Notre Dame Seeks Precision in Endowment Tax Regs

October 11, 2019

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

Re: REG-106877-18 — Comments on the Proposed Regulations Concerning the Determination of the Section 4968 Excise Tax Applicable to Certain Private Colleges and Universities

Dear Sir or Madam:

The University of Notre Dame du Lac (Notre Dame") respectfully submits this comment letter in response to the request for comments in REG-106877-18, issued by the Department of the Treasury ("Treasury") and the Internal Revenue Service ("IRS") on June 28, 2019, and published in the Federal Register on July 3, 2019 ("Proposed Regulations"). The Proposed Regulations relate to the determination of the Section 4968 excise tax applicable to certain private colleges and universities ("AEIs").¹

Notre Dame appreciates the opportunity to participate in the comment process and thereby help ensure the forthcoming final regulations are both consistent with Congressional intent and provide administrable rules that can be followed by affected AEIs to efficiently and accurately determine their Section 4968 excise tax liabilities.

The preamble to the Proposed Regulations acknowledges guidance is needed because of taxpayer uncertainty involving, inter alia, "whether net investment income would be determined under rules identical to or similar to the rules of section 4940(c), and if the latter, what the deviations from the rules of [S]ection 4940(c) would be."

With respect to the first question, Congress was clear when it enacted Section 4968(c). For purposes of Section 4968, an AEI's net investment income is to be determined "under rules similar to" the Section 4940(c) rules applicable to private foundations, not rules that are identical to the private foundation rules.

With respect to the second question, Section 53.4968-1(b)(3) of the Proposed Regulations includes only five deviations from the rules under Section 4940(c) and 53.4940-1(c) through (f), none of which accounts for organizational or operational differences between colleges and universities and private foundations. In addition, although the preamble to the Proposed Regulations identifies some (but not all) of the areas where deviations from the private foundation rules are appropriate, both the preamble and the Proposed Regulations fail to provide any new guidance that gives effect to the clearly-evidenced Congressional intent that the rules in this space be "similar to," but not identical to, the private foundation rules.

Notre Dame is organized and operated in ways that are fundamentally different from a private foundation. While Notre Dame acknowledges its responsibility to pay the correct amount of its Section 4968 excise tax liability, every dollar of tax will diminish the resources made available to students for financial aid and other, student-centered activities that form the basis of Notre Dame's exempt educational and religious purposes. These comments are being submitted to give effect to Congressional intent and ensure Notre Dame is able to correctly determine its tax liability.

In addition to submitting this comment letter, Notre Dame also has signed on to comments submitted by a coalition of other similarly-situated colleges and universities dated October 1, 2019.

Summary of Recommendations

Generally, Notre Dame recommends the Treasury and IRS exercise their rulemaking authority to, as Congress intended, establish regulations that are "similar to," but not identical to, those applicable to private foundations that are subject to the Section 4940 excise tax on net investment income. In so doing, Notre Dame recommends the Treasury and IRS establish bright line, administrable rules addressing the non-taxability of (i) income derived from housing students on campus during the academic year; (ii) certain gains associated with gifts of appreciated property; and (iii) royalties derived from research activities conducted by students, faculty, and Notre Dame researchers. Notre Dame also recommends the Treasury and IRS remove the Proposed Regulations requirement that, in applying the basis rules for assets held in a partnership (including through one or more tiers of partnerships), an AEI must obtain documentation from the partnership. Lastly, Notre Dame recommends the Treasury and IRS modify the Proposed Regulations' definition of control to adopt a standard that, consistent with Congressional intent, will not result in inequitable double taxation.

Discussion of Recommendations

I. Income derived from housing students on campus during the academic year should be excepted from the definition of "rents" that are taxable under Section 4968.

Notre Dame is a heavily residential university, with about four in five undergraduates living on campus. Uniquely, freshman, sophomores and juniors are required to live on campus, with residential life designed to form foundational undergraduate communities that are inclusive of all members and foster a collective sense of community, concern for the common good, and service to others.

Importantly, the term "rents" is not defined in Section 4968, the Proposed Regulations, or the legislative history supporting the enactment of Section 4968. Likewise, the term "rents" is not defined in Section 4940 or the regulations thereunder. The Proposed Regulation& acknowledgement that colleges and universities offer various types of housing and the corresponding request for comments regarding the factors that distinguish room and board payments from students living in a dormitory from rental income evidences the need for a bright line, administrable rule in this space. Notre Dame students do not always select the person(s) with whom they will share a room, and living with a stranger is a clear differentiator from a traditional rental arrangement. Moreover, Notre Dame students do not sign lease agreements to live on campus. Instead, Notre Dame students sign a contract agreement for integrated service and are bound by housing policies. These policies govern the kinds of appliances students may have in their rooms, prohibit cooking, limit the use of certain personal property (e.g., electronic skateboards), restrict how students may position and/or elevate their beds, limit when guests may be present, and prohibit the duplication of keys — all activities that a common tenant in a typical landlord-tenant relationships would expect to enjoy in an unrestricted manner. In addition, living on campus entitles Notre Dame students to cleaning services, the full breadth of campus safety security services, and access to campus dining halls. Lastly, and perhaps most importantly, living on campus provides Notre Dame students access to other, community-driven experiences that Notre Dame views as essential to its exempt educational and religious purposes.

In light of the foregoing, Notre Dame respectfully requests the Treasury and IRS except from the definition of "rents" that are taxable under Section 4968 all income derived from the housing of students on campus during the academic year.

II. Appreciation in a gift of donated property that occurred before the date of receipt by the AEI should be excluded from the definition of capital gain net income for purposes of determining an AEI's taxable net investment income

The Proposed Regulations adoption of the Section 4940(c) rules for determining gain upon the sale or other disposition of donated property, without accounting for differences between colleges and universities and private foundations, is in error. More often than not, a gift of donated property made to a private foundation comes from a donor known to the private foundation. In such cases, obtaining the donor's basis in the donated property (determined under the rules of Section 1015 in the case of an inter vivos gift) presents a relatively low administrative burden for the recipient private foundation. In contrast, Notre Dame annually receives gifts of donated property from a comparatively broad base of persons (in an average year, Notre Dame receives such gifts from approximately goo separate donors). Although these donors often provide Forms 8283, Noncash Charitable Contributions, and Notre Dame acknowledges receipt of their gifts and provides them with contemporaneous written acknowledgements consistent with the requirements applicable to Notre Dame's receipt of such gifts, donors are not required to provide, and Notre Dame does not always receive, complete basis records. This is particularly true when, as often is the case, gifts are made to Notre Dame in the form of publicly traded securities.

Consistent with the request for comments included in the Proposed Regulations, Notre Dame requests, for purposes of Section 4968, the final regulations include a special rule that would exclude any appreciation in a gift of donated property that occurred before the date of receipt. Such a rule would be consistent with the statutory language of Section 4968, as it would give effect to the Congressional intent that net investment income determined under Section 4968 be determined under rules "similar to," but not identical to, the rules of Section 4940(c). Such a rule also would acknowledge that a college or university that disposes of gifted property at the first reasonable opportunity did not hold such property for investment purposes.

Notre Dame respectfully submits that property that is disposed of within 30 days of receipt should be treated as having been disposed of at the first reasonable opportunity for this purpose. The establishment of a fixed time period would provide an administrable rule that would, in turn, enable affected colleges and universities to determine whether to retain such gifts for investment purposes (and, thus, rightly bring them within the reach of Section 4968 after the running of the proposed 30-day period). Such a rule also would recognize that, institutionally, colleges and universities are fundamentally different from private foundations. Where private foundations often know that gifts of donated property will be made in advance of their receipt, and a relatively short list of individuals are involved in the processing of such gifts, colleges and universities are more complex. In the case of Notre Dame, donors do not always announce their intentions to make large gifts in advance. Additionally, determinations as to whether a particular gift of donated property ought to be held for investment purposes or immediately disposed of may, in certain cases, require input from a broad group of stakeholders.

In light of the foregoing, Notre Dame respectfully requests the Treasury and IRS establish a special rule excluding any appreciation in a gift of donated property that occurred before the date of receipt if such property is disposed of within 30 days of receipt.

III. Royalty income derived from research conducted by an AEI's students, faculty, and researchers should be excluded from the definition of "royalties" that are taxable under Section 4968.

The Proposed Regulations' adoption of the rules provided in Section 4940(c) and the regulations thereunder, including Section 53.4940-1(d)(1), which specifies that "gross investment income means the gross amounts of income from, inter alia, royalties, without accounting for differences between colleges and universities and private foundations, is in error.

In addition to being an undergraduate teaching institution, Notre Dame is also at the forefront in innovative research and scholarship. The aerodynamics of glider flight, the transmission of wireless messages, and the formulae for synthetic rubber were pioneered at Notre Dame. Today researchers are achieving breakthroughs in astrophysics, radiation chemistry, environmental sciences, tropical disease transmission, peace studies, cancer, robotics, and nanoelectronics.

Royalties derived from research that is directly conducted by Notre Dame's students, faculty, and researchers is readily distinguishable from the royalty income earned by most private foundations and subjected to tax under Section 4940. In the normal course, a private foundation receiving royalty income has passive holdings in intellectual property that was not developed by the private foundation itself. Consider, for example, a case where a private foundation is a passive investor in an unrelated limited partnership that itself is a limited partner in a tiered partnership structure where the partnership at the bottom of the structure holds royalty-generating intellectual property. In such cases, the treatment of such passive income as taxable investment income is reasonable and appropriate. In the case of a college or university, like Notre Dame, that actively develops its own intellectual property in a manner that is consistent with its exempt educational purposes, a deviation from the rules of Section 4940(c) is warranted.

In addition, Notre Dame does not presently have a mechanism for timely and accurately capturing the allowable expenses that are associated with royalties it derives from research conducted by its students, faculty, and researchers. Furthermore, as is the case with student housing income, discussed above, it is likely that Notre Dame's allowable expenses would equal or exceed its annual gross investment income from such royalties. Establishing new systems and processes to capture current and past expenses (only some of which already are captured in different ways for other purposes, such as internal campus reporting, financial statement reporting, and government contracting) would result in additional administrative burden and expense that would reduce resources that otherwise would be available to support Notre Dame's students and, as a practical matter, it is likely that no additional net investment income would result.

In light of the foregoing, Notre Dame respectfully requests the Treasury and IRS except from the definition of "royalties" that are taxable under Section 4968 all income derived from royalties that are derived from research conducted by students, faculty, and researchers employed by the AEI.

IV. Treasury and IRS should remove the Proposed Regulations' requirement that an AEI must obtain documentation from a partnership in order to apply the basis step up rule to assets held by the partnership.

Notre Dame acknowledges and appreciates the establishment of a basis step up rule in the Proposed Regulations. However, the Proposed Regulations' requirement that an AEI must obtain detailed information from each partnership in which it held an interest on December 31, 2017, in order to apply the basis step up rule to assets held by each such partnership presents an undue burden that, if made part of the final regulations, would frustrate the ability of an AEI to utilize the basis step up to correctly identify its includible amounts of gain for Section 4968 purposes. Stated simply, as drafted the rule is impractical and unadministrable.

In general, an AEI that is a limited partner in a partnership does not receive on its Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., the information that it would require in order to determine whether the amount of gain reported on the face of the Schedule K-1 relates to the disposition by the partnership of assets that it had held on December 31, 2017. Requests made by Notre Dame to certain of the partnerships in which it is a partner have not yielded constructive responses. Moreover, even if Notre Dame were successful in obtaining the information required by the Proposed Regulations rule with respect to one or more of the partnerships in which Notre Dame is a partner, it is unlikely to obtain (timely or otherwise) the required information from each of the hundreds of partnerships in which it is a partner. Obtaining the required information from a single limited partnership that directly holds income-producing assets has proven challenging in its own right. When one considers that many limited partnerships in which colleges and universities are invested are tiered structures that necessarily would have to pass all such information requests down through each partnership tier to gather responsive information, it becomes clear that the Proposed Regulations' rule needs to be revisited.

In addition, the issue is not a one-time consideration. Although Schedules K-1 issued for the 2018 calendar year arguably are more likely to include gains from sales of assets held by the issuing partnerships on December 31, 2017, than Schedules K-1 issued in 2019 and subsequent years, such later-issued Schedules K-1 may also report gains of assets that were held by the issuing partnership on December 31, 2017. Thus, absent a modification to the Proposed Regulation's rule, Notre Dame would be required to indefinitely query each of its hundreds of partnerships for information not already provided on its Schedules K-1 and receive a 100% response rate in order to correctly identify its amounts of taxable capital gains.

Lastly, given the rules governing what information partnerships are required to provide to their partners on Schedules K-1 speak to income tax reporting matters, it is unclear what mechanisms AEIs have at their disposal to compel the partnerships to provide the information needed for compliance with this Section 4968 excise tax rule. As public reporting suggests the number of AEIs subject to tax is limited to approximately 30 colleges arid universities, it is equally unclear what motivation a given partnership would have to voluntarily account for and provide separate reporting of sales of assets held on December 31, 2017, for such a limited group of affected taxpayers.

In light of the foregoing, Notre Dame respectfully requests the Proposed Regulations' requirement that an AEI must obtain documentation from a partnership in order to apply the basis step up rule to assets held in the partnership be removed. Until such time as a practical and administrable rule is established, AEIs should be permitted to use any reasonable method to utilize the step up in basis of their outside interest in a given partnership held on December 31, 2017, to offset any inside gain recognized by such a partnership and reported to the AEI on a Schedule K-1 after December 31, 2017.

V. The "control" test proposed to be adopted for purposes of defining related organizations is too expansive and there are numerous circumstances in which the definition of control should be modified in the context of Section 4968.

As discussed in the preamble to the Proposed Regulations, Section 4968(d)(2) does not define the term "control." Appreciating that adopting a rule that is based on the definition of control under Section 512(b)(13)(D) may provide a level of administrative convenience and generally align the Section 4968 related organization definitions with those used for purposes of the annual reporting requirements on Form 990, Return of Organization Exempt From Income Tax, the proposed definition of "control" is not an appropriate measure for determining the sources of net investment income that will be taxable to an AEI in all circumstances.

First, a strict interpretation of the proposed "control" test could lead to an inequitable double taxation event that cannot be what Congress intended. For example, if an AEI were to own 100% of a taxable corporation, a strict interpretation of the control test could result in subjecting the AEI to tax on not only the dividends it receives from the corporation, but 100% of the net investment income of the corporation itself. Given that the corporation will have already been taxed under Section n in this example, further taxing an AEI on dividends it receives and on the net investment income of the corporation would be contrary to established principles of tax policy and fairness. The preamble to the Proposed. Regulations addresses this, stating that the Treasury and IRS do not consider it consistent with Congressional intent to tax the net investment income of the taxable entity again under Section 4968. (The specific reference in the preamble to Section i is admittedly unclear, and it is being interpreted here to mean Section 11.)

An even more unjust result obtains when one considers an AEI's holding of a limited partnership interest in a partnership. A strict interpretation of the proposed "control" test could lead an AEI to first treat as net investment income the non-UBI distributive share items of net investment income reflected on the Schedule K-1 it receives from the partnership. Next, if the AEI holds more than 50 percent (but less than 100 percent) of the profits interests or capital interests in the partnership, the AEI could be required to include in its net investment income 100% of the net investment income of the partnership. Not only would this unjustly subject the AEI to taxation on amounts of income it has no legal or equitable title to (i.e., amounts that likely were distributed to other partners of the partnership who themselves likely paid income or excise tax on the receipt of such items), it is unclear how the Treasury and IRS expect an AEI to determine what 100% of the net investment income of the partnership was for a given year. Application of the constructive ownership rules to these scenarios yields even more examples of repetitive taxation that cannot fairly be argued as being consistent with Congressional intent.

Second, the proposed "control" test is unjustly expansive and should be narrowed. Although there is no parallel provision in Section 4940 that would subject a private foundation to excise tax on the net investment income of a related organization for the Treasury and IRS to look to in fashioning a rule for purposes of Section 4968, it cannot have been the intent of Congress that an AEI be subjected to tax on the net investment income of certain organizations, such as split-interest trusts, retirement plans that are not formed as trusts, and estates.

The final regulations should reflect the idea that taxable net investment income should only be taken into account from entities that are controlled by the AEI in fact, and not just under the fiction of deemed control that is at the heart of the Section 512(b)(13)(D) test. (This would include, for example, expressly providing that an AEI that is a limited partner in a partnership will not be treated as controlling the partnership for purposes of Section 4968.) The standard properly established under the regulatory authority of the Treasury and IRS regarding certain Type III supporting organizations is instructive in this regard, as it would, if broadly applied, fairly and properly exclude from an AEI's net investment income the net investment income of another organization that is not intended or available for the use and benefit of, or otherwise fairly attributable to, the AEI.

In light of the foregoing, Notre Dame respectfully requests the Proposed Regulations definition of control be modified to give effect to Congressional intent that income not be subject to double taxation. In modifying the definition of control, the Treasury and IRS should exclude from an AEI's net investment income the net investment income of any other organization that is not intended or available for the use and benefit of, or otherwise fairly attributable to, the AEI.

We appreciate your consideration of these comments and look forward to responding to whatever questions you may have.

Sincerely,

Shannon Cullinan
Executive Vice President
University of Notre Dame du Lac
Notre Dame, IN