The Congressional Research Service Reports on University Endowments
A recent report prepared by the Congressional Research Service (“CRS”) examines the current taxation of college and university endowments and considers proposals for change. In 2014, these endowments consisted of assets totaling more than $500 billion and earned an average return of more than 15percent. When considering comprehensive tax reform, the Congress may look to impose a tax on the income earned by these endowments or limited deduction for contributions made to colleges and universities. Accordingly, this report may offer insights into future tax policy affecting colleges and universities.
U.S. institutions of higher education own financial assets, real estate and other income producing property (the “endowment”) to generate income in order to support the purposes for which they were formed, i.e., educating students and conducting research. An endowment typically consists of a multitude of funds provided by numerous donors to the institution. In some cases, donations may have been made to the general fund of the college or university. However, in many cases the donations will come with restrictions concerning use. For example, a contribution may be made to establish a student scholarship or to fund research by faculty members on a particular topic.
One notable fact about college and university endowments, is the concentration of funds in a relatively small number of institutions. The report states that 11% of all institutions hold 74% of endowment assets. For example, in 2014 the endowments of the eight universities of the Ivy League exceeded $100 billion, in the aggregate.
Endowments tend to be invested in equities, fixed income securities and alternative investment strategies (e.g., private equity, venture capital, hedge funds, etc.). According to the report, as of 2014, approximately 50% of college and university endowments were invested in alternative investment strategies.
Current Taxation of College and University Endowments
Under current law, the endowments of colleges and universities are exempt from U.S. federal income tax because the colleges and universities themselves are exempt from U.S. federal income tax under section 501(c)(3) of the Internal Revenue Code. Another tax benefit enjoyed by all section 501(c)(3) entities is that contributions made to them are generally deductible in computing the taxable income of the donor. This, in turn, encourages contributions to these institutions.
Proposals for change
Due to their size, college and university endowments have attracted the attention of policymakers. For example, the report notes that Sen. Charles Grassley has proposed requiring endowments to pay a minimum amount every year. The minimum payout might be 5%, which is in line with the requirement for private non-operating foundations. This amount would go to students in order to reduce the students’ need for federal financial aid.
Such a bright line rule has been criticized as too easy to meet for wealthier institutions with large endowments and too difficult to meet for institutions was smaller endowments. Also, a minimum payout requirement may be difficult to meet for institutions with donor-imposed restrictions.
The report also discusses a tax on endowment income. Such a tax has was proposed in 2014 by Rep. Dave Camp when he was Chairman of the House Ways and Means Committee. The report states that a 1% tax on the return from university endowments that exceed $100,000/student is estimated to generate additional tax revenue of $1.7 billion between 2014 and 2023. This revenue could be earmarked for educational purposes.
The author is aware of no established standard concerning the size of an endowment that is necessary or adequate for fulfilling a college or university’s charitable purpose. Such a size may be difficult to determine. For example, as a university’s endowment grows, the university may provide increased financial support to its students. Thus, more academically able students who otherwise lacked the necessary funds to pay tuition may matriculate to such universities. From this perspective, perhaps an endowment should be allowed to grow tax-free until all students may attend the institution tuition-free.
On the other hand, as an endowment grows, a university may spend some of the additional income in a way that is less directly related to providing educational services (e.g., additional administrative personnel, relatively luxurious student housing, recruiting bonuses and other perks for faculty members, etc.). This issue has not been studied from a tax policy perspective. Thus, as a matter of overall budget policy, the Congress may one day conclude that university endowments of a certain size should not be wholly tax-exempt or donations to universities with endowments of a certain size not be fully tax deductible.
 Sherlock, Gravelle and Stupak, College and University Endowments: Overview and Tax Policy Options, Congressional Research Service (December 2, 2015). The universities are Brown, Columbia, Cornell, Dartmouth, Harvard, Princeton, The University of Pennsylvania, and Yale. Section 501(c)(3) list various tax-exempt purposes for which an entity may be formed. One such purpose is education. There is some evidence that significant contributions to a college or university by a family member have influenced the decision whether to admit particular applicants. See, e.g., Golden, The Price of Admission (Random House, 2006).KEYWORD: Tax-Exempt Entities
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