In a September 22, 2016 campaign speech, Republican presidential nominee Donald Trump said he would "end the tax-exempt status of college endowments that don't spend enough of their funds on lowering tuition costs or supporting student activities," Tax Notes Today reports. ("Tax-Exempt College Endowments Need Closer Scrutiny, Trump Says," 2016 TNT 186-4, Sept. 23, 2016.)

Trump asserted that "universities are continuing to receive massive tax breaks for their massive endowments'" while "the cost of attending college has spiked by 500 hundred percent since 1973" and, rather than using enough of their endowment funds to help students pay for college, universities are "using tax-exempt donations to their endowments to pay their administrators or put donor names on buildings or just store it, keep it, and invest it.'"

Trump's strategy would be to "work with Congress on reforms to ensure that universities make good-faith efforts to reduce the cost of college and student debt and to spend their endowments on their students, rather than other things that don't matter" or risk losing "access to federal education subsidies and tax breaks."

Recent congressional hearing

Trump's comments follow a September 13, 2016 hearing before the House Ways and Means Oversight Subcommittee, entitled "Back to School: Review of Tax-Exempt College and University Endowments," that included a discussion of parallels between increased tuition costs, student loan debt, the subprime mortgage crisis, and efforts to control higher education costs. (See Tax Alert 2016-1540.)

In conjunction with the hearing, Rep. Tom Reed (R-NY) issued a press release noting his continuing commitment to the proposed Reducing Excessive Debt and Unfair Costs of Education (REDUCE) Act. The Act would require colleges with endowments larger than $1 billion to distribute a portion of the profits earned as tuition relief for students from working families. Reed also said he also wants to put a spotlight on schools' cost-containment policies.

Testifying at the hearing, Sandy Baum, a Senior Fellow with the Urban Institute's Income and Benefits Policy Center, pointed out that concerns about endowments are focused on a small number of institutions, while most colleges and universities are not so well resourced. Neal McCluskey, Director of the Center for Educational Freedom at the Cato Institute, emphasized that very few institutions have multi-billion dollar endowments. McCluskey also noted that the uses for endowment funds are often restricted by donors and cannot simply be directed to financial aid.

Implications

The idea pitched by Trump and Reed is not new. In 2008, then-Chair of the Senate Finance Committee, Max Baucus, together with Senator Charles Grassley, proposed a mandatory 5% payout for university endowments. As part of Baucus's proposal, letters were sent to 136 colleges with endowments of at least $500m inquiring about their endowment, financial aid and other practices. The Baucus proposal gained little support and ultimately failed. Numerous efforts to regulate endowments at the state level have proved unsuccessful as well.

In general, efforts to regulate university endowments have four common themes: (1) require more transparency from universities; (2) impose a tax on the investment income of well-off schools; (3) modify existing donor-tax laws; and (4) impose a minimum spending requirement on universities.

Calls for more transparency from universities with regard to endowments primarily focus on amending the Form 990 to require more endowment-specific information.

Advocates of a tax imposed on the endowment income of wealthy schools wish to fund financial aid programs with the dollars generated from the tax. Critics of an endowment tax argue that these proposals might be ineffective, as schools can either raise tuition or offset internal financial aid, or both.

Suggested changes in donor laws have concentrated on eliminating deductions for gifts that are restricted for periods of 25 years or more. Also tabled has been a cap on deductions for donations related to buildings, machinery or other campus improvements.

A distribution requirement on educational endowments, like the plans put forth by Mr. Trump and Representative Reed, have been the most popular of the four endowment reform themes among law makers. Under such a measure, universities would be forced to annually spend a certain percentage of their assets. Most versions of these proposals have been modeled on the 5% spending rule of tax-exempt private foundations.

While a 5% distribution rule would require universities to spend a portion of their endowment, the proposals put forth so far do not regulate what the funds could be spent on. Critics of the 5% distribution proposal are concerned that a 5% rule intended to act as a floor for spending may end up becoming a ceiling for institutions that may choose not to spend beyond that rate. Moreover, to make up for the increased spending, schools may engage in risky investment strategies or simply raise tuition rates.

The theory behind endowment regulation is clear, simple and seemingly well-intentioned: Encourage schools to spend more of their endowment income to keep tuition costs down for students and their families. However, what remains unclear is the type of proposals that will ultimately be enacted into law and their effects (both intended and unintended) on the practices of colleges and universities. The recent congressional hearings provide a preview of what may be enacted under future tax reform law and serve as a starting point for the push for tax reform in the endowment arena. Colleges and universities should carefully review the proposals that are currently being evaluated and analyze their effects on internal practices regarding endowment management and spending and also on policies as they relate to tuition spending.

Please contact your EY professional for further information.

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