Over the July 4th holiday, President Trump signed the budget reconciliation bill known as The One Big Beautiful Bill Act (OBBBA), which, among other things, contains amendments to provisions of the Internal Revenue Code applicable to tax-exempt organizations. Although an earlier version of the OBBBA passed only by the House of Representatives was more expansive in its application to tax-exempt organizations, several provisions were struck from the final version ultimately signed into law. Notably, the OBBBA as enacted omits the graduated tax rate on net investment income of private foundations, the so-called parking tax, and other modifications to the definition of unrelated business taxable income.
The final version of the OBBBA, however, contains two key provisions that aim to increase taxes paid by private colleges and universities and organizations that pay its employees annual compensation in excess of a certain threshold. These changes, which are effective for tax years beginning after December 31, 2025, are summarized below.
College and university endowments – Excise tax on net investment income
The OBBBA modifies the excise tax on net investment income paid by certain private colleges and universities under section 4968. Currently, a flat 1.4% tax is imposed on the net investment income of a private college or university with at least 500 tuition-paying students, of which more than half are located in the US, if the institution's assets per student ratio is at least $500,000. An educational institution subject to the tax is called an "applicable educational institution."
The OBBBA potentially increases higher education's tax burden by (i) introducing graduated tax rates of up to 8% based on an applicable educational institution's assets per student ratio (now referred to as "student adjusted endowment"); and (ii) increasing an applicable education institution's tax base by including in the computation of net investment income (x) interest on student loans, and (y) royalty income deriving from federally subsidized student and faculty inventions and creations, which are presently excluded under the section 4968 Treasury Regulations. The final version of the OBBBA does offer relief for smaller higher education institutions by excluding institutions with fewer than 3,000 tuition-paying students from the definition of an applicable educational institution.
The proposed tax rate schedule is as follows:
| Student adjusted endowment | Tax rate |
|---|---|
|
> $500,000 and < $750,000 |
1.4% |
|
> $750,000 and < 2,000,000 |
4% |
|
> $2,000,000 |
8% |
As with prior law, certain assets and net investment income of an education institution's related organizations are treated as assets and net income of the education institution for purposes of calculating its net investment income and student adjusted endowment. By extension, therefore, under the OBBBA, the assets of related organizations will factor into determining the applicable tax rate. Generally, a related organization refers to an organization that the education institution controls or is controlled by, as well as a supporting organization to the education institution (within the meaning of section 509(a)(3)), or a supported organization if the education institution is a supporting organization.
The OBBBA will require an applicable education institution to make certain disclosures in the Form 990 regarding its student count for purposes of section 4968.
The OBBBA also directs the Secretary of the Treasury to issue regulations, so further guidance should be forthcoming.
Upshot:
- Increase in tax payable for applicable educational institutions
-
- Net investment income would include items of income currently excluded.
- Higher tax rates for institutions with larger endowments per student.
Excise tax on excess compensation
The OBBBA expands application of the excise tax under section 4960 on employee compensation in excess of $1 million and excess parachute payments paid to a "covered employee" of an applicable tax-exempt organization. The compensation thresholds include remuneration paid by the applicable tax-exempt organization and related organizations. Notably, the OBBBA expands the definition of "covered employee" to include any employee or former employee of an applicable tax-exempt organization (or its predecessor) since 2017, whereas prior to the OBBBA, a "covered employee" refers only to the organization's five highest compensated employees during the current year or during any prior year.
Upshot:
- Excess compensation paid to a greater number of employees and former employees potentially subject to tax.
- Tax-exempt organizations should carefully monitor compensation of individuals that are also employed by related organizations to ensure compliance.
* * * * * *
The Withers team is available to assist your organization in implementing the provisions of the OBBBA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
