In a recently released report, the Congressional Research Service (CRS) summarized background information on college and university endowments, including size, performance and payout. The report also discussed various potential changes to endowments’ tax treatment, discussed in more detail below.
According to the report, fiscal year 2014 endowment balances for the 832 institutions included in the National Association of College and University Business Officers (NACUBO)-Commonfund Study of Endowments totaled $516 billion. Endowment balances are concentrated—11 percent of institutions hold 74 percent of endowment assets. For 2014, endowments earned an average of 15.5 percent; the 2014 payout rate for NACUBO institutions was 4.4 percent. Spending from the endowment includes expenditures on student financial aid, faculty research, maintenance of facilities and other campus operations. Larger endowments had higher payout rates than smaller endowments.
Potential Payout Requirements
Some policymakers proposed a minimum distribution requirement each year to prevent a perceived unreasonable accumulation of taxpayer-subsidized funds. This could be applied to all institutions regardless of endowment size and could impose a greater burden on institutions with smaller endowments. While a 5 percent payout similar to the private foundation rules has been discussed, the payout rate would be open to further review. It could be restricted to certain larger endowments, tied to investment earnings, determined on a rolling basis or even impacted by a student-based metric like tuition level or financial aid. Any legislation requiring a payout might need a “safe harbor” to help prevent the institution from being caught between legal restrictions on donations and payout requirements.
Tax Endowments or Endowment Earnings
Another option proposes a tax on endowments or endowment earnings. This could be designed in different ways; it could be applied only to endowments of a certain size or endowments that have increased tuition at a certain rate. The tax on endowment earnings could be designed in a similar manner to the current 2 percent excise tax on net investment income of private foundations. Alternatively, endowment earnings could be subjected to the unrelated business income tax. This additional revenue could be earmarked for student aid or treated as general fund revenue.
Limits on Charitable Deductions for Gifts to Endowments
Incentives for giving donations related to endowments could be changed by reducing the value of the charitable deduction for gifts spent over time or not immediately used for charitable purposes. Limiting gifts to endowments would encourage taxpayers to make gifts that could be used right away.
Changes to Policies for Certain Offshore Investments
Many endowments have substantial assets in alternative strategies that involve offshore investments. By using offshore blocker corporations to hold these alternative investments, some endowments can avoid unrelated business income tax. This can create a tax disparity between domestic and offshore investments. One proposal under consideration would create a look-through rule to disallow the benefits of the offshore blocker corporations and subject the income to unrelated business income tax.
While the CRS report focused only on higher education, it also is meaningful to other not-for-profit entities with significant endowments. These proposals are another indication of growing Washington scrutiny of the not-for-profit world.
If you have any questions on these or other issues, contact your BKD advisor.