Colleges Get Tax Reprieve in Push to Value Endowment Assets

(Bloomberg) -- Colleges facing the new endowment tax are getting some relief: they won’t be taxed on unrealized income from their billions of dollars in assets before the levy was approved.

Schools had been looking for help on this issue, and they got it in the form of Internal Revenue Service guidance issued Friday. A college trade group had asked Treasury Department officials last month to use a “stepped-up” basis for calculating the tax. Using appreciated prices means the tax will only apply to income earned since the end of 2017, which in turn would mean a lower bill than using the original cost basis.

The 1.4 percent tax on net investment earnings is set to hit about 30 private colleges in the fiscal year that begins July 1 for most schools. The tax affects schools with more than 500 tuition-paying students and net assets of at least $500,000 per student.

Schools are lobbying on two fronts: they are trying to repeal the tax and reduce their liability. Tracking down historical values of some investments, which could be decades old, would have been labor intensive for some endowments, said Matt Hamill, senior vice president of the National Association of College and University Business Officers, the trade group that sought the use of the stepped-up asset values.

“That’s very good news -- it will give colleges and universities an important element of certainty as they prepare to implement the new tax,” Hamill said of the IRS guidance.

The guidance says institutions that sell assets at a gain generally may use the fair market value at the end of calendar 2017 as its basis for figuring the tax on any resulting gain.

“In many instances, this new stepped-up basis rule will reduce the amount of gain subject to the new tax,” the IRS said in a statement.

Schools won’t pay any capital gains that might have accrued before the effective date of the legislation, said James Poterba, an economist and specialist in taxation at Massachusetts Institute of Technology, one of the universities facing the tax.

“It will have the effect of reducing the tax liability of the affected institutions,” he said.

“It has been the case when other new taxes have been implemented, embedded gains have been grandfathered in and not taxed after the fact,” said Deborah Kuenstner, chief investment officer of Wellesley College, whose $2 billion endowment fits the criteria to pay the tax.

The tax, which isn’t inflation adjusted, is expected to raise $200 million annually.

Schools including Emory University had been asking for the step up too. The Atlanta-based school, with a $6.9 billion endowment as of the most recent year, also asked for a one-year delay for the effective date of the tax.

“Emory is facing a multimillion-dollar unbudgeted tax liability,’’ President Claire Sterk wrote in a May letter to the Treasury Department. “A delay will enable our organization to more accurately estimate our new tax burden, budget for this dramatic tax increase, submit timely estimated tax payments and communicate and implement new policies and processes to our employees.”

Meanwhile, two competing bills addressing the endowment tax have been introduced in the House of Representatives.

The one that would outright repeal the tax has gained 11 sponsors, all of which have ties to schools that are likely to pay in the first year or in the future. The bill picked up two new sponsors this week -- alumni of Southern Methodist and Lehigh universities, each with more than $1 billion in endowment assets, according to data compiled by Bloomberg.

Another, sponsored by Tom Reed, a Republican from New York, waives the payment if schools spend a quarter of their annual earnings on middle-class tuition relief.

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