Tax-Free College Endowments in Crosshairs as Overhaul Looms

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By Colleen Murphy

Tax breaks for college endowments could be a target as lawmakers prepare to overhaul the tax code in the next congressional session.

Investment returns and any donations to colleges and universities aren’t taxed. This preferential treatment has allowed many schools to build massive nest eggs—something critics say is unacceptable as the cost of college has outpaced tuition and students are struggling under large debt loads. The issue has been a a focus for some Republican lawmakers for the last several years, though recently they have been reticent to push piecemeal tax legislation because they hope to move a larger overhaul package.

That may all change now that Republicans hold the majority in Congress and the White House, as they craft ways to simplify the tax code and make it fairer and flatter for individuals. Taxing or policing the investment returns and endowment spending of colleges, especially those with funds totaling more than $1 billion, would be a politically popular move for Democratic lawmakers concerned about college affordability and for Republican lawmakers critical of wealthy schools. It’s also a key issue for working-class families, researchers and attorneys specializing in higher education policy told Bloomberg BNA.

“There is a constellation of forces that say ‘tax reform yes, endowment reform yes,’ ” Mark Schneider, a vice president and institute fellow at American Institutes for Research, said Dec. 21. “I believe the window is open and I believe there are enough powers that be, enough forces, that there’s an excellent chance that taxing endowments will be included.”

Billion-Dollar Question Marks

Moving from broadly worded proposals and public hearings to concrete legislative language will be a long path, and lawmakers still haven’t reached consensus on exactly what should be done with endowments—making it hard to predict the changes or their impacts, practitioners said.

Still, the issue is one lawmakers have been considering, and is something President-elect Donald Trump also has weighed in on. His transition team didn’t return a request for further comment.

“In fact, many universities spend more on private-equity fund managers than on tuition programs,” he said during a September speech. “But they should be using the money on students, for tuition, for student life and for student housing. That’s what it’s supposed to be for.”

College endowments weren’t mentioned in the GOP tax overhaul blueprint released in June. Members of the House Ways and Means Committee have been using the document to shape conversations and have begun turning it into legislative language.

Stop Sitting on It

Requiring colleges to pay out a certain percentage of their endowment earnings each year is one route lawmakers could take, the practitioners said. A similar requirement currently exists for private foundations, which must spend 5 percent of the value of their assets, or face penalties under tax code Section 4942.

Rep. Tom Reed (R-N.Y.), a member of the House Ways and Means Committee and the vice chair of Trump’s transition team, is preparing to introduce legislation early in the next session to crack down on colleges. He has floated two proposals: one requiring the wealthiest colleges to funnel 25 percent of endowment earnings to aid middle-class students and the other mandating additional financial reporting on colleges’ tax returns.

The bills will either be introduced together or separately, depending on what will give them the best chance at passing, a staffer in Reed’s office told Bloomberg BNA. Reed has been working on the legislation for months, and put out a larger blueprint about college affordability and endowment spending Dec. 5.

But “money is fungible,” and colleges could easily save a higher percentage of tuition revenue to offset a payout requirement, said Eugene Steurle, an Institute fellow and the Richard B. Fisher chair at the Urban Institute. Steurle is a former deputy assistant secretary in the Treasury Department’s Office of Tax Analysis.

Some colleges say setting a payout requirement is unreasonable because donors can put restrictions on how money can be spent and endowment funds are already regularly used for scholarships and campus construction projects. The average spending rate from endowments was 4.4 percent in 2014—and endowment assets earned a rate of return of about 15.5 percent that year, according to data from the Congressional Research Service.

Spread the Wealth

Lawmakers may also take the approach of trying to level the playing field for all students, instead of focusing on the wealthiest schools, the practitioners said. About 100 colleges have endowments of more than $1 billion.

During a September Ways and Means hearing on the topic, Schneider proposed an excise tax ranging from 0.5 percent to 2 percent on schools with endowments above $500 million. The tax would be offset by the amount of aid the school sets aside for students who are eligible for federal need-based grants and the revenue raised would be put into a fund for area community colleges.

Or lawmakers could threaten colleges that if they don’t enroll a certain number of working-class students, they risk being qualified as a private club for tax purposes, losing the tax deduction on its donations, said Michael Dannenberg, the director of strategic initiatives for policy at Education Reform Now. Dannenberg has advised presidential candidates on higher education policy.

“Be accessible and affordable or open up the tax-favored lockbox,” Dannenberg said Dec. 22.

Setting a larger tax exemption for donations that go toward university scholarships and a smaller one for donations that go elsewhere is also an option practitioners highlighted, and something Rep. Peter Roskam (R-Ill.), chairman of the Ways and Means Oversight Subcommittee, has said he is interested in studying further. A spokesman in his office didn’t return a request for additional comment.

Currently, donors are entitled to the same deduction for donations to colleges and universities as to other charities. An exception: Tax code Section 170(l) applies an 80 percent deduction limit if the benefits to the donor include the right to buy athletic tickets.

Tax Changes With Ripple Effects

Other elements of a tax overhaul could also impact colleges, practitioners said.

Capping tax deductions or lowering tax rates, two options that Trump and lawmakers are mulling, could deter individuals from making donations. The chances of a repeal of the estate tax have also crystallized since the election. That would all be bad news for colleges that rely on donations for scholarships, construction projects and research ventures.

“Any kind of deduction in charitable deductions would significantly affect larger universities that have a very large development component that make a lot of money from alumni of the world,” said Clifford Perlman, a partner at Perlman and Perlman LLP in New York, a law firm that specializes in nonprofits.

However, it’s unlikely that lawmakers will attack endowments and deductions at once because doing so would be very unpopular in the charitable sector, said Brian Galle, a law professor at Georgetown University specializing in tax and nonprofits.

“Probably the appetite to do both would be limited,” Galle said. “I think colleges and universities and other institutions with big endowments would have a fair argument to say you’ve enacted one major change, why don’t you wait and see how that affects us.”

To contact the reporter on this story: Colleen Murphy in Washington at cmurphy@bna.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bna.com

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