Tax Code Changes Worrisome for Private Schools
Washington--Tax-exempt fringe benefits such as free housing that many independent private schools use to attract teachers would be taxed under recent changes in the nation's tax code.
Officials of independent schools say that unless the Congress votes this year to retroactively extend several tax provisions that expired at the end of 1985, they may have to increase budgets for salaries and personal benefits to compete with public schools for teachers.
The tax-reform bill that the House passed last month would restore the tax-exempt status of most of the benefits involved. But it would also impose new taxes on the pensions that many independent-school employees enjoy, and could raise those schools' administrative costs.
Included in the House measure are new taxes on the Teachers Insurance and Annuity Association and the College Retirement Equities Fund, the two companies that provide pension benefits for most of the higher-education community, as well as the vast majority of independent schools.
Of all the nonprofit sectors, education would be hurt the most by certain provisions of the House tax measure, according to Independent Sector, an organization that represents nonprofit groups.
Among the tax provisions that expired at the end of 1985 were several that excluded fringe benefits from an employee's taxable income.
All of the expired tax provisions--such as employer-paid tuition benefits--apply to employees generally, including those who work for public schools and private businesses.
But the tax-exempt status of fringe benefits is especially important to independent schools because they typically offer lower salaries than public schools, and they often "make up in fringe benefits" what they do not offer in salary, according to Robert Smith, the executive director of the Council on American Private Education.
Median salaries for public-school teachers average about $3,000 or $4,000 a year more than those for teachers at independent schools, Mr. Smith said, a difference that increases to about $6,000 a year if Catholic and other religious schools are included. "So the fringes are very important," he said.
The Congress had intended to renew the tax-exempt status of most of the fringe benefits last month, but in the scramble to recess they were omitted from a catchall reconciliation measure. The chairman of the House Ways and Means Committee, Dan Rostenkowski, Democrat of Illinois, promised to seek renewal of the provisions this year.
Fringe benefits that would now be taxed include:
Employer-provided educational assistance. Schools would have to demonstrate that faculty members and other staff who receive such assistance use it for course work directly related to their jobs or their field of study. Otherwise, the assistance would be treated as taxable income.
Assistance for courses taken to increase one's knowledge generally would be excluded from tax-exempt status.
The change does not, however, affect tuition-remission programs, which allow schools to provide free tuition to employees and their dependents.
According to Arthur G. Broadhurst, director of business services for the National Association of Independent Schools, the loss of tax-exempt status for employer-provided educational assistance "may require some narrowing of the parameters" of the courses that schools subsidize, but it should not have too great an impact, "given that teachers are in the education business."
Housing. Teachers and other employees who receive rent-free or subsidized housing in lieu of salary would now be taxed on the fair-market value of the lodging.
This change would not affect faculty who live in dormitories at boarding schools, where their presence is required as part of their jobs. But it could affect others who live on campus either at boarding or day schools primarily as a matter of convenience.
Independent schools are increasingly offering such housing benefits to compensate for low salaries, especially if they are located in well-to-do areas where rents are high, Mr. Broadhurst said.
He said the nais has alerted schools that to maintain the tax-exempt status of such housing, they should specify in job descriptions that it is job-related.
The House-passed tax-reform measure would not renew the tax-exempt status of housing benefits.
Group legal services. Many employers offer their employees a variety of tax-exempt benefits from which they may choose the ones that they want.
Such "cafeteria plans" would no longer be allowed to offer qualified group legal services as a tax-exempt benefit. Many independent schools offer such benefits, Mr. Broadhurst said.
Van pooling. Schools and employees who transport staff to and from work could no longer do so at no expense to the employees. The transportation would now be treated as taxable income.
Overall, nonprofit groups, including independent schools, were pleased with the House-passed tax-reform measure, primarily because it would make permanent the charitable deduction for non-itemizers who contribute more than $100 a year.
Preservation of the charitable deduction has been a top lobbying concern of the nonprofit sector ever since late 1984 when the Reagan Administration targeted it for elimination.
"I would say in general we came out better than we expected to" on charitable deductions, said cape's Mr. Smith.
But the House tax measure also includes several provisions that could prove costly to nonprofit groups, including independent schools, officials said.
The lowering of tax rates, alone, could cost nonprofits some $3.14 billion a year by reducing the incentive to give, Independent Sector has estimated.
The measure also disallows for tax purposes the deduction of the first $100 that a non-itemizer gives to charity, which could further reduce giving.
And it makes numerous changes in current law that would reduce independent-school employees' pension benefits and increase the cost of administering such retirement plans, including:
New taxes on tiaa-cref;
A 15 percent penalty for withdrawal of tax-deferred annuities prior to age 59;
The application of so-called nondiscrimination rules to all 403(b) annuity plans--those offered by nonprofit organizations.;
A $7,000 annual limit on contributions to 403(b) annuity plans, including a dollar-for-dollar offset against tax-deductible contributions to an Individual Retirement Account; and,
The modification of the so-called "three-year rule," which allows retirees to escape taxation during the first three years of retirement if their pension benefits do not exceed the total amount they paid in over the period of their employment. (See Education Week, Jan. 8, 1986.)
Officials said last week that although they could not estimate the impact of taxation of tiaa-cref, it would certainly reduce benefits.
"Clearly, if they tax tiaa, that reduces the amount of money available for pensions," Mr. Broadhurst said. "But I don't know by how much."
tiaa-cref has been exempt from taxes for 65 years.
By separating their pension and insurance accounts, the House measure would allow the two companies to escape taxation of their pension funds. Otherwise, the prevailing corporate rate would apply to the firms' pension accounts on Jan. 1, 1988.
But Francis P. Gunning, the executive vice president and general counsel of tiaa-cref, said the companies could escape taxation "only theorically" because such separation would require all their policies to be rewritten and that would be too costly.
The companies are concerned enough to have launched a letter-writing campaign by their one million policyholders to put pressure on the Senate to revise the House tax measure.
The Senate is expected to take up tax reform later this year.
The third-largest equity program in the country, tiaa-cref provides services for 83 percent of the faculty at private colleges and universities nationwide and 50 percent of the faculty at state colleges and universities.
Some 3,600 institutions offer tiaa-cref policies to their employees, including 814 private precollegiate schools.
In most cases, those 814 schools offer only tiaa-cref plans, Mr. Broadhurst said.
The modification of the three-year tax holiday applies to tiaa-cref policyholders, but only those who contribute to their retirement plan with after-tax dollars. The rule change could cost such employees up to $4,000 a year in lost pension benefits.
Most independent schools give their employees the option of contributing to their pension plans with after-tax or pretax dollars.
But according to Mr. Gunning, most independent-school employees pay for their pensions with pretax dollars, through so-called "salary-reduction" plans. Such plans reduce an employee's salary by the amount an employer contributes to a pension plan on the employee's behalf beyond the employer's set share.
The nais encourages schools to offer salary-reduction plans, and according to Mr. Broadhurst, "an increasingly large number are doing that."
But Robert A. Camner, business manager of The Sidwell Friends School in Washington, D.C., said many independent-school employees--up to 50 percent--continue to make their contributions in after-tax dollars.
Although "more and more schools are requiring contributions in pretax dollars," Mr. Camner said, unless the school makes it easy for employees to participate in salary-reduction plans, many contribute in after-tax dollars.
Mr. Broadhurst said the application of nondiscrimination rules to 4403(b) plans, such as the ones tiaa-cref offers, would also have a substantial impact on independent schools.
At many schools, pension benefits are made available to faculty only, or to administrators at one level and faculty at another, he said.
Support staff may or may not be included.
The application of nondiscrimination rules will require schools to offer all employees the same benefits, which he said "would require some radical rewriting and expense to schools."