New Tax On Colleges

I read that Harvard estimates that a change from the Tax Cut and Jobs Act will cost approximately $38 million.

Harvard is referring to the “endowment tax” on colleges and universities.

Have you heard about this?

Let us set up the issue by discussing the taxation of private foundations.

The “best” type of charity (at least tax-wise) is the 501(c)(3). These are the March of Dimes and United Ways, and they are publicly-supported by a broad group of interested donors. In general, this means a large number of individually modest donations. Mind you, there can be an outsized donation (or several), but there are mathematical tests to restrict a limited number of donors from providing a disproportionate amount of the charity’s support.

Then we get to private foundations. In general, this means that a limited number of donors provide a disproportionate amount of support. Say that CTG comes into big bucks and sets up the CTG Family Foundation. There is little question that one donor provided a lopsided amount of donations: that donor would be me. In its classic version, I would be the only one funding the CTG Family Foundation.

There can be issues when a foundation and a person are essentially alter egos, and the Code provides serious penalties should that someone forget the difference. Foundations have enhanced information reporting requirements, and they also pay a 2% income tax on their net investment income. The 2% tax is supposedly to pay for the increased IRS attention given foundations compared to publicly-supported charities.

The Tax Cut and Jobs Act created a new tax – the 1.4% tax on endowment income – and it targets an unexpected group: colleges and universities that enroll at least 500 tuition-paying students and have endowment assets of at least $500,000 per student.

Let me think this through. I went to graduate school at the University of Missouri at Columbia. Its student body is approximately 30,000. UMC would need an endowment of at least $15 billion to come within reach of this tax.

I have two immediate thoughts:

(1)  Tax practitioners commonly refer to the 2% tax on foundations as inconsequential, because … well, it is. My fee might be more than the tax; and

(2)  I am having a difficult time getting worked up over somebody who has $15 billion in the bank.

The endowment tax is designed to hit a minimal number of colleges and universities – probably less than 50 in total. It is expected to provide approximately $200 million in new taxes annually, not an insignificant sum but not budget-balancing either. As a consequence, there has been speculation as to its provenance and purpose.

With this Congress has again introduced brain-numbing complexity to the tax Code. For example, the tax is supposed to exclude endowment funds used to carry-on the school’s tax-exempt purpose.  Folks, it does not take 30-plus years of tax practice to argue that everything a school does furthers its tax-exempt purpose, meaning there is nothing left to tax. Clearly that is not the intent of the law, and tax practitioners are breathlessly awaiting the IRS to provide near-Torahic definitions of terms in this area.  

The criticism of the tax has already begun. Here is Harvard referring to its $40 billion endowment:

“We remain opposed to this damaging and unprecedented tax that will not only reduce resources available to colleges and universities to promote excellence in teaching and to sustain innovative research…”

Breathe deeply there, Winchester. Explain again why any school with $40 billion in investments even charges tuition.

Which brings us to Berea College in central Kentucky, south of Lexington. The school has an endowment of approximately $700,000 per student, so it meets the first requirement of the tax. The initial draft of the tax bill would have pulled Berea into its dragnet, but there was bipartisan agreement that the second requirement refer to “tuition-paying” students.

So what?

Berea College does not charge tuition.