The U.S. Tax system is a complex structure that involves various elements and regulations. One such aspect is the taxation of private nonprofit colleges and universities with large endowments. Under the 2017 Tax Cuts and Jobs Act (TCJA), institutions that enroll at least 500 students and have endowment assets exceeding $500,000 per student (excluding assets used for their exempt purpose) will be subject to a 1.4 percent tax on their net investment income. It is estimated that only around 40 institutions meet these criteria.
Current Treatment of Endowments
Private nonprofit colleges and universities, classified as 501(c)(3) organizations, enjoy tax-exempt status due to their educational mission. These institutions often accumulate endowments, which are financial assets that generate income to support their budgets and ensure long-term financial stability. Endowments play a vital role in funding various activities such as undergraduate and graduate education, research, and other institutional initiatives.
It is important to note that the tax treatment of private nonprofit college and university endowments differs from private foundations. Private foundations, established by individuals, families, or companies for charitable purposes, are subject to an excise tax on their net investment income. Nonoperating foundations, which distribute funds to other organizations instead of directly engaging in charitable activities, must distribute at least 5 percent of their funds annually. Operating foundations, on the other hand, operate charitable activities themselves and do not have specific payout requirements.
Size of Endowments
Colleges and universities in the United States collectively hold over $500 billion in endowment wealth. However, a significant portion of these assets is concentrated in a small number of institutions. Approximately 23 institutions hold around 50 percent of the total endowment assets, despite there being over 1,600 private nonprofit and 700 public four-year institutions in the country.
Endowments provide additional income to support education, research, public service, and other institutional activities. They act as a financial cushion, protecting institutional budgets from temporary revenue disruptions caused by cyclical pressures or unexpected changes in enrollments.
When assessing institutional strength based on endowments, it is more relevant to consider endowment per student rather than total endowment dollars. This metric, while not perfect, helps account for the differences in undergraduate and graduate student populations and the variations in institutional missions. Undergraduate colleges primarily utilize endowments to support undergraduate education, whereas research universities allocate these funds to a broader range of activities.
For private research universities enrolling 10 percent of the students in the sector, the average endowment per student is approximately $1.5 million. On the other hand, the institutions with the lowest endowments, where the other half of the sector’s students are enrolled, have an average endowment of around $43,000 per student. The disparity in endowment wealth is also present in private bachelor’s colleges, although to a lesser extent. In master’s universities, where there is less overall wealth, the top half of institutions still have an average endowment nearly five times greater than the bottom half.
The Impact of the New Tax
The introduction of the new tax on college and university endowments is not expected to generate a significant amount of revenue for the federal government, estimated at around $200 million per year. However, it may set a precedent for potential future taxes on nonprofit entities. Some members of Congress question whether these wealthy institutions effectively utilize their resources to advance educational goals, particularly concerning the lack of enrollment of low-income students in institutions with large endowments, which often have selective admissions.
Nevertheless, high-endowment schools do allocate some of their resources to reduce the financial burden on low-income students. These students benefit from both the opportunities provided by these institutions and lower net tuition prices compared to other options. The tax is unlikely to impact tuition prices significantly, as these institutions already offer generous financial aid packages. Additionally, it is worth noting that these wealthy institutions enroll a relatively small percentage of students in the private nonprofit sector and a fraction of the overall postsecondary student population.
The new tax on endowments has sparked controversy, prompting bipartisan efforts in Congress to repeal it. The higher education community has been vocal in its opposition to the tax. Earlier proposals for taxing colleges and universities involved incentivizing certain spending or pricing modifications. However, the current legislation does not include such provisions, nor does it allocate the generated revenue to further educational goals.