The proposed amendment to Internal Revenue Code Section 4968 will increase the excise tax on net investment income for university foundations meeting certain criteria. The endowments of institutions having less than $500,000 in endowment per student, public institutions, and religiously affiliated institutions are exempt from these taxes.
The percentage of tax that will apply to an institution is based on the size of the endowment on a per-student basis using the fair market value of assets at the end of the preceding tax year. For those institutions that meet the criteria, their tax rate may increase from the current baseline of 1.4%, as follows:
If you are a university business officer or foundation executive, there are nuances to the calculation of both the size of the endowment and the number of students that the university has which impact your calculation of endowment per student.
Included v. excluded assets
The snapshot of the endowment is based on the fair market value of assets at the end of the preceding taxable year, excluding “those assets which are used directly in carrying out the institution’s exempt purpose . . .” Presumably, this means that fixed assets such as academic buildings are not included. Whether it would also apply to funds established to endow academic chairs is unclear, though those assets are certainly “used directly in carrying out the institution’s exempt purpose. . . .”
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The largest universities have access to stellar lawyers and tax advisors who will consider ways to stay below the threshold that triggers higher taxes. Institutions may consider creating separate legal endowment entities for each college within the university, funding them either with a portion of gifts already housed in the main university endowment, or using the new entities for “spill over” that would cause the main endowment to meet the triggers for higher taxes.
This has already been contemplated and will be ineffective in avoiding the tax. Subsection (g) articulates a control test, meaning that all related entities’ assets and net investment income are included in the calculation of endowment per student, the applicable tax rate and the taxes owed.
Also consider athletic scholarships. If a separate endowment with separate governance were created for athletics, how will the institution meet the NCAA’s requirement that it annually certify to institutional control? The House settlement means that athletic scholarship approaches will be in flux for the next few years. The proposed increase in endowment taxes adds a new wrinkle to an already complex situation.
Universities may explore use of entities they do not control. For example, directing future gifts into a community foundation not controlled by the university might be effective.
The balance between short-term, spend-it-now gifts and long-term endowed gifts may also shift, with some endowment executives expressing a preference for short-term gifts as an endowment approaches the next tax threshold. Long-term strategies may be sacrificed for short-term strategies.
Calculating endowment per student
Once you hit the threshold of at least $500,000 per student, you owe taxes on the investment income. The higher the endowment per student, the higher the tax rate.
The wild card in calculating the denominator—the number of students—is that the formula for counting students increases the endowment per student. Two factors will decrease the number of students in the denominator. First, noses are not counted. Instead, institutions are required to use “the daily average number of full-time students attending such institution. . .” PT students are considered on an FTE basis. What is not clear is how the “daily average” is calculated. In higher education, we typically use FTEs as reported to IPEDS.
The second factor that will decrease the students is whether a student is an “eligible student.” Only eligible students are used to calculate endowment per student. The term “eligible student” references section 484(a)(5) of the Higher Education Act of 1965. These are students who are citizens, permanent residents, and those who “are able to provide evidence from the Immigration and Naturalization Service that he or she is in the United States for other than a temporary purpose with the intention of becoming a citizen or permanent resident. . . .” An international student with an F-1 or J-1 student visa will likely not count in the institution’s denominator. A high percentage of international students at an institution will increase the endowment per student.
Conclusion
Taxing endowment income hurts college and university students. A recent NACUBO study of endowments found that about half of the $30 billion spent in fiscal year 2024 went to students. A reduction in student support, combined with higher prices as institutions struggle to maintain buying power, will result in fewer students receiving the aid they need to complete degrees.
