Excise Tax on University Endowments
The Tax Cuts and Jobs Act of 2017 signed into law by President Trump late last year includes a provision that will subject certain colleges and universities to an excise tax of 1.4% on net investment income, similar to the excise tax on private foundations. The tax only affects large private colleges and universities. State schools are not subject to the tax, and private schools with less than 500 students are not impacted by the tax, which takes effect for tax years beginning after December 31, 2017.
The tax specifically applies to private universities whose total endowment assets per student is greater than $500,000. In determining total assets for the assets-per-student calculation, an important exception exists for assets “which are used directly in carrying out the institution’s exempt purpose.” Some in the sector would argue that the entirety of a tax-exempt university’s endowment assets are used directly in carrying out its exempt function; the “organizational test” that allows them to be exempt as 501(c)(3) organizations in the first place requires it. No additional guidance has been issued by the Treasury Department as yet, so the exact interpretation of this phrase remains uncertain.
Net investment income for this purpose includes interest, dividends, rents, royalties, net capital gains (but not net capital losses) and similar amounts, less ordinary and necessary expenses incurred in the production of investment income. In determining both total assets and net investment income, the assets and income of any related organizations are generally treated as assets and income of the institution.
Depending on how the assets-per-student amount is calculated, the tax may only impact perhaps three dozen organizations in the United States, nearly all of them prominent and elite institutions, leading some to call this provision the “Harvard tax” in reference to Harvard University’s $36 billion endowment (the world’s largest, over 40% larger than the next-largest endowment held by Yale University). There is concern in this sector about the encroachment of taxes on otherwise tax-exempt organizations. The portion of the Act which imposes the tax makes explicit reference to Section 4940(c), which describes the excise tax on private foundations. Colleges and universities are specifically and statutorily excluded from private foundation classification, and yet some may now find themselves subject to tax as though they were. Harvard University President Drew Faust called the tax “unprecedented,” adding that he was “deeply concerned” about the impact on the university’s ability to support students and research.
As an excise tax rather than an income tax, organizations that find themselves subject to the tax need not make quarterly estimated payments. A federal excise tax liability typically will not trigger a state tax liability in the way that federal taxable income would in many instances.