February 16, 2018 Bipartisan Budget Act adopts two exempt organization provisions excluded from final Tax Cuts and Jobs Act legislation The Bipartisan Budget Act of 2018 (BBA 2018), enacted February 9, 2018, includes two to exempt organization-related provisions that did not make it into the final enacted version of the Tax Cuts and Jobs Act (TCJA): (1) an exception from the excise tax on college and university investment income for certain tuition-free schools; and (2) an exception to the Section 4943 excess business holdings tax for certain philanthropic business holdings. Both provisions apply to tax years beginning after December 31, 2017. Excise tax based on investment income of private colleges and universities New Section 4968 imposes a 1.4% excise tax annually on the net investment income of an "applicable educational institution." An "applicable educational institution" is defined, in part, as an eligible education institution that has at least 500 students during the preceding tax year, more than 50% of whom are located in the United States, and has investment assets of at least $500,000 per student. BBA 2018 amends Section 4968 to change "students" to "tuition-paying students" in the definition of applicable educational institution. The amendment thereby creates an exception for certain tuition-free schools. The "tuition-paying student" language was included in the Conference Agreement for the TCJA, but was ultimately excluded from the final enacted version due to certain procedural rules. For a more detailed discussion of the provision as included in the Conference Agreement, see Tax Alert 2017-2142. Exception to private foundation excess business holdings rules for philanthropic business holdings Under Section 4943, a private foundation that owns more than a 20% interest in a business enterprise is subject to an excise tax equal to 10% of the value of the excess business holding. A private foundation that does not divest itself of the excess business holding by the end of the applicable Section 4943 tax period becomes subject to a 200% excise tax on the excess business holding. At one point, both the House and Senate versions of the TCJA bill included a provision that would exempt certain for-profit business holdings of private foundations from the excise tax if certain limiting conditions were met and the for-profit business contributed all of its net operating income after taxes to the private foundation. The enacted TCJA, however, included no such provision. BBA 2018 adds this exception in Section 4943(g). Under the exception, the Section 4943 excise tax will not apply to private foundations with holdings in any business enterprise that meet certain requirements for the tax year, including: (1) an ownership requirement; (2) an "all profits to charity" distribution requirement; and (3) requirements regarding independent operation. The ownership requirements are satisfied if: (1) 100% of the voting stock in the business enterprise is held by the private foundation at all times during the tax year; and (2) all the private foundation's ownership interest in the business enterprise was acquired by means other than by purchase (e.g., by gift or under the terms of a will or trust upon the death of the testator or settlor). The "all profits to charity" distribution requirement is generally satisfied if the business enterprise distributes an amount equal to its net operating income for such tax year to the private foundation within 120 days after the close of the tax year. Net operating income includes the gross income of the business enterprise less: 1) ordinary taxes and deductions as generally defined by the Internal Revenue Code; and 2) set-asides for a reasonable reserve and working capital. The independent operation requirements are satisfied if, at all times during the tax year: (1) no substantial contributor to the private foundation, or family member of such a contributor, is a director, officer, trustee, manager, employee or contractor of the business enterprise (or an individual having powers or responsibilities similar to any of the foregoing); (2) at least a majority of the board of directors of the private foundation are not also directors or officers of the business enterprise or family members of a substantial contributor to the private foundation; and (3) there is no loan outstanding from the business enterprise to a substantial contributor to the private foundation or a family member of such contributor. The exception does not apply to: (1) donor-advised funds or supporting organizations that are subject to the excess business holdings rules by reason of Section 4943(e) or (f); (2) any trust described in Section 4947(a)(1) (charitable trusts); and (3) any trust described in Section 4947(a)(2) (split-interest trusts). Implications BBA 2018 contains two exempt organization provisions that clarify and add to certain TCJA provisions. The first exempt organization provision in BBA 2018 clarifies that, for purposes of determining whether the educational institution is subject to the provisions of Section 4968, the 500-student threshold applies to only tuition-paying students. Thus, the amendment exempts tuition-free private colleges and some smaller universities from the excise tax, if those smaller institutions have less than 500 tuition-paying students. The second exempt organization provision in BBA 2018 creates new opportunities for private foundations to own 100% of the voting stock of a for-profit business enterprise and allow continued independent operation of that enterprise to earn future profits, as long as the profits are distributed to charity through the private foundation. Before BBA 2018, as required by Section 4943, private foundations were generally allowed to hold a 20% ownership interest in a business enterprise without having to pay the Section 4943 excise tax. A private foundation that received, by contribution, a greater-than-20% ownership interest in a business was required to dispose of the additional interest in that business within five years (with an additional five years for large or complex holdings). Now, private foundations may retain a 100% interest in a for-profit business enterprise, so long as the income is distributed to charity, and the other requirements of Section 4943 are met. To meet the Section 4943 exception outlined in BBA 2018, a private foundation may not purchase the relevant for-profit business enterprise. Rather, the private foundation must receive its ownership interest in the for-profit business through a non-purchase, such as by gift or under the terms of a will or trust upon the death of the testator or settlor. Thus, this amendment to Section 4943 presents a new business continuity planning option for owners contemplating business succession issues. Because this is merely an amendment to Section 4943, exempt organizations should remember that the other rules for excess business holdings remain intact. Further, once the income of a for-profit business enterprise is distributed to a private foundation, all other rules regarding private foundations and the distributions made to private foundations continue to apply. Please contact your Ernst & Young LLP professional for further information. ——————————————— — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg. ———————————————
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