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Emory Targets 5 Areas for Change in Endowment Tax Regs

OCT. 1, 2019

Emory Targets 5 Areas for Change in Endowment Tax Regs

DATED OCT. 1, 2019
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October 1, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-106877-18), Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Comments — Proposed Regulation 53.4968-1

Emory University (“Emory”) appreciates the opportunity to provide comments as the United States Treasury (“Treasury") and the Internal Revenue Service (“IRS") develop guidance for Internal Revenue Code §4968. The implementation of this law will have a significant impact on Emory's mission as we serve and support the students, faculty, employees, and healthcare patients of Emory University and its affiliated entities.

Founded in 1836, Emory is a top-ranked private institution of higher education and one of the world's leading healthcare systems. With nine schools and colleges, Emory educates over 15,000 undergraduate and graduate students from across the country and world. As an academic medical center, Emory also includes Emory Healthcare, which is comprised of primary, urgent, and specialty care practices at 200 locations including ten hospitals. As the largest employer in Atlanta, Emory's comments below focus on areas of implementation that will impact our students, patients, and employees.

We are writing specifically to provide recommendations in five areas related to Proposed Treasury Regulation 53.4968-1(b)(2) & (3). All code section references are to the Internal Revenue Code of 1986 as amended (“IRC”).

1. Prop Reg §53.4968-1 (b)(2) — Overall applicability of using IRC §4940(c) and §53.4940-1 (c) through (f)

2. Prop Reg §53.4968-1 (b)(2) & (3) — Interest income from loans to students and income from provision of housing to students

3. Prop Reg §53.4968-1 (b)(2) & (3) — Capital gain on sale of donated property

4. Prop Reg §53.4968-1 (b)(3)(iv) — Gains from pass through entities

5. Prop Reg §53.4968-1 (c) — Related organizations

Because of the complexities involved in the calculations under IRC §4968, we respectfully request any penalties arising from underpayment of the excise tax for tax years prior to and including tax years in which final guidance is issued be waived. Given the timing of the implementation of this provision and the complexities involved, Emory is facing a multimillion-dollar unbudgeted tax liability as well as increased administrative burden in complying with the rules. These are funds that would otherwise be directed to our academic and healthcare missions.

1. Prop Reg §53.4968-1 (b)(2) — Overall applicability of IRC §4940(c) and §53.4940-1 (c) through (f)

Under Prop Reg §53.4968-(1)(b)(2), net investment income of an applicable educational institution is to be determined under the rules of IRC §4940(c) and Treasury Regulation §53.4940-1 (c) through (f). These rules were put in place to provide guidance to private foundations in determining their net investment income. However, the statute under IRC §4968(c) only requires that for determining net investment income of an applicable educational institution, rules similar to the rules of IRC §4940(c) should be used.

Educational institutions are fundamentally different from private foundations, and the operating assets needed by educational institutions are very different from private foundations.

Educational institutions must charge tuition and other fees to help offset the cost of the instruction by qualified faculty and educational experiences designed to prepare students to be contributing members of the work force. Other program services, including housing and loans, are offered to support students and allow them to access educational opportunities that might not be available otherwise. In addition, as an academic medical center, Emory not only provides healthcare services to some of the most complex medical cases in our community, but we also train future medical personnel to serve communities throughout the country, whether in large metropolitan or rural areas, with quality medical care.

Congress's intent in enacting §4968 was to impose a tax on the investment income of educational institutions with large amounts of endowment assets on a per-student basis, as Congress perceived these universities were raising tuition and not utilizing their endowments to assist students. Taxing income typically considered program service revenue by colleges and universities, such as housing, would not be in line with Congress's intent. If Congress's intent were to tax the net investment income of educational institutions in the same way as the net investment income of private foundations, they would have referenced the Code section and Regulations in the statute and not utilized the verbiage “similar to," which indicates the intention for differences to occur.

Emory requests that Treasury and the IRS consider these differences when promulgating the final regulations under §4968 and allow for the exclusion of certain items of income from the definition of net investment income for purposes of computing the excise tax under this section. Specific examples of these income items are discussed below. These exclusions would enable universities to continue providing valuable services at a high level to their students and help to reduce the administrative and financial burden of computing tax on items generally considered program service revenue (not investment income) by educational institutions.

2a. §53.4968-1 (b)(2) & (3) — Interest income from loans to students

Under Prop Reg §53.4968-(1)(b)(2), net investment income of an applicable educational institution is to be computed following the rules of IRC §4940(c) and Treasury Regulation §53.4940-1 (c) through (f). Specifically, the example in §53.4940-1 (d) requires that interest received on a student loan be included in such income.

Loans to students offered by educational institutions differ from those offered by private foundations. An educational institution loans money to its own students, and these loans are similar to deferred tuition payments, which Treasury acknowledged in its preamble to the proposed regulations. Private foundations, on the other hand, do not have their own students and are simply loaning money but not providing direct education to the students. In addition, private foundations generally set their own loan terms (interest rates, repayment criteria, etc.) and may use the income from the loans for other initiatives.

Educational institutions, on the other hand, offer loans through federal government programs as well as their own programs. For the loans through federal government programs (e.g. Departments of HHS and Education), interest rates, loan terms, and qualification criteria are set by the federal government agency and not by the institution. Repayments and interest go into a pool of funds to be used to provide future loans.

Institutional loans are need-based loans, which typically have an interest rate set below market rates. At Emory, this rate has not increased in over 15 years and is simply charged to encourage repayment so funds may be used to assist other students rather than to make a profit.

The number of students with either institutional and/or government loans is quite large. Emory averages 7,000 - 8,000 active borrowers at any one time with the number of actual loans much greater as some students have multiple loans.

Emory recommends that interest from student loans for current and former students of the applicable educational institution be specifically excluded from the definition of net investment income under §4968 as a modification listed in §53.4968-1 (b)(3).

2b. §53.4968-1 (b)(2) & (3) — Income from provision of housing to students

Under the rules of IRC §4940(c), net rental income is includible in the computation of net investment income. The provision of student housing is different than rental income. Providing housing to students is not done to make a profit and should not be considered rental income under the rules of §4968 for several reasons.

First, housing is offered by an educational institution to its students to provide a sense of community and the opportunity to learn aspects of community behavior, as well as to facilitate studying and attending classes on campus. To promote this community as well as position students for success, many universities mandate that all students with less than a minimum amount of academic credit reside in university-provided housing. In many cases, if the educational institution did not offer campus housing, students may not be able to attend as the area around the school may lack sufficient housing. In addition, housing programs in higher education are an extension of the classroom learning experience. For example, some housing areas are theme based and learning communities where students can experience a variety of academic, cultural, organizational, and personal interests.

Second, while a university may enter into are housing contracts with its students, these contracts are not the same as typical leases. In order to be eligible for housing through a university, an individual generally must be a student at the institution or attending summer programs on campus. Rates are generally less than apartment rentals in the area. Students are subject to specific University housing rules and codes of conduct while in student housing. Campus housing is usually closed during semester breaks and students must leave campus. Additionally at Emory (and at many other colleges and universities), all students living in campus housing must participate in an on-campus dining plan.

Universities also provide housing for educational programs and camps held on campus to students and nonstudents throughout the year, especially during summer months. These programs are all designed to support learning and community growth and are clearly differentiated from normal housing leases in the real estate markets.

Emory recommends that, as campus housing is different than other rental income, income from housing arrangements for students or for educational programs on campus be specifically excluded from the definition of investment income under §4968 as a modification listed in §53.4968-1 (b)(3).

3. Prop Reg §53.4968-1 (b)(2) & (3) — Capital gain on sale of donated property

Under the rules of the proposed regulations and to be consistent with the rules under §4940(c), applicable educational institutions are to compute the gain on the sale or disposition of donated property using the donor's basis. The result of using the donor's basis for the computation under §4968 would be to tax the educational institution on any appreciation in value that occurred prior to the institution receiving the donation.

A donor's intent in making a gift to an educational institution is to give the organization a certain amount for use in the institution's exempt mission. The donor may gift cash, property, or a combination of both. The most common type of property gift is publicly traded stock. Under the rules of IRC §170, a donor may take a charitable deduction for the fair market value of the stock on the date of gift. Educational institutions generally sell this stock as soon as possible so that funds are available for immediate use in exempt programs. Subjecting the gain on the sale of this stock to tax reduces the benefit and funds available for use in exempt programs. In addition, institutions have an increased administrative burden in obtaining basis information from donors in order to calculate gain subject to the excise tax. Private foundations, under the rules of §4940(c) also must use the donor's basis in computing any gain. However, private foundations have the option of making gifts of the appreciated property to other 501(c)(3) public charities, resulting in no income tax for either organization.

Since the intent of Congress under §4968 was to tax investment income of applicable educational institutions and not tax donations,

Emory recommends any gain on the sale of donated property be excluded from the calculation of net investment income under §4968. Alternatively, the regulations could provide that for purposes of §4968, the basis for property received from donations be equal to the fair market value of the asset on the date of gift. Either recommendation would reduce the administrative burden placed on the educational institutions and allow the educational institution to use the full value of the donation for exempt purposes.

4. Prop Reg §53.4968-1 (b)(3)(iv) — Gains from pass-through entities

Under Prop Reg. §53.4968-1 (b)(3)(iv), if an applicable educational institution owned an interest in a partnership on December 31,2017 and the partnership held assets on December 31,2017, the partnership's basis in the assets with respect to the applicable educational institution's share for purposes of determining the educational institution's gain on the sale of the assets (“inside basis”) shall not be less than the fair market value of such assets on December 31, 2017. However, the proposed regulations require that documentation must be received from the partnership to substantiate this inside basis.

The types of partnership investments held by educational institutions include both privately held and publicly traded partnerships, many with numerous investors of various tax classifications, all of which may request the partnership provide different tax related information. Without a requirement under partnership rules mandating partnerships provide this information, it will be difficult for one exempt organization to obtain basis documentation information from all partnerships as it will place additional administrative burden on the partnership and the exempt entity, especially those which, like Emory, are currently invested in over 350 partnerships. Emory recommends that, instead of requiring documentation from the partnership, the regulation allow the applicable educational institution to compute the gain on the sale of partnership assets held on December 31,2017 using any reasonable method.

One reasonable method could be to use the tax basis of the outside partnership interest (“outside basis”) to determine the inside built-in gain. The amount of outside built-in gain generally corresponds to the amount of inside built-in gain. Applicable educational institutions should be allowed to offset any inside gain recognized by the partnership and reported on Schedule K-1 after December 31, 2017 by the amount of this outside built-in gain determined as of December 31, 2017. The simplest and most administrable rule would allow applicable educational institutions to determine its outside built-in gain as of December 31,2017, and then not report as subject to §4968 any capital gains flowing through from partnerships after such date until the cumulative amount of such excluded gains equals the original amount of outside built-in gain. Use of this method would lessen the additional administrative burden that educational institutions are already facing in complying with §4968.

5. Prop Reg §53.4968-1 (c) — Related organizations

For purposes of computing the aggregate fair market value of assets as well as the net investment income of an applicable educational institution under §4968, the assets and net investment income of related organizations are required to be taken into account. The proposed regulation provides definitions on what constitutes a related organization generally using the rules under IRC §512(b)(13), including control of more than 50 percent stock, ownership, or beneficial interest or control of directors/trustees of nonstock organizations. Certain aspects of the proposed rules create outcomes that are inequitable and contrary to congressional intent and we would recommend modifications of these rules as outlined below.

First, Emory recommends that income of related taxable corporations be excluded from the calculation of net investment income. Taxable corporations are already paying tax on the income and including this same income in the net investment income tax calculations would result in double taxation of the amounts. This would apply for both domestic and foreign corporations. An educational organization would also have already included any dividends paid by the corporation in the calculation of net investment income.

Second, Emory recommends the regulations clarify that, in the case of related partnerships, S corporations, or other pass-through entities, only the educational institution's allocable share of income should be included in the calculation of net investment income regardless of control. Including 100% would result in double taxation as other (non-exempt) partners would be subject to income tax on this income. Educational organizations are already paying tax (either Nil or UBIT) on the amounts reported on Schedule K-1 so having to compute the investment income of a partnership will not only be an administrative burden but would also result in the double counting of the educational institution's share of investment income from the partnerships.

Third, Emory recommends the special rule for Type III supporting organizations be extended to all Type III supporting organizations. Type III supporting organizations are generally not under the control of the educational institution. These organizations do not have to have any board members in common with the educational institution and can be set up without the educational institution's knowledge or input. Usually, the amounts given by Type III supporting organizations to an educational institution are grants or donations for program use. Educational institutions do not have control and have no input on when or how much is received from the Type III organization. Some Type III supporting organizations do not list the supported organizations in governing documents so could essentially stop providing any grants at any time. This lack of control is the same for newly created Type III supporting organizations; therefore, we recommend the income of all Type III supporting organizations be excluded from net investment income calculations and not just those formed prior to December 31,2017.

Finally, Emory recommends several other types of organizations be excluded from the definition of related organizations under §4968 as the applicable educational institution does not have effective control to direct the assets nor is it the ultimate beneficial owner. These organizations would include split-interest trusts, charitable remainder trusts, §403(b) plans, §457 plans, VEBAs, and defined benefit plans. With charitable remainder trusts, an educational institution generally is not able to receive any benefit until the primary beneficiary passes away and cannot utilize assets until that time. Even if the educational institution is named as trustee, it must still comply with restrictions included in the trust documents. In the case of various retirement and benefit plans (including but not limited to §403(b), §457, VEBAs, and defined benefit plans), the beneficiaries of these plans are employees of the educational institutions. We do not believe that it was the intent of Congress to tax the investment income of these entities; however, the definitions under the proposed regulations could be construed to include them. Thus, we would recommend language in the regulations to specifically exclude these organizations.

We appreciate the opportunity to share our recommendations with you as you develop guidance in these areas and welcome any communication opportunities as you continue to work on these provisions. Please consider Emory University a resource during the rule-making process. If I can answer any questions, please feel free to reach out to me or have your staff contact Cameron Taylor, Vice President, Government and Community Affairs at Cameron.Taylor@emory.edu.

Sincerely,

Christopher L. Augostini
Executive Vice President for Business Administration
Emory University
Atlanta, GA

CC:
Elinor Ramey, Attorney-Advisor, Office of Tax Policy, U.S. Department of Treasury
Janine Cook, Deputy Associate Chief Counsel, Tax Exempt & Government Entities, IRS
The Honorable Senator Isakson
The Honorable Senator Perdue

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