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.
