Navigating the Complex World of College Taxation
Colleges and universities play a crucial role in higher education. This guide is the second part of a four-part series (read about schools here). We delve into tax planning strategies specifically tailored for colleges, helping these institutions make informed financial decisions to support their educational missions.
Understanding College Tax Status
A tax-exempt college is an educational institution that is exempt from paying federal income tax. This exemption is granted by the IRS to colleges that meet certain requirements. This includes operating exclusively for educational purposes and not engaging in political activities.
Tax-exempt status is important for colleges because it allows them to keep more of their resources available to support their students and programs. It also makes it more attractive for individuals and businesses to donate to colleges, since they can deduct their donations from their taxable income.
Types of Colleges
There are three main types of colleges: public, private, and nonprofit.
- Public colleges are funded by government taxes and are tuition-free for in-state students. Public colleges are not tax-exempt, but they do receive several tax benefits, such as exemptions from property taxes and sales tax on certain purchases.
- Private colleges are funded by tuition fees and other private sources. Private colleges may be tax-exempt, depending on their structure and operations.
- Nonprofit colleges are private colleges that are operated by nonprofit organizations. Nonprofit colleges are typically tax-exempt.
Tax Compliance for Colleges
Even though tax-exempt colleges do not pay federal income tax, they still have some tax compliance requirements. These requirements include:
- Filing Form 990: Tax-exempt colleges must file Form 990 with the IRS each year. Form 990 is an annual tax return that provides information about the college’s finances and operations.
- Unrelated Business Income: If a college generates income from an activity that is unrelated to its educational mission, such as operating a bookstore, it must pay tax on that income.
Sources of Revenue
Tuition and Financial Aid
Tuition fees are generally not taxable for students. However, there are some exceptions to this rule, such as scholarships that are awarded based on athletic or artistic ability.
Financial aid, such as grants and loans, is also not taxable for students. However, students may have to pay taxes on any income that they earn from working part-time while in school.
Endowments and Charitable Gifts
College endowments and charitable gifts are not taxable for colleges.
State Taxation for Colleges
State Tax Regulations
Colleges must also comply with state tax laws. State tax laws vary widely, so colleges should consult with a tax professional to understand their obligations. State tax regulations may cover a variety of areas, such as income tax, sales tax, and property tax. Colleges should be aware of the specific tax regulations that apply to them in their state.
Sales Tax and Fundraisers
Colleges are typically exempt from paying sales tax on goods and services that are used to support their educational mission. However, certain sales made at fundraising events may require collection and remit sales tax on them.
Tax Credits and Deductions
Education Tax Credits
There are many education tax credits available to students and parents, such as the American Opportunity Tax Credit and the Lifetime Learning Tax Credit. Colleges can inform students and parents about these tax credits through their financial aid offices and websites.
Educators and staff may be able to deduct certain expenses related to their jobs from their taxable income. For example, teachers can deduct the cost of classroom supplies and professional development. Colleges can inform their employees about potential tax deductions through their human resources departments.
For-Profit vs. Nonprofit Colleges
The main tax difference between for-profit and nonprofit colleges is that for-profit colleges are not tax-exempt. This means that for-profit colleges must pay federal income tax on their profits.
Impact of Tax Reform
The Tax Cuts and Jobs Act of 2017 made some changes to the tax treatment of educational institutions. One of the most significant changes is that the law doubled the standard deduction, which means that fewer taxpayers are eligible to claim education tax credits.
Tax Planning and Budgeting
When developing their budgets, colleges should consider the following tax implications:
- Tax-exempt status: Colleges should prioritize allocating funds to programs and activities that are eligible for tax-exempt status.
- Unrelated business income: Colleges should avoid generating income from activities that are unrelated to their educational mission, as this income will be subject to tax.
- Tuition and financial aid: Colleges should be aware of the tax implications of tuition fees and financial aid.
- Income diversification: Colleges can diversify their income streams to reduce their reliance on tuition revenue. This can help to stabilize the school’s finances and make it less vulnerable to fluctuations in tuition rates and student enrollment.
- Tax-advantaged investments: Colleges can invest in tax-advantaged accounts, such as 501(c)(3) endowments and retirement plans. These accounts can help to grow the school’s assets and reduce its tax liability.
- Deductions and credits: Colleges can deduct a variety of expenses from their taxable income, such as the cost of tuition refunds, research and development, and charitable contributions. Colleges may also be eligible for tax credits, such as the Work Opportunity Tax Credit.
Long-Term Financial Planning
Long-term financial planning is essential for all organizations, but it is especially important for colleges and universities. Colleges and universities have a unique set of financial challenges, including:
- Tuition revenue: Tuition revenue is a major source of income for colleges and universities, but it can be unpredictable and unstable.
- Capital costs: Colleges and universities must invest in capital assets, such as buildings, equipment, and technology. These investments can be expensive and require long-term planning.
- Endowments: Many colleges and universities have endowments. These are invested funds that are used to support the school’s mission. Endowments must be managed carefully to ensure that they grow over time. They provide a sustainable source of income for the school.
When developing their long-term financial plans, colleges and universities should consider the following:
- Educational mission: The college’s educational mission should be the foundation of its long-term financial plan. The plan should ensure that the college has the resources it needs to support its academic programs and student life.
- Financial goals: The college should set clear and measurable financial goals. These goals may include increasing tuition revenue, growing the endowment, and reducing debt.
- Risk tolerance: The college should develop a risk tolerance statement that outlines its willingness to take risks to achieve its financial goals.
- Investment strategy: The college should develop an investment strategy that is aligned with its financial goals and risk tolerance.
- Tax implications: The college should consider the tax implications of its financial decisions.
Tax Challenges for Colleges
Colleges and universities are subject to IRS audits. Audits can be time-consuming and costly, but they are an important part of the IRS’s mission to ensure that taxpayers are complying with the tax laws.
Colleges and universities can prepare for IRS audits by:
- Keeping thorough records of their income and expenses.
- Having a system in place to respond to IRS inquiries.
- Working with a qualified tax professional.
Adapting to Tax Law Changes
Tax laws are constantly changing. Colleges and universities need to monitor changes in tax law and update their financial strategies accordingly.
Colleges and universities can stay up-to-date on tax law changes by:
- Subscribing to tax publications and newsletters.
- Attending tax seminars and conferences.
- Working with a qualified tax professional.
Innovations in College Taxation
Technology can streamline tax compliance and reporting for colleges and universities. For example, there are many software programs that can help colleges and universities to:
- Track their income and expenses.
- Prepare their tax returns.
- File their tax returns electronically.
Education Finance Platforms
Several fintech platforms have emerged that are tailored to the needs of educational institutions. These platforms can help colleges and universities to:
- Manage their endowments.
- Process financial aid payments.
- Collect and remit sales tax.
By using digital tools and education finance platforms, colleges and universities can reduce the time and cost of tax compliance and reporting.
Colleges and universities are at the forefront of higher education. By effectively navigating the complexities of tax planning, these institutions can allocate resources wisely, ensuring that every dollar supports their mission of providing quality education and research. So, utilize marketplaces like IfindTaxPro where you can post your project and find the right tax specialist for you.