As schools break for Thanksgiving, many of the most prominent colleges and universities are going to have less to be thankful for this holiday season. Last week, House Republicans pushed through a raft of federal tax reforms which included new taxes aimed at university and college endowments, potentially changing the face of higher education in the United States. A similar bill now lies in the Senate.
Beyond expected reductions in corporate tax rates and changes to individual tax brackets, the proposed tax reforms include a 1.4% tax on the net investment income of around 70 private college endowments. Another provision—the elimination of tax-free bond offerings—makes it costlier for colleges to build or upgrade infrastructure. The proposed guidelines also require the investment management arms of these colleges and universities to pay a 20% excise tax on executive compensation over $1 million, hampering their ability to recruit Wall Street’s best to help preserve and grow endowment assets. To make matters worse, the tax plan may also put a damper on gifting, as donors may be discouraged by the tax on their charitable contributions; also, for many donors, the bill would eliminate itemized deductions, making it less beneficial to gift to university endowments.
To be clear, the proposed reforms don’t affect public charities. The measures would tax private university endowments larger than $250,000 per student. The House and Senate bills place private university endowments on a similar footing with private foundations which already pay an excise tax of 2%. About 70 colleges and universities are estimated to be affected by the proposed federal tax overhaul, ranging from Ivy League schools to smaller colleges and universities. The actual impact to a university endowment earning annual returns of 5%-to-8% will be around seven basis points to 11 basis points a year, according to NEPC estimates.
The impact of the proposed federal tax overhaul would be greatest on institutions of modest means where even a small decline in net investment income could hamper their ability to provide student aid and meet university expenses. Particularly vulnerable are endowments that contribute over 10% to a school’s operating budget. If passed by the Senate, the tax would take effect in 2018, meaning schools—especially those with the fiscal year ending June 30—would need to factor in the impact of the new rules within the first six months of the year.
To those fretting over the potential impact of the bill on student resources and operations, we say this: NEPC’s work with its private foundations clients has put us in good stead to be of service to you. While we believe taxing charitable organizations in general slows down their mission, we can help shape your investment policy so your dollars can go that extra mile without adversely impacting your endowment’s assets. Our total enterprise management study includes an exhaustive review of spending guidelines, management costs and investment fees. Our aim is to help bring down your expenses so the endowment may use the savings to finance academic expense. We will think about your portfolio in the context of total resources. Our total enterprise management model ultimately links to long-term returns; by looking at the needs of the organization we can weigh policies, fees and total-return goals.
While the bill can go through significant changes in the Senate before it sees the light of day in the real world, the proposed tax reform has the potential to alter the course of higher education in this country for many generations. If you are concerned about the potential impact on your institution’s endowment, please contact your NEPC consultant to learn more about us and how we may be of help.