Emerging Issues Example Publication

The Pension Protection Act of 2006: Impact on Colleges and Universities
Introduction

On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006.1 Most of the provisions in this new tax bill, as its name suggests, relate to a broad range of pension plan-related items that pertain to employers of all stripes, both for-profit and nonprofit. Colleges and universities, like other employers, need to review the vast array of pension plan items to see how they may impact the institution’s own retirement plans.

This article will not attempt to discuss the numerous and detailed pension plan provisions contained in the new tax bill other than to note that some of them have a particular application to section 501(c)(3) organizations and governmental entities, such as new rules on (1) purchase of permissive service credit; (2) the application of the minimum distribution rules to governmental plans; and (3) eligibility for participation in section 457 plans.

Instead, this article will focus on those non-pension plan items contained in the new bill that have the potential for impacting higher education institutions. The two major areas that fall into this category are the new rules regarding (1) section 509(a)(3) supporting organizations, and (2) the requirement to publicly disclose copies of the school’s unrelated business income tax return (Form 990-T).
Section 509(a)(3) Supporting Organizations

Many colleges and universities operate with and through separately organized affiliated organizations. In some cases, these organizations (foundations, alumni clubs, etc.), while closely aligned with the institution, operate independently of it. In other situations, however, the college or university controls the affiliated foundation, usually through the power to appoint all or a majority of the foundation’s Board of Directors. The college or university may control the organization, but the organization has its own section 501(c)(3) status, remains a separate legal entity, and has its own reporting and other tax responsibilities.

All section 501(c)(3) organizations are classified as either public charities or private foundations. Of the two classifications, public charity status is preferred because private foundations are subject to an excise tax on their net investment income and to certain operational restrictions that are enforced by a series of penalty-type excise taxes. While some controlled foundations are classified as public charities by reason of the sources and amounts of their financial support, others achieve public charity status by qualifying as a so-called “supporting organization” under section 509(a)(3). These are organizations that are organized for the exclusive benefit of the college or university and are operated, supervised, or controlled by the institution.

There are three types of supporting organizations, referred to as Types I, II, and III. Types I and II are controlled by the public charity, but the Type III is not. The Type III organization derives its supporting organization status from the fact that its activities are so important to the public charity that the charity will be responsive to, and be significantly involved in the operations of, the organization. While Congress and the IRS have expressed concern that supporting organizations in general have the potential for engaging in abusive activities, the primary concern has been with the Type III organizations because they operate outside the public charity’s control.

The new tax law has a substantial favorable and unfavorable impact on supporting organizations. The favorable aspect relates to the fact that under prior law, payments of interest, rents, annuities, and royalties received by a college or university from its controlled section 501(c)(3) organizations were subject to the unrelated business income tax. But the new law provides that these payments are tax-free to the parent and only become taxable to the extent that they do not represent an arm’s length charge. This new provision is effective for all payments that are received by college or university after December 31, 2005, and before January 1, 2008.

Other provisions in the new tax bill affecting supporting organizations are not so favorable. The new statute requires a college or university parent that is required to file Form 990 to report all income from and loans to their controlled foundations as well as all transfers between the two entities. This reporting must be included with Forms 990 that are due (determined without regard to extensions) after the August 17, 2006 date of enactment.

In addition, the bill imposes certain other requirements on supporting organizations, including:

* If a supporting organization makes a grant, loan, compensation or similar payment to a “substantial contributor,” the transaction is treated as an automatic excess benefit transaction under section 4958 with the substantial contributor becoming subject to a 25% excise tax on the amount of the payment. (A substantial contributor is a person who contributed more than $5,000 to the organization, provided that amount is more than 2% of total contributions received by the organization).

* All supporting organizations are required to file an annual Form 990 with the IRS, regardless of the organization’s gross receipts, and must indicate the basis for its supporting organization status, identify its supported organizations, and certify that it is not controlled by one or more disqualified persons.

* Certain types of Type III supporting organizations are subject to a separate set of rules, including a requirement to make annual minimum payouts for exempt purposes and to provide its public charity parent with information to help ensure the organization’s responsiveness to the charity’s overall activities. In addition, these types of Type III supporting organizations are subject to the excess business holdings rules of section 4943 and therefore are restricted as to the amount of corporate stock they can hold.
Requirement to Disclose Forms 990-T

Under current law, section 501(c)(3) organizations are required to publicly disclose the annual information returns that they file with the IRS (Form 990). The statute requires that the organization make available for public inspection its Forms 990 for the past three years. While this public disclosure rule applies to all private colleges and universities, it does not apply to state colleges and universities because these institutions are not required to file Form 990, even if they have received separate section 501(c)(3) status from the IRS.

The new tax bill extends the same public disclosure requirements applicable to the Form 990 to the unrelated business income tax return (Form 990-T). Unlike the Form 990, which does not have to be filed by state colleges and universities, state institutions are required to file the Form 990-T, and it is currently unclear from a reading of the statute whether this new disclosure provision will apply to state colleges and universities that file the Form 990-T. This is because the statutory language imposes the new disclosure requirement only on organizations that are both (1) “described in” section 501(c)(3) (which state colleges and universities are), and (2) “exempt from taxation under section 501(a)” (which many colleges and universities are not because they have not applied for and received their own section 501(c)(3) status). Thus, we will have to await further instructions from the IRS to determine whether this new Form 990-T public disclosure provision will apply to state colleges and universities.

The new disclosure rule goes into effect for returns filed after the August 17, 2006 date of enactment.
Other Provisions

In addition to the new rules on section 509(a)(3) supporting organizations and the new Form 990-T public disclosure requirements, there are several other non-pension plan provisions in the new tax bill that may impact colleges and universities:

* Revisions to the rules governing so-called “donor-advised funds” (where the donor is able to advise and consult as to how the donee is to use the funds), including new excise taxes and new rules regarding charitable contribution deductions for gifts to such funds

* Various new charitable giving rules, including recapture of tax benefit for charitable contributions of exempt use property not used for an exempt purpose and an extension of the charitable deduction rules for contributions of book inventory

* Beginning in 2008, tax-exempt organizations with annual gross receipts under $25,000, which are currently exempt from filing Form 990, must file an annual notice with the IRS.

For a detailed discussion of all of the new pension plan and non-pension plan related provisions in the new tax bill, see the Joint Committee on Taxation’s Technical Explanation of the new statute at http://www.house.gov/jct/x-38-06.pdf.2

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Notes

1. The Pension Protection Act of 2006 (H.R.4)
2. “Technical Explaination of H.R. 4″, The Joint Commitee on Taxation’s Technical Explanation, August 3, 2006.