Final endowment tax rules tailor the policy for colleges

Dive Brief:

• The IRS and the U.S. Department of the Treasury issued final rules for how they will implement the so-called endowment tax on private universities that the 2017 Tax Cuts and Jobs Act established.
• The tax applies a 1.4% levy to the net investment income of private colleges and universities that enroll at least 500 tuition-paying students and whose endowments are valued at $500,000 or more per student.
• The final rules include changes from interim rules posted last year that at least two higher education groups say could benefit colleges. 

Dive Insight:

Private colleges pushed back on the tax, and industry groups pressed for exemptions. The final rules, which have yet to be published in the Federal Register, show the sector gained at least some ground.

“Despite the fact that most schools don’t want to pay this tax, the final rule looks to be fairly good news in a time that we are seeing a lot of uncertainty and disruptions on college campuses,” said Liz Clark, vice president for policy and research at the National Association of College and University Business Officers (NACUBO). NACUBO, which commented on the proposed rule, estimates several dozen institutions are paying the tax and more will join the list over time, Clark said. 

The new rules draw a clearer distinction between private colleges and private foundations, the group the legislation intended to treat them more like. Private foundations were being taxed before the 2017 law passed. 

One way the rule carves out space for postsecondary institutions is by excluding certain types of income from being taxed — among them, interest income from student loans issued by the institution, revenue from student and employee housing, and royalties from intellectual property.

While private foundations tend to have a narrow mission and distribute their assets as grants, colleges have a broader scope, said Steven Bloom, assistant vice president for government relations at the American Council on Education, which undersigned NACUBO’s comment. That includes physical plants, managing housing, and providing grants to thousands of students, he added.

As such, while the terms are narrow for what income private foundations can deduct, the final endowment rules have widened them for colleges to say that certain income is advancing their educational mission, Bloom said.

Changes to the rules also give schools “more room” to demonstrate how much cash they need to have on hand to effectively run the institution, Clark said. 

And they clarify which institutions qualify for the tax. Colleges enrolling 500 or more tuition-paying students fall under the tax’s purview. But while the proposal defined “tuition-paying” as paying any tuition or fees to attend the school, the final version excludes federal scholarships and grants, including the Pell Grant, as a form of tuition payment. 

These changes may not have a major impact on the colleges subject to the tax, which was designed to apply “pretty narrowly” to institutions with the largest endowments, said Charlie Eaton, a sociology professor at the University of California, Merced, who studies endowments. 

For instance, he’s skeptical those schools enroll enough low-income students — who would be more likely to qualify for federal aid — for the changes around what tuition income counts to matter.

And the new exemptions to taxable income aren’t typically what people would think of as endowment revenue, he added.

“We’ll learn more as it’s implemented,” he said.