The enactment of the Tax Cuts and Jobs Act of 2017 has raised a number of potential issues for institutions of higher education. Due to this significant impact, institutions need to study the Tax Act and plan appropriately.
Unrelated Business Income
The Tax Act requires institutions to separately compute unrelated business income for each “trade or business” conducted. This means that an institution will no longer be able to use the unrelated business income of one trade or business to offset the net operating loss of another trade or business. In addition, the Tax Act limits the deduction for net operating losses to 80 percent of taxable income. We are hoping for some guidance with regard to how different trade or business operations must be separated. Currently, there may be many ways to aggregate the operations to offset the effects of the Tax Act.
Excise Tax on Excess Compensation for Covered Employees
The Tax Act also subjects an institution to an excise tax on compensation in excess of $1 million paid by the institution to any of its five highest-paid employees for the tax year. The excise tax would apply to all monies paid to a covered employee for services, including cash and the cash value of all remuneration (including benefits) paid in a form other than cash, once such remuneration is no longer subject to a substantial risk of forfeiture. Both contributions to a tax-qualified retirement plan and compensation for the medical services of qualified medical professionals (e.g., doctors, nurses, or veterinarians) are exempt from the million-dollar limitation.
It is important to note that once an employee is determined to be a “covered employee,” that person will continue to be a covered employee as long as he or she is paid by the institution. The excise tax also would apply to excess parachute payments paid by the institution to such individuals.
Based on the language in the Tax Act, it is unclear as to whether public institutions are subject to this provision. We will let you know once a clarification has been issued.
Excise Tax on Investment Income for Applicable Educational Institutions
Certain private colleges and universities would be subject to a 1.4 percent excise tax on net investment income if they are “applicable educational institution[s].” For the purposes of this provision, an applicable educational institution means a private college or university that meets the following requirements:
- The college or university had at least 500 students during the preceding taxable year.
- More than 50 percent of the students are located in the United States.
- It is not a state college or university.
- The aggregate fair market value of the assets at the end of the preceding tax year (other than those assets which are used directly in carrying out the institution’s exempt purpose) is at least $500,000 per student of the institution.
Institutions can start planning while they wait for the Secretary of the Treasury to issue regulations that clarify:
- which assets are used directly in carrying out the educational institution’s exempt purpose;
- how to compute net investment income; and
- which assets are intended or available for the use or benefit of the educational institution.
Transportation Fringe Benefits
Another decision that institutions will have to make is regarding how they offer qualified transportation fringe benefits to their employees for the 2018 taxable year. The Tax Act provides that the unrelated business income of a tax-exempt institution will include the value of any qualified transportation fringe benefit provided on a pre-tax basis to employees. As a result, if an institution provides these benefits on a pre-tax basis, the institution will be required to report the value of such benefits as unrelated business income. The other option is to no longer provide the benefits on a pre-tax basis. This option will result in an increase in taxable compensation to employees.
Other provisions that are aimed at individual taxpayers and may have a direct effect on colleges and universities include:
- the increase in the standard deduction, which will affect the value of a charitable donation and may decrease the number of charitable donations in future tax years;
- the repeal of the rule that provided a charitable deduction of 80 percent of the amount paid for the right to purchase tickets for athletic events;
- a limit on state and local tax (SALT) deductions that may have the unintended consequence of decreasing state funding for public higher education institutions; and
- the requirement that for taxable years 2018 through 2025, institutions must include in income any amount they reimburse for moving expenses.
While there are many unanswered questions, we know that the Tax Act creates challenges for which institutions must be prepared. Some will impact future operations, while others will have additional requirements for legal compliance. Many of these concerns may be mitigated by a well-thought-out and executed action plan, so now is the time to seek input and put together a team to address the challenges.