Knowledge summary
- The 2017 Tax Cuts and Jobs Act (TCJA) imposed the first-ever excise tax on the net investment income of some private higher education institutions.
- Several bills have been introduced that may affect the tax-exempt and funding status of colleges.
- As some provisions in the TCJA are set to expire at the end of 2025, lawmakers are taking a closer look at the tax code, which could draw more attention to the tax treatment of endowments.
- The U.S. will also have to deal with the debt ceiling again next year against a backdrop of continued federal deficits and the need to boost government revenue. As a result, Congress may be looking for alternative sources of funding.
The endowment tax
Over the years, Congress has had a keen interest in universities and the non-profit status of their endowments. These endowments—especially at the wealthiest Ivy League schools—and rising tuition have placed private colleges and universities in the public eye. Various legislators have proposed a mixed bag of bills focused on colleges and universities and held hearings to learn more about how these institutions determine tuition, manage their funds and endowments, use tax-exempt bonds, and utilize their charitable status.
In December 2017, the Tax Cuts and Jobs Act (TCJA) was enacted into law. Among many major tax reform provisions, the TCJA included a new 1.4% excise tax on the investment income of certain private colleges and universities (see sidebar below). The tax on endowments was a means to raise revenue to help offset other tax cuts in the TCJA.
Since the endowment excise tax, several bills have been introduced that could alter the tax burden on universities. A bill1 introduced in May 2021 proposes a 1% tax on the aggregate fair market value of any "applicable" educational institutions with assets of at least $2.5 billion, except religious institutions. The bill also imposes a 30% tax on any undistributed excess endowment amounts. A separate bill2 in September 2022 sought to increase to 10% from 1.4% the excise tax on the net investment income of applicable educational institutions (certain private colleges and universities). Despite these and other bills focusing on endowments and universities, none have been enacted since the TCJA.
2017 Tax Cuts and Jobs Act—Endowment Tax for Colleges
The Tax Cuts and Jobs Act included a 1.4% excise tax on the net investment income of certain tax-exempt higher education institutions. Specifically, the tax applies to private institutions with at least 500 tuition-paying students, more than half of whom are in the U.S, and assets valued at greater than $500,000 per student. In October 2020, Treasury and the IRS issued final regulations on the university endowment tax.3 According to IRS Statistics of Income 2022 data, 58 universities paid the university endowment tax for a total of $243 million.4
Student protests and administration responses put universities in spotlight
Recent student protests on college campuses regarding the war between Israel and Hamas and how university administrations responded have drawn criticism. Universities and lawmakers are grappling with how to react to the conflict and the protests. In fact, several committees in the U.S. House of Representatives have held hearings focused on universities' leadership in handling the crisis.
Several pieces of legislation have been introduced recently in response to antisemitism at college campuses. In addition, there is increasing focus on efforts to stop terrorism. One of these is a bill5 introduced in November 2023 to revoke the tax-exempt status for any organization that provides financial support or resources to designated terrorist groups. The House of Representatives passed the bill in April this year, and it is awaiting action in the Senate. In May 2024, a separate bill6 called for institutions of higher education to be ineligible for funds under the Higher Education Act of 1965 due to campus disorder. The bill is currently awaiting committee action.
The effects of the fiscal cliff
There is increased focus on the upcoming fiscal cliff with the national debt at an all-time high of $34.7 trillion.7 The U.S. will also have to deal with the debt ceiling next year. In June 2023, President Biden signed legislation that suspends the $31.4 trillion debt ceiling until January 2025. While extraordinary measures will be deployed to allow the government to pay bills for several months beyond the end of the suspension expiration date, Congress will need to act to raise the debt ceiling once again.
Since many of the individual tax provisions of the TCJA will expire at end of next year, there is mounting pressure among lawmakers to find new revenue to offset the cost. An extension of all the tax provisions could cost an estimated $4.9 trillion.8 While we may not see every expiring TCJA provision get extended, the government will still need to find revenue. We believe that given the increasing political scrutiny on universities and endowments, these institutions could be seen as a potential revenue source.
Conclusion
In our view, it will be difficult to predict how the political and tax landscape will play out over the next few years. A lot will depend on the factors discussed above, including the outcome of elections in November. The outcome of the legislative enquiry into colleges and universities and the amount of revenue needed to extend all or parts of TCJA will be key components. Endowments may want to collaborate with platforms that can provide holistic services to better navigate not only the investment landscape, but also the evolving policy landscape.
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