Executive Compensation Limits: Do they Apply to Public Colleges and Universities?

Under the Tax Cuts and Jobs Act, a new excise tax applies to compensation in excess of $1 million paid to any of the five most highly-compensated employees of an exempt organization as well as certain separation payments made to these individuals (roughly equal to three times base salary).   It’s unclear, however, whether these apply to public colleges and universities.

First, some background on the tax.  The tax on separation payments generally applies to payments that exceed three times the employee’s base amount, which is computed based on a five year average salary. While the tax is modeled after Section 280G in the for profit context, application of that section is triggered based on changes in control, not separation from service.  It is unclear what it means for a payment to be contingent on separation from service (i.e. whether the fact that a payment is payable at that time is enough). 

A key question is whether the excise tax applies to public universities. Section 4960 defines an “applicable tax-exempt organization” as one that is either exempt from taxation under section 501(a), a farmers cooperative organization described in section 521(b)(1), has income excluded from taxation under section 115(1), or is a political organization described in section 527(e)(1).  At issue is whether income from public universities is exempt from taxation under section 501(a) and/or section 115(1).

A recent exchange of articles in Tax Notes highlights this issue. On one side is Professor Douglas Kahn from the University of Michigan Law School who argues that a public university is subject to the excise tax in section 4960.  Kahn argues that not only is income of a public university exempt from federal income tax because of the doctrine of implied statutory immunity, its income is also exempted by section 501(a) and (c)(3) and section 115(1).  He contends that the implied statutory immunity’s exemption of a public university’s income does not prevent section 501(a) and (c)(3) from also exempting the income.  Section 501(c)(3) applies only to a corporation, community chest, fund, or foundation.  Kahn believes that all or almost all public universities are incorporated, and so 501(c)(3) applies to them.  And section 4960 requires only that the organization be exempt from taxation under 501(a) but not exclusively by 501(a).  Furthermore, Kahn proposes that the implied statutory immunity doctrine does not prevent the application of section 115(1) to income of a public university.  Section 115(1) excludes from taxation the income derived from the exercise of any essential governmental function and accruing to a political subdivision of the state.  Kahn points to a Technical Advice Memorandum (TAM) prepared by the IRS as support.  Kahn concludes then that the literal language of section 4960 applies the excise tax to public universities.  Furthermore, in Kahn’s opinion, the intent of Congress to apply the tax to public universities is so clear that courts would most certainly enforce this intent despite any defects that may exist in the language of the provision. 

Professor Ellen Aprill from Loyola Law School Los Angeles responded to Kahn arguing in the alternative that section 4960 did not apply to public universities despite the clear Congressional intent for it to.  Aprill explains that while some public universities are exempt from taxation under section 501(c)(3) (and 501(a)) others are not and rely solely on the doctrine of implied statutory immunity.  In order for a public university to qualify for the exemption under 501(c)(3) it must apply for and receive a determination letter confirming its exempt status under the provision.  Without this determination letter the public university does not automatically qualify for the exemption.  Aprill explains that the driving force for a public university to obtain the exemption relates to fundraising (tax-deductible contributions).  In Aprill’s opinion, public universities that have applied for and received a determination letter that they qualify under 501(c)(3) would appear to be subject to section 4960’s excise tax.  Aprill notes that not all public universities have applied for and received the determination letter.  Furthermore, Aprill objects to Kahn’s reading of the TAM as support for the proposition that section 115(1) applies to a public university.  Aprill explains that the language Kahn cites was merely referencing a hypothetical in the memorandum which involved a college or university within the scope of section 511(a)(2)(B), the provision that subjects public universities and colleges to unrelated business income tax.  Aprill concludes that since 115(1) does not apply to public universities and section 501(c)(3) only applies to those universities who applied for and received a determination letter, a public university that has not been granted 501(c)(3) exempt status is not within the category subject to the section 4960 excise tax as an organization “exempt from tax under section 501(a).” 

Aprill offers up a few options for what public universities may want to do in light of what she perceives as the ambiguity in section 4960.  First, if the public university has 501(c)(3) status they could either pay the tax, relinquish their 501(c)(3) status, or argue that, as in the case of the excise tax on excess benefit transactions under section 4958, comity calls for exempting them from the new section 4960 tax.  Second, regardless of whether a public university has 501(c)(3) status, the university could decide to wait and see if Congress clarifies the application of the excise tax to them.  As yet another option, the university may decide to see whether the IRS, rather than Congress, issues guidance that reinterprets section 115(1) to apply generally to political subdivisions and their integral parts. 

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