June 18, 1998
Non-Profit Update # 14 (Universities)
Below are several new tax items of specific interest to colleges and universities from the past year or so.
I. Higher Education Tax Incentives for Students and Parents
Several tax benefits are available to students and parents at the state and federal level. The Taxpayer Relief Act of 1997 created many new credits for parents and students. Yesterday, the South Carolina General Assembly finalized the details of the new state scholarship program. Governor Beasley is expected to sign the bill in the very near future.
A. State Tax Credits and Incentives
The state=s Legislative Initiative for Future Excellence, or LIFE, program provides scholarships to college students in South Carolina who graduated from high school in May 1995 or later, have a B average, and score at least 1,000 on the SAT. Students must be enrolled in at least 30 credit hours a year to receive the scholarship. Students will be eligible for the $2,000 scholarships beginning this fall. The money will go directly to the colleges, who will deduct the scholarships from tuition.
Students who do not qualify for the scholarship may be eligible for a tuition tax credit. Under this program, a refundable income tax credit of $500 in the case of four year institutions and $250 in the case of two year institutions for tuition paid is available. Students cannot receive the tax credit and the LIFE Scholarship. Also, students who receive Palmetto Fellows Scholarships do not qualify for either program.
B. Federal Tax Incentives
The federal Taxpayer Relief Act also provides financial assistance for students. The Hope Scholarship Credit allows an individual to take a maximum $1,500 tax credit for his or her own educational expenses, as well as those of his or her spouse or children. Educational expenses include required tuition and fees to attend the institution, but do not include room, board, and other personal expenses. Students must be enrolled at least half-time in one of the first two years of post-secondary education to qualify. This credit is available beginning in 1998.
The Lifetime Learning Credit allows taxpayers to take a tax credit of up to $1,000 for undergraduate, graduate, or professional courses if the taxpayer, his or her spouse, or child attends a degree or certificate program and is at least a half-time student. Under this credit, taxpayers may claim up to 20% of the first $5,000 in education expenses. Individuals cannot qualify for both the Hope Scholarship and the Lifetime Learning Credit in the same year.
The Lifetime Learning Credit is distinguished form the Hope Scholarship Credit because there is no limit on the number of years an individual may claim the Lifetime Learning Credit, but the Hope Scholarship is only available for the first two years of post-secondary education. Also, the Lifetime Learning Credit is calculated on a per-family basis, while the Hope Scholarship is calculated on a per-student basis.
For the Hope Scholarship and Lifetime Learning Credit, colleges and universities are required to report every student who pays any tuition and related expenses that exceed reimbursements and refunds the student receives. The school needs to report each student=s name, address, and social security number. Schools will also need to report whether the student is enrolled at least half-time and whether he or she is enrolled in a graduate program. Form 1098-T will be used to report this information. The IRS is working on Form W-9S, which the school can use to obtain information from the student.
Parents, grandparents, and other family members can now contribute $500 per year per child to an Aeducation I.R.A.@ Contributions can be made until the child is 18. Although the contributions are not tax-deductible, earnings from the I.R.A. are tax-free, as are withdrawals from the account to pay for tuition and fees.
If an individual takes money out of an I.R.A. to pay for education expenses, including graduate programs, this money will not be subject to the usual 10% early withdrawal penalty. This withdrawal can be to pay for expenses of an individual, his or her spouse, children, or grandchildren.
Credit for interest on student loans for your schooling, or that of your spouse or child, is another new deduction available. This deduction can only be taken for the first five years of repayment. This year, individuals can deduct $1,000. A maximum deduction of $2,500 will be phased in over the next four years.
Under the Taxpayer Relief Act, students can also do some charitable work to pay for student loans. The work must be under the guidance of a charitable organization or a government entity with a special need.
Employers providing educational assistance for undergraduate courses can continue to provide up to $5,250 per year to each employee on a tax-free basis. The benefit will not be available for courses beginning on or after June 1, 2000.
The Department of Revenue is contemplating producing a pamphlet, State and Federal Tax Incentives for Higher Education. We are also thinking about adding this to our Web Site. We=d appreciate any input which you might have on the desirability of the pamphlet, and whether you would be interested in proofing it.
II. IRS Warns Colleges and Universities About Travel Tours
Travel tours conducted by colleges and universities are a high priority for the IRS, and as detailed below, it has recently issued a number of documents in this regard.
The IRS has very recently issued proposed regulations, 63 FR 20156, on travel tours sponsored by exempt organizations. AAll relevant facts and circumstances@ will be used to determine if the tour furthers the organization=s exempt purpose. Factors the IRS will use include whether or not the following exist: a significant amount of time for instruction; Aincidental@ sightseeing time; library-type resource materials; academic credit; and examinations. A copy of the proposed regulation may be downloaded from the IRS= website: www.irs.ustreas.gov.
The IRS also recently issued a Technical Advice Memorandum (TAM) involving a travel program. TAM 9702004 involved travel tours offered by a Section 501 (c)(3) organization. The organization=s activities included conducting study missions, a commission on international affairs, the dissemination of study materials, cooperation with an international federal of communities, and an international travel program.
The central issue in TAM 9702004 was whether the tour program was substantially related to the organization=s exempt function. Three factors help determine whether this substantial relation exists: (1) how the tour is structured, (2) what the tour consists of, and (3) what the tour accomplishes. The organization=s primary purpose in offering the service must also be determined. This primary purpose test examines the nature, scope, and motivation for a tour, as well as the facts and circumstances of the tour.
The primary purpose test will differ according to the nature of the organization. Programs of educational organizations should include Abona fide educational methodologies@ such as organized study, reports, lectures, and readings. Other relevant factors include whether credit can be earned and whether a tour has a clearly demonstrable connection to an ongoing class or exhibit.
For all types of travel, the time spent on the related activities is an important factor. For example, a two hour educational activity may not be sufficient to establish education as the primary purpose of a seven-day tour. Though time allocation is not always conclusive, organizations should be prepared to demonstrate why it should not be if they need to make that case. A class or other educational activity will be given less weight if it is merely Avoluntary,@ especially if alternative recreational activities are available, Also important is evidence reflecting the process of tour selection, design, and advertising, as well as what actually took place on the tour.
Applying these principles, the IRS ruled that only certain types of tours relate to an organization=s exempt purpose. Tours that typically consist of an intensive learning experience and involve visits to places of special historic, religious, and cultural significance to the members of the organization were related to the organization=s exempt purpose. Tours that were substantially similar to commercially sponsored tours were not related. The IRS was concerned about a lack of contemporaneous documentation about what actually happened on the latter tours. All that was provided was the material in the travel catalogue.
III. University Sponsored Research Under Scrutiny
The IRS is increasingly scrutinizing university sponsored research. Arrangements in which Aequity-like@ compensation is offered to employees responsible for creating intellectual property is a specific concern. IRS auditors will be given training in how to probe this area. The IRS plans to publish an article this summer on intellectual property that should help clarify the policies. Let me know if you would like a copy.
IV. University Exclusivity Arrangements
The IRS has expressed concern over exclusivity arrangements. These are the typical Asoft drink deals@ in which a company pays the university to be the only vendor of a particular product. At a recent higher education conference, an IRS official explained that such arrangements could be considered in one of three ways: as a gift from the sponsor, a royalty payment for the university, or the sale of access to the student body. He added that the IRS tends to believe that the arrangements are a sale and as such are unrelated business income. The IRS will continue to review this concern in upcoming audits.
V. Student FICA Exception
The IRS has issued Rev. Proc. 98-16, which addresses the issue of whether student employment at a college or university qualifies for an exemption from social security taxes. Undergraduate, graduate, and professional students who are not career employees now qualify for the exemption regardless of how many academic hours they are taking. The change helps to distinguish between career employees and student employees. This is a significant change from the previous A12/20" rule which required students to work no more than 20 hours a week and take a minimum of 12 credit hours.
VI. New IRS Publications on Tax Benefits for Higher Education
As detailed below, the IRS has recently issued two publications of interest. First, Publication 520, Scholarships and Fellowships, is now available from the IRS. The publication explains tax rules for scholarships, fellowships, and tuition reductions. It includes the tax consequences of studying abroad. Second, Publication 970, Tax Benefits for Higher Education, does an excellent job of explaining the various new Higher Education Incentives. Both of these publications are available on the IRS Web Site. We have a limited number of copies. If you would like one, contact Mary Frances Gibson at (803)-898-5166.
VII. Mailing List Update
As previously indicated, we are cleaning up our non-profit mailing list.
If you have not previously done so and would like to stay on our mailing list, please initial and return the front page of this letter or call my assistant Jane Baker at (803)-898-5445.
The Department of Revenue now has new telephone numbers. My new number is (803)-898-5040. My new fax number is 898-5020.