Ellen P. Aprill (Loyola-L.A.), Congress Fumbles the Ball on Section 4960:
The tax legislation signed into law by President Trump on December 22 takes aim at tax-exempt organizations that pay presidents, college football coaches, and other employees more than $1 million a year. But as with so many other aspects of the hastily drafted bill, Republican lawmakers fumbled on this provision too. While the drafters evidently intended to impose a 21% excise tax on both public and tax-exempt private institution that have employees with compensation over $1 million, they appear to have inadvertently left public universities off the hook.
As a result, the new excise tax quite likely won’t apply to public universities with highly paid employees, such as Nick Saban (who makes more than $11.1 million a year), Clemson coach Dabo Swinney ($8.5 million), or Michigan coach Jim Harbaugh ($7.0 million). It will, however, apply to private universities with their own highly compensated employees, such as Stanford coach David Shaw ($5.7 million), Texas Christian’s Gary Patterson ($5.1 million), and Northwestern’s Pat Fitzgerald ($3.3 million). That’s good news for state-school sports fans, whose teams will now have an advantage in the scramble for top coaching talent. But it may come as a surprise to Republican lawmakers who—according to the explanation accompanying the House-Senate conference report — thought that the new excise tax would apply to state and local government employers whose income is excluded from federal income tax.
If subjecting public institutions to this excise tax was the drafters’ intent, they did not succeed. Section 115(1) states that gross income “does not include income derived from any public utility or the exercise of any essential governmental function and accruing to a State or any political subdivision thereof.” The drafters of section 4960 seem to believe that public colleges and universities rely on section 115(1) in order to avoid income taxation. That is a common and understandable reading of the language of section 115(1). It is, however, a misreading. . . .
The IRS has long taken the view that states and political subdivisions avoid income tax not under section 115(1), but under a doctrine of implied statutory immunity. . . . [And] [p]ublic universities and colleges . . . rarely base their tax-free status on section 115(1). As dozens of private letter rulings attest, they escape federal income taxation because they are either an integral part of a state or political subdivision or possess themselves sufficient powers, such as police power, to qualify as a political subdivision. . . .
If . . . Congress thought that, by including section 115(1) entities among the organizations subject to section 4960, the provision will require public universities to pay the excise tax on excessive compensation of football and basketball coaches or university presidents, the lawmakers failed to achieve their goal. To achieve this goal, section 4960 needs technical correction that revises it to include a provision similar to the one subjecting public colleges and universities to the unrelated business tax. This possible error is but another of the problems inherent in drafting tax legislation too quickly.