Earlier this year, we posted about some of the unanswered questions raised by the new investment income tax (Section 4968) enacted by the Tax Cuts and Jobs Act that will subject certain private universities (those with at least 500 full-time tuition-paying students and that has at least $500,000 endowment per student) to a 1.4 percent excise tax on their net investment income. The IRS has just issued Notice 2018-55 to provide some clarity in response.
Most importantly the Notice announced the IRS’s intention to issue proposed regulations for calculating net investment income similar to the rules set forth for private foundations in Section 4940(c). Under Section 4940(c), net investment income is defined as the amount of income from interest, dividends, rents, payments with respect to securities loans, and royalties, plus net capital gain income, less deductions for ordinary and necessary expenses with respect to the production of the investment income, and less expenses for the management, conservation, or maintenance of property that produces investment income. The 1.4% excise tax is then applied to this net income figure.
For purposes of calculating capital gain income, the Notice also states that property held on December 31, 2017 and held continuously until disposition will have basis equal to its fair market value on December 31, 2017 plus or minus any adjustments after that date. So taxpayers will be given a free step up in basis on assets, which is consistent with the treatment under the Section 4940(c) regulations. Similarly, losses will only be allowed to the extent they offset gains from other sales or dispositions and there will be no carryforwards or carrybacks of losses. However, related-party gains and losses may be used to offset each other provided the related party either controls or is controlled by the educational institution, is controlled by the same persons that control the institution, or is a supported organization.
The consequences of these rules will likely be an increased record-keeping burden on the educational institutions to which the new tax applies because they will be required to separately track each investment with respect to basis and fair market value in order to comply with the new regulations. The IRS has stated that taxpayers may rely on the rules as explained by the Notice until the proposed regulations are issued.