership interest sale rule
described in paragraph 6.d.iii. of the Summary of Comments and
Explanation of Revisions).
e. Capital Loss Carryovers
A commenter represented that private foundations and educational
institutions differ in their flexibility in regards to the treatment of
sales of investments and operating budgets. Specifically, a private
grant-making foundation, to the extent it has satisfied its minimum
distribution requirements, can easily curtail its spending (and the
realization of capital gains while converting investment assets to
cash) by issuing fewer or smaller grant awards to manage its section
4940 tax liability. The commenter contrasted such a foundation with an
educational institution that typically has a large operating budget
with significant nondiscretionary expenses related to employees and
infrastructure and must find ways to meet its ongoing cash needs, which
may involve selling investments at particular times that may not be
advantageous from an investment or tax perspective.
The Treasury Department and the IRS acknowledge the differences
between private foundations subject to section 4940(c) and educational
institutions in their missions, functions, and operating expenses.
Based on these differences, these final regulations allow the use of
capital loss carryovers consistent with the approach recommended by the
commenter.
C. Related Organizations for Purposes of Net Investment Income and
Assets
Section 4968(d)(1) provides that the assets and net investment
income of any related organization with respect to an educational
institution are to be treated as assets and net investment income,
respectively, of the educational institution. The statute provides two
exceptions: (1) No such amount is to be taken into account with respect
to more than one educational institution, and (2) unless the related
organization is controlled by the institution or is a supporting
organization (as described in section 509(a)(3)) with respect to the
institution for the taxable year, assets and net investment income that
are not intended or available for the use or benefit of the institution
are not to be taken into account by that educational institution.
Under section 4968(d)(2), the term ``related organization'' means,
with respect to an educational institution, any organization that (1)
Controls the educational institution; (2) is controlled by the
educational institution; (3) is controlled by one or more persons that
also control the educational institution; (4) is a supported
organization (as defined in section 509(f)(3)) with respect to the
educational institution during the taxable year; or (5) is a supporting
organization (as described in section 509(a)(3)) with respect to the
educational institution during the taxable year.
The first three categories of related organizations require control
of an organization, but the statute does not define the term
``control.'' Furthermore, whether the educational institution is the
controlling or controlled entity matters because, if the related
organization controls the educational institution, or is controlled by
one or more persons that also control the educational institution, then
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. In contrast, if a related
organization is controlled by an educational institution, then all the
assets and net investment income of the related organization are taken
into account by the educational institution.
Specifically, the proposed regulations defined control as: (1) In
the case of a corporation, ownership (by vote or value) of more than 50
percent of the stock of the corporation; (2) in the case of a
partnership, ownership of more than 50 percent 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 percent 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, (a) more than 50 percent of the directors or trustees of the
educational institution or nonstock organization are either
representatives of, or are directly or indirectly controlled by, the
other entity or (b) more than 50 percent 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 educational institution.
The commenters sought clarifications and modifications of how
related organizations are treated based around three major issues: (1)
Control, (2) potential double taxation of certain types of related
organizations, and (3) treatment of the assets of certain related
organizations.
a. Control
Commenters stated generally that use of the proposed definition of
``control'' would result in educational institutions' being required to
take into account assets and net investment income that
[[Page 65555]]
the educational institutions do not actually control and that they will
never receive because the assets and income actually belong to
unrelated third parties. The commenters also stated that such a rule is
inconsistent with Congressional intent, and would not address
Congressional concerns that educational institutions might attempt to
avoid the section 4968 excise tax by holding assets in structures that,
as compared to direct ownership, represent a difference in form but not
substance.
The final regulations provide separate rules for the different
relationships that may exist and separately define control for
organizations that (1) control an educational institution, (2) are
controlled by an educational institution, and (3) are controlled by one
or more persons that also control an educational institution.
b. Double Taxation of Certain Related Organizations
Even if an educational institution controls certain types of
related organizations, subjecting the assets or net investment income
of these organizations to the section 4968 tax might result in double
or triple taxation. In applying the related organization provisions of
section 4968(d), commenters recommended disregarding taxable
corporations and trusts, partnerships and pass-through entities, and
split-interest trusts.
Several types of entities that might be related organizations are
taxed and then provide after-tax dollars to the educational
institution. Counting these distributions toward the section 4968 tax
might result in double taxation. The Treasury Department and the IRS do
not consider it consistent with Congressional intent to tax the income
again under section 4968. These final regulations exclude from the
definition of ``related organization'' a taxable corporation and
certain taxable trusts, in each case whether foreign or domestic.
To prevent double taxation of a partnership's net investment income
and overcounting of its assets, these final regulations exclude from
the definition of ``related organization'' a partnership, S
corporation, or other pass-through entity a portion of whose income
flows through to the educational institution.
c. Treatment of Assets of Certain Related Organizations
i. Trusts
With respect to trusts, commenters raised issues concerning
``control'' and whether charitable remainder trusts should be counted
as an asset of the educational institution, even if the educational
institution is deemed to control the trust. Several commenters stated
that the proposed rule for control of trusts, which provided that
control of a trust with beneficial interests means ownership of more
than 50 percent of the beneficial interests in the trust, would not
lead an educational institution to control the trust within the
generally accepted meaning of that term. Commenters stated that the
trustee of a trust does not control a trust in a way that is relevant
for purposes of section 4968, because the trustee is required to
administer the trust in accordance with, and to the extent of the
trustee's duties and powers as determined by, the terms of the trust
and applicable law.
The Treasury Department and the IRS acknowledge that the concept of
control does not mesh well with trusts. In attempting to construct a
replacement for the control rule for trusts to be used in the context
of section 4968, the Treasury Department and IRS identified the
circumstances under which a trust should be deemed to have a
relationship with the educational institution that is sufficiently
similar to that generally intended by the concept of control.
These final regulations provide that a trust is a related
organization, and an educational institution is deemed to control that
trust, only: (1) If the educational institution is substantially the
sole permissible trust beneficiary or appointee of both income and
principal, whether or not the timing of distributions is subject to the
trustee's discretion; (2) if the trust is a pooled income fund
described in sections 642(c)(3) and 642(c)(5); (3) to the extent that
the assets of the trust were contributed to the trust by the
educational institution (or by a person controlled by the educational
institution, as determined under these regulations); or (4) to the
extent that the educational institution (or a person controlled by the
educational institution, as determined under these regulations) has the
right to demand (or can otherwise cause) a distribution of principal
from the trust to the educational institution (or a person controlled
by the educational institution). The final regulations clarify how to
determine whether a person is controlled by an educational institution.
With respect to split interest and charitable remainder trusts,
commenters noted that an educational institution generally is not able
to receive any benefit from, and cannot use assets in the trust, until
the termination of the interests of the income beneficiaries (which may
be decades into the future). This is true even if the value of the
educational institution's interest in the trust exceeds 50 percent of
the present value of all beneficial interests in the trust. Further,
commenters noted it would be difficult for an educational institution
to obtain information about the income of a split-interest trust, as
there is currently no federal requirement for a split-interest trust to
report this information to its remainder beneficiary(ies).
With regard to charitable remainder trusts and split-interest
trusts, even those that are administered by an educational institution,
the Treasury Department and the IRS concluded that the assets and net
investment income of such trusts should be included in the educational
institution's assets and net investment income only as they are
received by the educational institution. Any income from such trusts
already is included in the educational institution's net investment
income as it is received. A remainder interest held by an educational
institution is deferred for a sometimes lengthy and sometimes
indeterminate amount of time and is subject to market fluctuations that
will affect (or could eliminate) the amount of any eventual
distribution of principal to the educational institution.
In addition, because there are only limited circumstances in which
the educational institution would have sufficient control over a trust
to justify treating the trust as a related organization, the final
regulations also exclude all other taxable trusts from the definition
of a related organization except to the extent the educational
institution is deemed to control the trust.
ii. Employee Benefit Funds
Commenters stated that various retirement and benefit plans should
be excluded from the definition of related organization for purposes of
section 4968(d), stating that the beneficiaries of these plans are
employees of the educational institutions and it was not the intent of
Congress to tax the investment income of these entities. Accordingly,
these final regulations provide that an employee benefit fund is not a
related organization for purposes of section 4968(d).
iii. Nonstock Organizations
One commenter objected to the proposed rule for control of nonstock
organizations, stating that the portion of the rule that is based on
directors or trustees of the educational institution being
representatives of the other organization often incorrectly determines
which entity controls the
[[Page 65556]]
other, as the presence of common directors or trustees alone is not
determinative of control.
The Treasury Department and the IRS agree that a modified version
of control for nonstock organizations that is based on the power of the
educational institution (or one or more of its managers, directors,
officers, trustees, or employees, acting only in that capacity) to
cause (or prevent) a certain act would more appropriately reflect
control by the educational institution over the nonstock organization.
Thus, these final regulations provide that an educational
institution controls a nonstock organization if the educational
institution (or one or more of its managers, directors, officers,
trustees, or employees acting only in that capacity) can (1) appoint or
elect (which must include the power to remove and replace) more than 50
percent of the members of the nonstock organization's governing body
(such as directors, officers, or trustees), or otherwise can appoint or
elect that majority with reasonable frequency; (2) require the nonstock
organization to make an expenditure (or prevent the organization from
making an expenditure); or (3) require the nonstock organization to
perform any act that significantly affects its operations (or prevent
it from performing such an act). Such control includes control by
aggregating votes or positions of authority (including by veto power)
but applies regardless of the method by which the control is exercised
or exercisable.
Paperwork Reduction Act
The collections of information contained in the final regulations
will be submitted to the Office of Management and Budget for review in
accordance with the Paperwork Reduction Act of (1995) (44 U.S.C.
3507(d)). An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a valid control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
return information are confidential, as required by 26 U.S.C. 6103.
A. Collections of Information Imposed by the Regulations
The collection of information in these final regulations is in
Sec. Sec. 53.4968-1(b)(2), (3), (4), and (5); 53.4968-2(d)(2)(ii) and
(iii); and 53.4968-3(c) and (d)(2). The collection of information for
Sec. 53.4968-1 is required to determine whether an educational
institution is an applicable educational institution, as defined in
section 4968(b). In particular, this collection of information includes
definitions to enable educational institutions to determine what
individuals constitute students of the educational institution, which
students are tuition-paying, which students are located in the United
States, and which assets of the educational institution are used
directly in carrying out an institution's exempt purpose. The
collection of information for Sec. 53.4968-2 is required to calculate
net investment income as defined in section 4968(c). In particular,
this collection of information includes determining an applicable
educational institution's share of gain upon the sale or other
disposition of a partnership asset. The collection of information for
Sec. 53.4968-3 is required to determine the assets and net investment
income of related organizations that are treated as assets and net
investment income of applicable educational institutions, as defined in
section 4968(d). In particular, this collection of information includes
whether an organization is a supporting organization (as described in
section 509(a)(3) of the Code) with respect to such institution
(including whether the supporting organization is a Type I, Type II, or
Type III), whether the related organization supports more than one
educational institution, and determining the assets and net investment
income of a related organization that are attributed to the educational
institution.
The excise tax for section 4968 is reported by timely filing a Form
990, Return of Organization Exempt From Income Tax, and Form 4720,
Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal
Revenue Code, Schedule O, Excise Tax on Net Investment Income of
Private Colleges and Universities. In 2016, the IRS released and
invited comments on drafts of an earlier version of Form 4720 in order
to give members of the public the opportunity to benefit from certain
specific amendments made to the Code. The IRS received no comments on
Form 4720 during the comment period. Consequently, the IRS made Form
4720 available on December 9, 2016, for use by the public. The IRS is
contemplating making additional changes to Form 4720 to accommodate new
provisions provided for in the final regulations, such as for the
allowance of capital loss carryovers. The IRS intends that the burden
of the collections of information will be reflected in the burden
associated with Form 4720, OMB approval number 1545-0047.
B. Burden Estimates
The burden associated with Form 4720 is included in the aggregated
burden estimates for OMB control number 1545-0047. The burden estimates
in 1545-0047 relate to all filers associated with the Forms 990 and
4720, and will in the future include, but not isolate, the estimated
burden of the information collections associated with these final
regulations.
The expected burden estimates for this final rule are based on the
information that is available to the IRS, and have been updated from
the proposed regulations to include new provisions provided in the
final regulations that reduce the record keeping burden for the private
colleges and universities that are subject to the tax under section
4968. The final regulations clarify that an educational institution may
use any reasonable method for determining whether a student is located
in the United States as long as that method is consistently applied,
and that the educational institution may use any reasonable method to
determine the reasonable cash balance necessary to cover current
operating expenses, providing an example of a reasonable method. The
final regulations also exclude several items of income from the
definition of gross investment income, such as interest income from
certain student loans, rental income from the provision of certain
housing to students, faculty, and staff, and certain royalty income.
The final regulations further disregard from the calculation of capital
gains any gain from the sale or exchange of the portion of property
that is used by an applicable educational institution for its exempt
purpose and any appreciation in the value of donated property that
occurred prior to the date of its donation. The final regulations
provide an easier method for applicable educational institutions to
substantiate interests and assets in partnership holdings. Finally, the
final regulations exclude several types of organizations from the
definition of ``related'' and adjust the definition of control for
purposes of determining when an organization is related for purposes of
section 4968.
The expected burden for private colleges and universities that are
subject to this rule as described in section 4968(b) is listed below:
Estimated number of respondents: 40.
Estimated average annual burden hours per response: 10 hours, 7
minutes.
[[Page 65557]]
Estimated total annual burden: $39,026 ($2017).
Estimated frequency of collection: Annual.
Accordingly, the new provisions in the final regulations reduced
the estimated average annual burden hours per response by 22 hours, 20
min, and the estimated total annual burden by $84,310 from the burdens
estimated in the proposed regulations, which provided for an estimated
40 number of participants, 32 hours and 27 minutes average burden hours
per response, and $123,336 (2017) total annual burden.
In the proposed regulations, the Treasury Department and the IRS
requested comments on all aspects of information collection burdens
related to the regulations, including estimates for how much time it
would take to comply with the paperwork burdens described above for
each relevant form and ways for the IRS to minimize the paperwork
burden. The Treasury Department and the IRS did not receive any
comments on these issues. Proposed revisions (if any) to the forms that
reflect the information collections contained in these final
regulations will be made available for public comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.html and will not be
finalized until after these forms have been approved by OMB under the
PRA. Comments on these forms can be submitted at https://www.irs.gov/forms-pubs/comment-on-tax-forms-and-publications.
Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it
is hereby certified that these final regulations will not have a
significant economic impact on a substantial number of small entities.
In the proposed regulations, the Treasury Department and the IRS
invited comments on the impact this rule may have on small entities.
The Treasury Department and the IRS did not receive any comments on
this issue. As discussed elsewhere in this preamble, this rule merely
provides definitions regarding the applicability of the section 4968
excise tax to certain private colleges and universities and rules for
calculating any tax that might be imposed. The requirements in this
regulation fall only on educational institutions whose non-exempt
assets have an aggregate fair market value of at least $500,000 per
student of the institution and that have at least 500 tuition-paying
students (for a minimum investment asset value of $250,000,000).
The threshold established by the Small Business Administration for
an educational institution to be considered a small entity is income
from all sources exceeding $27.5 million. This final rule will not
affect a substantial number of small entities. Only about 1.7 percent
of four-year colleges and universities (less than 40 out of over 2,400
institutions in the National Center for Education Statistics'
Integrated Post-Secondary Education System Data for 2016) are expected
to be affected by the tax. This is because at a modest 4 percent rate
of return, the minimum endowment alone would generate income of $10
million. To generate another $17.5 million in income would require
receipts of $35,000 per student if the institution had only the minimum
number of students, compared to average tuition and fees at a four-year
private college or university, which was $39,529 in 2015-16.
Accordingly, the Secretary certifies that this rule will not affect a
substantial number of small entities.
Pursuant to section 7805(f), the notice of proposed rulemaking was
submitted to the Chief Counsel for the Office of Advocacy of the Small
Business Administration for comment on its impact on small business (84
FR 31795, July 3, 2019). No comments on the notice were received from
the Chief Counsel for the Office of Advocacy of the Small Business
Administration.
Congressional Review Act
The Office of Management and Budget has determined that the final
rule is not a ``major rule'' within the meaning of the Congressional
Review Act (5 U.S.C. 801, et seq.).
Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. The final regulations do not include any Federal mandate
that may result in expenditures by state, local, or tribal governments,
or by the private sector in excess of that threshold.
Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. The final regulations do not have
federalism implications and do not impose substantial direct compliance
costs on state and local governments or preempt state law within the
meaning of the Executive order.
Drafting Information
The principal authors of these regulations are Melinda Williams and
Amber L. MacKenzie, Office of Associate Chief Counsel (Employee
Benefits, Exempt Organizations, and Employment Tax). However, other
personnel from the Treasury Department and the IRS participated in
their development.
Statement of Availability of IRS Documents
IRS Revenue Procedures, Revenue Rulings, Notices, and other
guidance cited in this document are published in the Internal Revenue
Bulletin (or Cumulative Bulletin) and are available from the
Superintendent of Documents, U.S. Government Publishing Office,
Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov.
List of Subjects in 26 CFR Part 53
Excise taxes, Foundations, Investments, Lobbying, Reporting and
recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 53 is amended as follows:
PART 53--FOUNDATION AND SIMILAR EXCISE TAXES
0
Paragraph 1. The authority citation for part 53 continues to read, in
part, as follows:
Authority: 26 U.S.C. 7805.
* * * * *
0
Par. 2. Sections 53.4968-1 through 53.4968-4 are added to subpart K to
read as follows:
Sec.
53.4968-1 Excise tax based on investment income of certain private
colleges and universities.
53.4968-2 Net investment income.
53.4968-3 Related organizations.
53.4968-4 Applicability date.
Sec. 53.4968-1 Excise tax based on investment income of certain
private colleges and universities.
(a) Excise tax on the investment income of certain private colleges
and universities. For taxable years beginning after December 31, 2017,
section 4968 of the Internal Revenue Code (Code) imposes a tax equal to
1.4 percent of the net investment income (as defined in
[[Page 65558]]
section 4968(c) and Sec. 53.4968-2) of an applicable educational
institution (as defined in section 4968(b)(1) and paragraph (b)(1) of
this section).
(b) Definitions. The definitions in this paragraph (b) apply for
purposes of section 4968 and Sec. Sec. 53.4968-1 through 53.4968-4.
(1) Applicable educational institution. The term applicable
educational institution means any eligible educational institution (as
defined in section 25A(f)(2) of the Code and Sec. 1.25A-2(b) of this
chapter)--
(i) That had at least 500 tuition-paying students during the
preceding taxable year;
(ii) More than 50 percent of whose tuition-paying students are
located in the United States;
(iii) That is not described in the first sentence of section
511(a)(2)(B) of the Code (relating to state colleges and universities);
and
(iv) The aggregate fair market value of the assets of which at the
end of such preceding taxable year (other than those assets that are
used directly in carrying out the institution's exempt purpose) is at
least $500,000 per student.
(2) Student. The term student means a person who is enrolled and
attending a course for academic credit from the institution and who is
being charged tuition at a rate that is commensurate with the tuition
rate charged to students enrolled for a degree. The number of students
of an educational institution (including for purposes of determining
the number of students at a particular location) is based on the daily
average number of full-time students (with part-time students taken
into account on a full-time student equivalent basis). The standards
for determining part-time students, full-time students, full-time
equivalents, and daily average are determined by each educational
institution. However, the standards may not be lower than the minimum
applicable standards established by the Department of Education under
the Higher Education Act of 1965 (20 U.S.C. 1088), as amended.
(3) Tuition-paying--(i) In general. The term tuition-paying means
the payment of any tuition or fees required for the enrollment or
attendance of a student for a course of instruction at an educational
institution. Tuition and fees do not include payment for supplies or
equipment required during a specific course once a student is enrolled
in and attending the course, or payment for room and board or other
personal living expenses.
(ii) Treatment of a comprehensive or bundled fee. If a student is
required to pay a fee (such as a comprehensive fee or a bundled fee) to
an educational institution that combines charges for tuition with
charges for personal expenses such as room and board, the student is a
tuition-paying student.
(iii) Scholarships, grants, and work study programs. Whether a
student is tuition-paying is determined after taking into account any
scholarships and grants provided directly by the educational
institution or by the Federal government or any state or local
government, and after application of any work study programs operated
directly by the institution. Scholarships and grants provided by non-
governmental third parties, even if administered by the institution,
are considered payments of tuition on behalf of the student.
Accordingly, a student will be considered a tuition-paying student if
payment of 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,
any work study program operated directly by the institution, and any
grants and scholarships provided by the Federal government or any state
or local government.
(4) Located in the United States. A student is located in the
United States if the student resided in the United States for at least
a portion of the time the student attended the educational institution
during the institution's preceding taxable year. Whether a student
resided in the United States in any given year can be determined using
any reasonable method, as long as that method is consistently applied.
(5) Assets used directly in carrying out an institution's exempt
purpose--(i) In general. Except as provided in paragraph (b)(5)(iv) of
this section, an asset is used directly in carrying out an educational
institution's exempt purpose only if the asset is actually used
directly by the institution in carrying out its exempt purpose. Whether
an asset is used directly by the institution to carry out its exempt
purpose is 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 percent 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 percent of the
total use, the institution must make a reasonable allocation between
such exempt and nonexempt uses.
(ii) Illustrations. Examples of assets that are used directly in
carrying out an institution's exempt purpose include, but are not
limited to, the following--
(A) Administrative assets, such as office equipment and supplies
used by the institution directly in the administration of its exempt
activities;
(B) Real estate or the portion of any building used by the
institution directly in its exempt activities;
(C) Physical property such as paintings or other works of art owned
by the institution that are on public display (or held for public
display), fixtures and equipment in classrooms, research facilities and
related equipment that under the facts and circumstances serve a useful
purpose in the conduct of the institution's exempt activities;
(D) The reasonable cash balance, determined using any reasonable
method, necessary to cover current operating and administrative
expenses and other normal and current disbursements directly connected
with the educational institution's exempt activities. For this purpose,
a reasonable method would include calculating an amount equal to three
months of operating expenses allocable to program services, calculated
by dividing annual functional expenses allocable to program services by
four. A larger amount may be a reasonable cash balance for this purpose
if, under the facts and circumstances, a larger amount is established
to be necessary to cover administrative expenses and other normal
disbursements directly connected with the institution's exempt
activity.
(E) Any property the educational institution leases to other
persons at no cost (or at a nominal rent) to the lessee in furtherance
of the institution's exempt purposes; and
(F) Patents, copyrights, and other intellectual property and
intangible property to the extent that income from those assets is
excluded from net investment income by Sec. 53.4968-2(b)(2)(iii).
(iii) Assets not used directly. The following assets are examples
of assets not used directly in carrying out an institution's exempt
purpose--
(A) Assets that are held for the production of income or for
investment (for example, stocks, bonds, interest-bearing notes,
endowment funds, or leased real estate not described in paragraph
(b)(5)(ii)(E) of this section), even if the income from such assets is
used to carry out such exempt purpose; and
(B) Property (such as offices and equipment) used for the purpose
of managing the institution's endowment funds.
(iv) Assets of related organizations. An asset of a related
organization that is treated as an asset of an educational
[[Page 65559]]
institution by section 4968(d) and Sec. 53.4968-3(c) and that is used
directly in carrying out an educational institution's exempt purpose,
or that is used directly in carrying out the exempt purpose of a
related organization that is described in section 501(c)(3), is
considered used directly by the educational institution in carrying out
its exempt purpose.
(v) Valuation of assets not used directly in carrying out an
institution's exempt purpose--(A) In general. The values of assets not
used directly in carrying out an educational institution's exempt
purpose are determined under the rules of section 4942(e) and Sec.
53.4942(a)-2(c)(4), as modified by paragraph (b)(5)(v)(B) of this
section.
(B) Modifications. In applying the rules of Sec. 53.4942(a)-
2(c)(4), an educational institution must--
(1) Substitute ``educational institution'' for ``private
foundation'' or ``foundation'' every place they appear; and
(2) Make such adjustments as are reasonable and necessary to obtain
the fair market value of any and all assets as of the last day of the
preceding taxable year, rather than as of any other times permitted or
required by Sec. 53.4942(a)-2(c)(4).
Sec. 53.4968-2 Net investment income.
(a) Net investment income--(1) In general. For taxable years
beginning after December 31, 2017, section 4968(a) of the Internal
Revenue Code (Code) imposes a 1.4 percent excise tax on the net
investment income (as defined in section 4968(c) and this section) of
an applicable educational institution and on certain amounts of net
investment income of certain related organizations, as described in
section 4968(d) and Sec. 53.4968-3. For purposes of this section, net
investment income is determined under rules similar to the rules of
section 4940(c) of the Code. Thus, net investment income generally is
the amount by which the sum of the gross investment income (as defined
in paragraph (b) of this section) and the capital gain net income (as
defined in paragraph (d) of this section) exceeds the deductions
allowed by paragraph (c) of this section. Except to the extent
inconsistent with the provisions of this section, net investment income
is determined under the principles of subtitle A of the Code.
(2) Tax-exempt income. For purposes of this section, net investment
income is determined by applying section 103 of the Code (relating to
State and local bonds) and section 265 of the Code (relating to
expenses and interest relating to tax-exempt income).
(b) Gross investment income--(1) In general. For purposes of this
section and except as provided in paragraph (b)(2) of this section, the
term gross investment income means the gross amounts of income from
interest, dividends, rents, payments with respect to securities loans
(as defined in section 512(a)(5) of the Code), and royalties, but not
including any such income to the extent included in computing the tax
imposed by section 511 of the Code. Such term also includes income from
sources similar to those in the preceding sentence. In general, gross
investment income includes the items of investment income described in
Sec. 1.512(b)-1(a) of this chapter.
(2) Exceptions. The following items of income are excluded from the
definition of gross investment income:
(i) Interest income from a student loan that was made by the
applicable educational institution or a related organization to a
student of the applicable educational institution in connection with
the student's attendance at the institution;
(ii) Rental income from the provision of housing by the applicable
educational institution or a related organization to students of the
applicable educational institution and from housing for faculty and
staff if the housing is provided contingent on their roles as faculty
or staff of the applicable educational institution; and
(iii) Royalty income that is derived from patents, copyrights, and
other intellectual property and intangible property to the extent those
assets resulted from the work of student(s) or faculty member(s) in
their capacities as such with the applicable educational institution.
However, neither royalty income from trademarks on the institution's
logo or name nor royalty income from intellectual property donated or
sold to the institution is excluded from gross investment income under
this rule.
(c) Deductions--(1) In general. For purposes of computing net
investment income--
(i) There is allowed as a deduction from gross investment income
all the ordinary and necessary expenses paid or incurred for the
production or collection of gross investment income or for the
management, conservation, or maintenance of property held for the
production of such income, determined with the modifications set forth
in paragraph (c)(2) of this section. Taxes paid or incurred under
section 4968 are not paid or incurred for the production or collection
of gross investment income. Allowable expenses include that portion of
an applicable educational institution's operating expenses that is paid
or incurred for the production or collection of gross investment
income. An applicable educational institution's operating expenses
include compensation of officers, other salaries and wages of
employees, outside professional fees, interest, and rent and taxes on
property used in the applicable educational institution's operations.
Where an applicable educational institution's officers or employees
engage in activities on behalf of the institution for both activities
that generate net investment income and for activities that do not
generate net investment income, compensation and salaries paid to such
officers or employees must be allocated between the activities that
generate net investment income and for activities that do not generate
net investment income.
(ii) Where only a portion of property produces, or is held for the
production of, income subject to the section 4968 excise tax, and the
remainder of the property is used for other purposes, the deductions
allowed by this paragraph must be apportioned between the taxable and
other uses.
(iii) No amount is allowable as a deduction under this section to
the extent it is paid or incurred for purposes other than those
described in paragraph (c)(1)(i) of this section. Thus, for example,
the charitable deductions prescribed under sections 170 and 642(c) of
the Code; the net operating loss deduction prescribed under section
172; and the special deductions prescribed under part VIII of
subchapter B of chapter 1 of the Code are not allowable.
(2) Deduction modifications. The following modifications must be
made in determining deductions otherwise allowable under this paragraph
(c):
(i) The depreciation deduction is allowed, but only on the basis of
the straight-line method provided in section 168(b)(3) and without
regard to section 168(b)(1) and (2).
(ii) The depletion deduction is allowed, but such deduction is
determined without regard to sections 613 and 613A of the Code,
relating to percentage depletion.
(iii) The basis to be used for purposes of the deduction allowed
for depreciation or depletion is the basis determined under the rules
of part II of subchapter O of chapter 1 of the Code (part II of
subchapter O), subject to the modifications found in paragraphs
(c)(2)(i) and (ii) of this section (relating to depreciation and
depletion), and without regard to Sec. 53.4968-2(d)(2) (relating to
the basis for determining
[[Page 65560]]
gain for property held on December 31, 2017, and continuously
thereafter to the date of disposition), or section 362(c) of the Code
(relating to certain special basis rules regarding contributions of
capital to corporations). Thus, an applicable educational institution
must reduce the cost or other substituted or transferred basis by an
amount equal to the straight-line depreciation or cost depletion,
without regard to whether the applicable educational institution
deducted such depreciation or depletion during the period prior to its
first taxable year beginning after December 31, 2017. However, where an
applicable educational institution has previously taken depreciation or
depletion deductions in excess of the amount which would have been
taken had the straight-line or cost method been employed, such excess
depreciation or depletion also is taken into account to reduce basis.
If the facts necessary to determine the basis of property in the hands
of the donor or the last preceding owner by whom it was not acquired by
gift are unknown to the applicable educational institution, then the
original basis to the applicable educational institution of such
property is determined under the rules of Sec. 1.1015-1(a)(3) of this
chapter.
(iv) The deduction for expenses paid or incurred in any taxable
year for the production of gross investment income earned as an
incident to a charitable function can be no greater than the income
earned from such function which is includible as gross investment
income for such year. For example, where rental income incidentally is
realized in a year from historic buildings held open to the public,
deductions for amounts paid or incurred in that year for the production
of such income is limited to the amount of rental income includible as
gross investment income for the year.
(d) Capital gains and losses--(1) In general. In determining
capital gain net income for purposes of the tax imposed by section
4968--
(i) Interaction with section 511. No gain or loss from the sale or
other disposition of property is taken into account to the extent that
such gain or loss is taken into account for purposes of computing the
tax imposed by section 511.
(ii) Sales or other dispositions of exempt use property. To the
extent that property is used by the educational institution for its
exempt purposes, capital gain from the sale or exchange of the portion
of that property that is used by the educational institution for its
exempt purposes is disregarded;
(iii) Sales of donated property--(A) In general. Any appreciation
in the value of donated property that occurred prior to the date of its
donation to the institution is disregarded.
(B) Date of donation. The date of donation is determined under the
timing rules of Sec. 1.170A-1(b) of this chapter.
(C) Value on the date of donation. The value of the donated
property on the date of donation is determined under the valuation
rules of Sec. 1.170A-1(c) of this chapter; and
(iv) Capital losses. Net losses from sales or other dispositions of
property by one related organization (or by the applicable educational
institution) reduce (but not below zero) net gains from such sales or
other dispositions by other related organizations (or by the applicable
educational institution). Should overall net losses from sales or other
dispositions of property exceed gains from sales or other dispositions
of such property during the same taxable year, such excess may not be
deducted from gross investment income in any taxable year, nor may such
excess be used to reduce gains in prior taxable years. However, capital
loss carryovers are allowed and may be deducted from capital gains in a
future year.
(2) Basis--(i) For purposes of calculating gain from the sale or
other disposition of property other than a partnership interest.
Subject to the modifications of paragraphs (c)(2)(i) and (ii) of this
section (referring to the modifications relating to deductions against
gross investment income) and without regard to section 362(c), the
basis for purposes of determining gain from the sale or other
disposition of property (other than a partnership interest) for
purposes of determining capital gain net income for purposes of the tax
imposed by section 4968 is the greater of--
(A) Fair market value on December 31, 2017, plus or minus all
adjustments after December 31, 2017, and before the date of disposition
under the rules of part II of subchapter O, provided that the property
was held by the applicable educational institution on December 31,
2017, and continuously thereafter to the date of disposition, or
(B) Basis as determined under the rules of part II of subchapter O.
(ii) For purposes of determining a distributive share of gain from
the sale or other disposition of a partnership asset. For purposes of
determining an applicable educational institution's share of gain upon
the sale or other disposition of a partnership asset, the applicable
educational institution's basis in each such partnership asset
generally is determined under the rules of subchapter K of chapter 1 of
the Code (subchapter K). However, see paragraph (d)(3) of this section.
(iii) For purposes of determining gain on the sale or other
disposition of a partnership interest. For purposes of determining an
applicable educational institution's gain upon the sale or other
disposition of all or a portion of a partnership interest, the
applicable educational institution's basis in such partnership interest
is generally determined under the rules of subchapter K, subject to the
special rules in paragraph (d)(3) of this section.
(iv) For purposes of calculating loss. Subject to the modifications
of paragraphs (c)(2)(i) and (ii) of this section (referring to the
modifications relating to deductions against gross investment income)
and without regard to section 362(c), basis as determined in paragraph
(d)(2)(i)(B) of this section applies for purposes of determining loss.
For purposes of determining loss from the sale or other disposition of
a partnership interest, basis is determined under the rules of
subchapter K.
(3) Special rules regarding partnership interests and partnership
assets--(i) Reduction of distributive share of capital gain net income
from a partnership. For purposes of computing net investment income, an
applicable educational institution reduces the amount of its
distributive share of capital gain net income from a partnership by the
least of--
(A) The applicable educational institution's share of applicable
capital gain (as defined in paragraph (d)(3)(iii)(A) of this section)
from such partnership;
(B) One-third of the applicable educational institution's
unadjusted step-up (as defined in paragraph (d)(3)(iii)(B) of this
section) for such partnership; or
(C) The applicable educational institution's adjusted step-up (as
defined in paragraph (d)(3)(iii)(C) of this section) for such
partnership.
(ii) Reduction of capital gain net income from a sale or other
disposition of all or a portion of a partnership interest. For purposes
of computing net investment income, an applicable educational
institution reduces the amount of its capital gain net income upon the
sale or other disposition of all or a portion of a partnership interest
by an amount that bears the same relation to the applicable educational
institution's adjusted step-up (as defined in paragraph (d)(3)(iii)(C)
of this section) for such partnership as the fair market value of the
transferred portion of the interest bears to the fair market
[[Page 65561]]
value of the applicable educational institution's entire interest in
such partnership before the sale or other disposition.
(iii) Definitions. For purposes of this section--
(A) Applicable capital gain. For an applicable educational
institution's first taxable year beginning after December 31, 2017, the
term applicable capital gain means an applicable educational
institution's share of both short-term and long-term capital gains and
losses subject to section 4968 from a partnership. For subsequent
taxable years, applicable capital gain does not include an applicable
educational institution's share of short-term capital gains and losses
subject to section 4968 from a partnership. For purposes of this
paragraph, applicable capital gain is not less than zero.
(B) Unadjusted step-up. An applicable educational institution
computes an unadjusted step-up for each partnership interest it held on
December 31, 2017. The unadjusted step-up for a partnership interest
equals the excess, if any, of the fair market value of such partnership
interest on December 31, 2017, over the adjusted basis of such
partnership interest on December 31, 2017.
(C) Adjusted step-up. An applicable educational institution
computes an adjusted step-up for each partnership interest it held on
December 31, 2017. The adjusted step-up for a partnership interest
equals the unadjusted step-up for such partnership, reduced by the
amount of any capital gain net income reduction pursuant to paragraphs
(d)(3)(i) and (ii) of this section for such partnership.
(4) Examples. The following examples illustrate paragraph (d)(3) of
this section. Unless stated otherwise in the examples, partners have no
tax items other than those listed in the example. With respect to
partnerships, all allocations are in accordance with section 704(b) and
the regulations under section 704(b) in part 1 of this chapter (Income
Tax Regulations).
(i) Example 1--(A) Facts. University (U), an applicable educational
institution, is a partner in partnership PRS. On December 31, 2017, U's
PRS interest had a fair market value of $130 and tax basis of $100. In
2018, U's share of capital gain net income from PRS is $5, which is
comprised of $20 of gain from the sale of capital asset X and ($15) of
loss from the sale of capital asset Y. Further, such $5 of capital gain
net income is applicable capital gain (as defined in paragraph
(d)(3)(iii)(A) of this section).
(B) Analysis. U has an unadjusted step-up (as defined in paragraph
(d)(3)(iii)(B) of this section) for PRS of $30 ($130 fair market value
- $100 tax basis on December 31, 2017). Pursuant to paragraph (d)(3)(i)
of this section, for purposes of computing its net investment income, U
reduces the amount of its capital gain net income from PRS by $5, which
is the least of: U's share of applicable capital gain from PRS ($5); or
one-third of U's unadjusted step-up for PRS ($10); or U's adjusted
step-up for PRS ($30). Thus, U reduces its $5 of capital gain net
income allocated from PRS by $5, resulting in U having $0 of capital
gain net income in 2018 for purposes of section 4968. As a result, U's
adjusted step-up for PRS for subsequent taxable years is reduced to $25
($30 - $5) pursuant to paragraph (d)(4)(iii)(C) of this section.
Pursuant to section 705, the $5 of gain allocated to U increases U's
tax basis in its PRS interest to $105.
(ii) Example 2--(A) Facts. The facts are the same as in paragraph
(d)(4)(i)(A) of this section (Example 1). In 2019, U sells its entire
interest in PRS for $130, which, immediately prior to the sale, had a
tax basis of $105. As a result, U has $25 of capital gain from the sale
of its PRS interest.
(B) Analysis. Pursuant to paragraph (d)(3)(iii) of this section,
for purposes of computing its net investment income, U reduces its
capital gain net income resulting from the sale of its entire PRS
interest by $25, which is the amount that bears the same relation to
U's adjusted step-up for PRS ($25) as the fair market value of the
transferred portion of PRS ($130) bears to the fair market value of the
U's entire interest in PRS before the sale or other disposition ($130).
Thus, U reduces its $25 of capital gain net income from the sale of its
PRS interest by $25, resulting in U having $0 of capital gain net
income in 2019 for purposes of section 4968.
(iii) Example 3--(A) Facts. The facts are the same as in paragraph
(d)(4)(i)(A) of this section (Example 1). In 2019, U's share of capital
gain net income from PRS is $15, which is comprised of $15 of gain from
the sale of capital asset Z. Further, such $15 of capital gain net
income is applicable capital gain (as defined in paragraph
(d)(3)(iii)(A) of this section).
(B) Analysis. Pursuant to paragraph (d)(3)(i) of this section, for
purposes of computing its net investment income, U reduces the amount
of its capital gain net income from PRS by $10, which is the least of:
U's share of applicable capital gain from PRS ($15); or one-third of
U's unadjusted step-up for PRS ($10); or U's adjusted step-up for PRS
($25, computed as $30 of unadjusted step-up, less $5 of capital gain
net income reduced in 2018 pursuant to paragraph (d)(3)(i) of this
section). Thus, U reduces its $15 of capital gain net income allocated
from PRS by $10, resulting in U having $5 of capital gain net income in
2019 for purposes of section 4968. As a result, U's adjusted step-up
for PRS is reduced for subsequent taxable years to $15 ($25 - $10)
pursuant to paragraph (d)(3)(iii)(C) of this section. Pursuant to
section 705, the $15 of gain allocated to U increases U's tax basis in
its PRS interest to $120.
Sec. 53.4968-3 Related organizations.
(a) Definition of related organization--(1) In general. For
purposes of section 4968(d) of the Internal Revenue Code (Code) and
Sec. Sec. 53.4968-1 through 53.4968-4, except as provided in paragraph
(a)(2) of this section, the term related organization means, with
respect to an educational institution, any organization that--
(i) Controls such institution;
(ii) Is controlled by such institution;
(iii) Is controlled by one or more persons that also control such
institution;
(iv) Is a supported organization (as defined in section 509(f)(3)
of the Code) with respect to such institution during the taxable year;
or
(v) Is a supporting organization (as described in section
509(a)(3)) with respect to such institution during the taxable year.
(2) Organizations not considered related organizations. For
purposes of section 4968(d) and Sec. Sec. 53.4968-1 through 53.4968-4,
the term related organization does not include any organization that
is--
(i) A taxable corporation;
(ii) A taxable trust, including a non-grantor charitable lead trust
(except to the extent the trust is controlled by the educational
institution as described in paragraph (b)(2)(ii) of this section);
(iii) A grantor charitable lead trust;
(iv) A charitable remainder trust;
(v) A partnership, S corporation (as defined in section 1361(a)(1)
of the Code), or other pass-through entity that is generally not
subject to Federal income tax, the income of which is taxable to its
partners or other interest holders; or
(vi) A decedent's estate.
(3) Employee benefit plans or arrangements. A trust or similar
funding vehicle of an employee benefit plan or arrangement, such as a
section 501(a) trust funding a section 401(a) qualified retirement
plan, or an annuity contract funding a section 403(b) plan, or a
section 419(e) welfare benefit fund
[[Page 65562]]
(including a voluntary employees' beneficiary association under section
501(c)(9)) funding a welfare benefit plan, will not be treated as a
related organization and its assets will not be treated as the assets
of the educational institution or of a related organization. A trust or
other funding vehicle of an unfunded employee benefit plan of an
educational institution or a related organization, such as a grantor
trust described in section 671 et seq., used in connection with a
section 457(b) plan or an arrangement subject to section 457(f), will
be treated as a related organization for purposes of section 4968(d)
and its assets will be treated as the assets of the educational
institution or of a related organization, but the assets are not
considered ``used directly in carrying out the institution's exempt
purpose'' for purposes of section 4968(b)(1)(D). For purposes of
determining whether the employee benefit plan of an educational
institution is funded or unfunded, the educational institution and all
of its related organizations are treated as a single sponsor and payor
of the benefits.
(b) Control--(1) Controls such institution. For purposes of section
4968(d) and Sec. Sec. 53.4968-1 through 53.4968-4, an organization
controls an educational institution if--
(i) The organization owns (by vote or value) more than 50 percent
of the voting and non-voting stock or membership interest of the
educational institution; or
(ii) The organization (or one or more of its managers, directors,
officers, trustees, or employees, acting only in those capacities)
can--
(A) Appoint or elect (which must include the power to remove and
replace) more than 50 percent of the members of the educational
institution's governing body (such as directors, officers, or
trustees), or otherwise has the ongoing power to appoint or elect more
than 50 percent of such members with reasonable frequency;
(B) Require the educational institution to make an expenditure (or
prevent the educational institution from making an expenditure); or
(C) Require the educational institution to perform any act that
significantly affects its operations (or prevent it from performing
such an act).
(2) Is controlled by such institution. For purposes of section
4968(d) and Sec. Sec. 53.4968-1 through 53.4968-4, an organization is
controlled by an educational institution:
(i) Tax-exempt corporation. In the case of a corporation recognized
as exempt from income tax under section 501(a), if the educational
institution owns (by vote or value) more than 50 percent of the voting
and nonvoting stock or membership interest of the corporation.
(ii) Trust--(A) In general. In the case of a trust--
(1) If the educational institution is substantially the sole
permissible trust beneficiary or appointee of both income and
principal, whether or not the timing of the distribution is subject to
the trustee's discretion;
(2) If the trust is a pooled income fund described in sections
642(c)(3) and 642(c)(5);
(3) If, but only to the extent that, the assets of the trust were
contributed to the trust by the educational institution (or by a person
controlled by the educational institution); or
(4) If, but only to the extent that, the educational institution
(or person controlled by the educational institution) has the right to
demand (or can otherwise cause) a distribution of principal from the
trust to the educational institution (or a person controlled by the
educational institution).
(B) Person controlled by the educational organization. For purposes
of this paragraph (b)(2)(ii), a person is controlled by an educational
institution if the educational institution has the power to remove and
replace such person or otherwise controls the person under one of the
tests described in Sec. 53.4968-3(b)(2)(i), (ii), or (iii), with
similar principles applying for purposes of determining control of any
other form of entity.
(iii) Nonstock organization. In the case of a nonstock
organization, if the educational institution (or one or more of its
managers, directors, officers, trustees, or employees, acting only in
those capacities) can--
(A) Appoint or elect (which must include the power to remove and
replace) more than 50 percent of the members of the organization's
governing body (such as directors, officers, or trustees), or otherwise
has an ongoing power to appoint or elect more than 50 percent of such
members with reasonable frequency);
(B) Require the organization to make an expenditure (or prevent the
organization from making an expenditure); or
(C) Require the organization to perform any act that significantly
affects its operations (or prevent it from performing such an act).
(3) Is controlled by one or more persons that also control such
institution. For purposes of section 4968(d) and this section, an
organization (other than one described in paragraph (a)(2) of this
section) is controlled by one or more persons that also control the
educational institution if more than 50 percent of the members of the
governing body of the other organization are directly or indirectly
controlled by persons that comprise more than 50 percent of the members
of the governing body of the educational institution.
(4) Constructive ownership. The principles of section 318(a)(2)
(relating to ownership attribution from partnerships, estates, trusts,
and corporations) apply for purposes of determining ownership of stock
in a corporation, and similar principles apply for purposes of
determining ownership of an interest in any other entity.
(5) Method of control. Control includes control by aggregating
votes or positions of authority (including by veto power), but applies
regardless of the method by which the control is exercised or
exercisable.
(c) Organization described in section 509(a)(3) during the taxable
year with respect to the educational institution. A section 509(a)(3)
organization is a supporting organization with respect to an
educational institution only if the supporting organization meets the
organizational, operational, and relationship tests of section
509(a)(3)(B) and Sec. 1.509(a)-4 of this chapter with respect to the
educational institution.
(d) Assets and net investment income of related organizations--(1)
In general. A related organization's assets and net investment income
are taken into account both in determining whether an institution is an
applicable educational institution and in computing the net investment
income of an applicable educational institution. For purposes of
determining the aggregate fair market value of the assets and net
investment income of an educational institution, the assets and net
investment income of all related organizations are treated as the
assets and net investment income, respectively, of the institution,
unless an exception provided in paragraph (d)(2) of this section or the
exception provided in Sec. 53.4968-1(b)(5)(iv) (relating to assets
used directly in carrying out an exempt purpose) applies. In cases in
which an organization is a related organization with respect to an
educational institution under more than one definition of this Sec.
53.4968-3, then the rule that attributes the largest amount of assets
and net investment income of the related organization to the
educational institution must be applied.
(2) Exceptions. For purposes of section 4968 and this paragraph
(d)(2)--
[[Page 65563]]
(i) No amount is taken into account with respect to more than one
educational institution. In determining the aggregate fair market value
of the assets and net investment income of an educational institution,
assets and net investment income of a related organization are not
taken into account with respect to more than one educational
institution. Thus, 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 or among the educational institutions as to which the
organization is a related organization, subject to paragraph (d)(2)(ii)
of this section. The educational institution must make such allocation
in a reasonable manner, taking into account all facts and
circumstances, that is consistent across all related organizations.
(ii) Assets and net investment income that are not intended or
available for the use or benefit of the educational institution--(A) In
general. Unless a related organization is controlled by the educational
institution or is a supporting organization described in section
509(a)(3) with respect to such institution for the taxable year, assets
and net investment income of a related organization that are not
intended or available for the use or benefit of the educational
institution are not taken into account by that educational institution.
(B) Determining whether assets and net investment income of a
related organization are intended or available for the use or benefit
of an educational institution. If a related organization controls the
educational institution, is controlled by one or more persons that also
control such institution (but is not described in section 509(a)(3)
with respect to the educational institution for the taxable year), or
is a supported organization (as defined in section 509(f)(3)) during
the taxable year with respect to the educational institution, then the
related organization's assets and net investment income are taken into
account as assets and net investment income of the educational
institution only to the extent the assets and net investment income are
intended or available for the use or benefit of that educational
institution. Assets and net investment income of a related organization
are intended or available for the use or benefit of an educational
institution if such assets and net investment income are specifically
earmarked or restricted for the benefit of, or otherwise are fairly
attributable to, the educational institution. For example, assets are
fairly attributable to the educational institution if they have been
affirmatively designated or appropriated for the educational
institution or made available for the educational institution to draw
upon at will. Conversely, assets and net investment income of a related
organization are not intended or available for the use or benefit of an
educational institution if such assets and net investment income are
specifically earmarked or restricted for another entity or for
unrelated purposes or otherwise are not fairly attributable to the
educational institution. The assets and net investment income of a
related organization must be allocated between those intended or
available for the use or benefit of an educational institution and
those not intended or not available for the use or benefit of that same
educational institution. The educational institution must make such
allocation in a reasonable manner, taking into account all facts and
circumstances, that is consistent across all related organizations.
(C) Related organizations that are controlled by the educational
institution or that are supporting organizations (as described in
section 509(a)(3)) with respect to the educational institution during
the taxable year--(1) In general. If a related organization is
controlled, as defined in paragraph (b)(2) of this section, by an
educational institution, or is a supporting organization with respect
to the educational institution during the taxable year, as defined in
paragraph (c) of this section, the assets and net investment income of
the related organization are taken into account as assets and net
investment income of the educational institution regardless of whether
those assets and net investment income are earmarked or restricted for
the benefit of, or otherwise are fairly attributable to, the
educational institution and even if they are specifically earmarked or
restricted for another entity or for unrelated purposes or otherwise
are not fairly attributable to the educational institution, subject to
paragraph (d)(2)(ii)(C)(2) of this section. However, see Sec. Sec.
53.4968-1(b)(2)(ii)(A)(3) and (4) regarding trusts that are controlled
related organizations only to the extent assets of the trust were
contributed to the trust by the educational institution (or by a person
controlled by the educational institution), or only to the extent the
educational institution (or person controlled by the educational
institution) has the right to demand (or can otherwise cause) a
distribution of principal from the trust to the educational institution
(or a person controlled by the educational institution). See also Sec.
53.4968-1(b)(5)(iv) for rules relating to when assets of a related
organization are deemed to be used directly in carrying out the
institution's exempt purpose.
(2) Special rule for Type III supporting organizations with respect
to an educational institution as of December 31, 2017. An educational
institution with a related organization that was a Type III supporting
organization with respect to the educational institution on December
31, 2017, takes into account only the assets and net investment income
of such Type III supporting organization that are intended or available
for the use or benefit of, or otherwise are fairly attributable to, the
educational institution, as described in paragraph (d)(2)(ii)(B) of
this section. An educational institution may determine whether the
assets and net investment income of such a Type III supporting
organization are intended or available for the use or benefit of, or
otherwise are fairly attributable to, the educational institution using
any reasonable method. A method that attributes to an educational
institution assets and net investment income of a supporting
organization that specifically are earmarked for the educational
institution, are restricted for the benefit of the educational
institution, or otherwise are fairly attributable to the educational
institution (such as those that have been affirmatively designated or
appropriated for the educational institution or made available for the
educational institution to draw upon at will) will be deemed to be
reasonable.
(3) Determining assets of related organizations. To determine which
assets of a related organization are included by an educational
institution under section 4968(b)(1)(D) for a particular year, an
educational institution determines which organizations are related
organizations, as defined in section 4968(d)(2) and Sec. 53.4968-3, as
of the end of the educational institution's preceding taxable year, and
values the relevant assets on that date.
(4) Determining net investment income of related organizations. To
determine the amount of net investment income of a related organization
that is included by the applicable educational institution in
calculating the tax imposed by section 4968(a) for a particular taxable
year, an applicable educational institution determines which
organizations are related organizations, as defined in section
4968(d)(2) and Sec. 53.4968-3, as of the
[[Page 65564]]
end of that taxable year of the applicable educational institution and
includes the net investment income from each related organization's
taxable year that ends with or within that same taxable year of the
applicable educational institution. If an organization became a related
organization after the beginning of the applicable educational
institution's taxable year, then the applicable educational institution
includes the organization's net investment income for the portion of
the year that the organization was a related organization, using any
reasonable method.
Sec. 53.4968-4 Applicability date.
The rules of Sec. Sec. 53.4968-1 through 53.4968-3 apply to
taxable years of an educational institution beginning after October 15,
2020.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: September 4, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-20933 Filed 10-14-20; 8:45 am]
BILLING CODE 4830-01-P
