IRS Notice 2018-55 provides rules that institutions may use to calculate the new 1.4-percent excise tax on a private college or university endowment’s net investment income. A stepped-up basis rule reduces gain on a disposition of property, while normal basis rules apply when a disposition produces a loss. The IRS also intends to include these rules in proposed regulations.
The proposed regulations will also govern the netting of the institution’s capital gains and losses.
Excise Tax on Private College Endowments
The Tax Cuts and Jobs Act of 2017 imposes a 1.4 percent excise tax on the net investment income of an applicable educational institution. An applicable educational institution must:
- be a private college or university,
- have at least 500 full-time tuition-paying students, more than half of whom are located in the United States, and
- have an endowment of at least $500,000 per student.
The IRS estimates that no more than 40 institutions are applicable educational institutions.
Net Investment Income
Net investment income is:
- the sum of the institution’s gross investment income and capital gain net income,
- minus allowable deductions.
Gross investment income is income from interest, dividends, rents, payments with respect to securities loans, and royalties, plus income from similar sources. However, gross investment income does not include any income that the institution takes into account when calculating the unrelated business income tax.
Allowable deductions include all ordinary and necessary expenses for:
- the production or collection of gross investment income, and
- the management, conservation, or maintenance of investment property.
However, the endowment may have to limit depreciation and depletion deductions.
Gain and Loss on the Disposition of Property
The new basis rules for calculating gain and loss apply to property that the institution:
- held on December 31, 2017, and
- continues to hold until it sells or otherwise disposes of the property.
To determine gain on the disposition of qualified property, the institution’s basis is:
- the fair market value of the property on December 31, 2017,
- plus or minus all adjustments after that date.
If there is a loss on the disposition, basis is determined under the regular rules for determining gain or loss under IRC §§1011 through 1023. This is the same rule that applies when calculating the excise tax on a private foundation’s net investment income.
The IRS intends to include these rules in proposed regulations, but taxpayers may rely on them until the regulations are issued.
Netting Capital Gains and Losses
Proposed regulations will also provide that an applicable educational institution’s deductible losses from sales and other dispositions of property cannot exceed its gains. Thus, the institution will not be able to use capital loss carryovers or carrybacks.
However, the institution and its related organizations will be able to net their overall gains and losses from sales and other dispositions of property. A related organization is one that:
- controls, or is controlled by, the educational institution,
- is controlled by the same persons that control the institution, or
- is the institution’s supported organization, as defined by the rules for exempt private foundations.
These rules are also similar to the rules that apply to the excise tax on a foundation’s net investment income.
Finally, the IRS seeks comments regarding:
- the rule for netting capital gains and losses,
- whether it should issue transitional relief and, if so, what type, and
- whether it should issue other guidance for calculating an applicable educational institution’s net investment income.
Interested parties may email comments to Notice.Comments@irscounsel.treas.gov, with “Notice 2018-55” in the subject line. They may also mail comments to the IRS. The submission deadline is September 6, 2018.