Mark to Market Guidance Issued for College and University Investment Excise Tax

Under the Tax Cuts and Jobs Act, colleges and universities with endowments over $500,000 per student are now required to pay a 1.4% excise tax on investment earnings. 

The IRS has now provide guidance that will take a bit of the bite out of this new tax -- at least at first.

By way of background, the new tax applies to institutions meeting a defined set of criteria: at least 500 tuition paying students, 50% in the US, and 500,000 per student (not adjusted for inflation), including assets of related organizations.  (There are a number of definitional issues surrounding the criteria under which the tax applies. In the words of economist Peter Hinrichs at the Cleveland Fed, colleges may “behave strategically” to avoid the tax by tweaking how they compute these data.)

The tax applies to a small number of colleges and universities.   Wellesley College professor Phillip Levine has computed that it will apply to 23 colleges, but, that due to the lack of an adjustment for inflation, that number will grow in the next few years.

Harvard University has indicated that it would have paid an estimated $43 million per year based on 2017 data.  While Harvard has portrayed this as having a “big impact” on what the endowment is able to fund, in my view it is a drop in the bucket for an  organization with $6.6 billion in revenue. The real concern to me is the creep in the scope of application over time, or possible expansion of the tax, to institutions that are unable to afford it.  The original proposal contained a limit of $100,000 per student which would have applied to 150 colleges.  Colleges and university leaders have spoken out against the tax and a bill to repeal the tax has also been proposed.

In its guidance issued today, Notice 2018-55, the IRS stated that it intends to issue guidance stating that in the case of property held by an applicable institution on December 31, 2017 the starting point for computation of basis is its fair market value on that date, adjusted by gains or losses thereafter.  This is a big win for colleges and universities subject to the tax.  It means that, instead of paying tax on the gain since they purchased the property, their gain will be limited to the appreciation since the enactment of the tax. 

The guidance will also state that capital gains and losses can be netted against each other, but that there can be no capital loss carryforwards or carrybacks.  This is similar to the rules applicable to the private foundation excise tax.

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