Category: Insights

Executive Summary

• Congress is currently discussing multiple endowment tax proposals.
• While most colleges today pay no federal tax as nonprofit institutions, the 2017 Tax Cuts and Jobs Act (TCJA) introduced a 1.4% excise tax on the wealthiest of endowments. Fifty-six institutions paid that tax in 2023.[i]
• The new proposals look to (1) increase the existing excise tax from 1.4% to 21%[ii] or above, and (2) expand the applicability of the tax to include a broader range of institutions by reducing the endowment assets per student criteria.
• While there are many opponents, certain groups believe some version of these proposals will get passed.
• The greatest impact on affected institutions would be the reduction of funds available to the institutions to support their mission, whether financial aid or general operating budget.
• Higher endowment taxes will also raise the required rate of return for endowments. TIFF is available to assist clients in navigating these challenges and understanding the potential implications for their portfolios.

The Impact of Proposed Endowment Tax Changes

The discussion surrounding the taxation of college endowments is intensifying as legislators evaluate potential amendments to the existing tax regulations. The most well-known proposed changes have centered around increasing the rate at which endowments are taxed and broadening the group of colleges and universities that are impacted. If enacted, these proposals could materially change the financial strategies of these institutions.

Understanding the Current Excise Tax

Historically, colleges and universities operated as tax-exempt nonprofits, with no taxes paid on donations or investment earnings. However, during the first Trump administration, the Tax Cuts and Jobs Act (TCJA) of 2017 introduced an endowment tax. The existing tax is as follows:

• Tax: 1.4% excise tax on net investment income.
• Criteria for inclusion: (1) private institutions with (2) at least 500 tuition-paying students and (3) endowment assets exceeding $500,000 per full-time student.

The rationale behind the tax was to generate additional revenue and address concerns that educational institutions were not contributing enough to public finances. The tax aimed to encourage colleges and universities to use their endowment funds to reduce tuition costs and increase student aid.

The tax affects only the wealthiest of private colleges and universities. In 2023, 56 universities paid about $380 million in endowment tax, up from about $68 million in 2021 from 33 institutions1. The tax threshold for qualifying for taxation is not adjusted for inflation, resulting in an increasing number of schools becoming liable for the tax over time. As college and university endowments continue to grow, the associated tax revenue will grow as well.

Proposed Changes to the Endowment Tax Law

The Trump administration’s tax proposals for 2025 focus on extending and potentially expanding some of the provisions of the TCJA of 2017, which are set to expire at the end of this calendar year. While the endowment excise tax is permanent, it has garnered attention due to its significant revenue-generating potential and the current federal budget deficit.

Proposed adjustments to the endowment tax focus on two potential changes:

• Increasing the excise tax rate: Proposals suggest raising the tax rate from 1.4% to 10%, 14%, 21% or potentially even higher.
• Expand the number of colleges and universities subject to the tax: Proposals range from no change to lowering the criteria to $200,000 of assets per student. Rep. Michael Lawler (R-NY-17)’s Endowment Accountability Act proposes the reduction to $200,000 of assets per student[iii] while Rep. Troy E. Nehls (R-TX-22)’s Endowment Tax Fairness Act does not include an expansion.

As with TCJA of 2017, the objective is to raise federal revenue further to reduce the national deficit.[iv] Taxfoundation.org estimates that increasing the endowment tax from 1.4% to 21%, with a 7.5% average annual endowment return, would generate about $69.8 billion in extra revenue over 10 years.

Taxing Endowments: Revenue Analysis of an Endowment Tax

Source: Taxfoundation.org

How Likely Is this Expanded Endowment Tax to Pass?

These proposals are still in the early stages, and there are many opponents. Certain groups believe changes are likely due to the administration’s focus on fair resource distribution and raising federal revenue. The first Trump administration passed the first-ever endowment tax, albeit small, and the second Trump administration has struck an action-oriented tone. It remains to be seen what is approved, if anything, and in what form.

Potential Implications of the Proposed Tax Law Changes on Impacted Endowments

For those impacted, the proposed increase in the endowment tax would undoubtedly reduce the amount of endowment funds available to support the institution’s mission. Colleges and universities are preparing for possible tax changes and trying to understand how these challenges might affect the higher education landscape more broadly.

School business offices are thinking about the impact higher taxes will have on:

• College affordability: Higher taxes could reduce funds for tuition assistance and scholarships, making college less affordable for some students.
• Budget and spending: Tuition alone doesn’t cover education costs, so institutions rely on endowments and donors to fill the gap. Reduced support from the endowment could force cuts to student services, infrastructure, and other areas.
• Research funding: Increased taxes could lead universities to scale back research initiatives, affecting advancements in science, technology, and medicine.
• Charitable giving: Higher taxes might deter future donations, as donors may not want part of their gift to go toward taxes.

The long-term effects of taxing endowments are a topic of debate. However, the bottom line is that colleges and universities will need to generate returns to offset any tax burden. Given that most colleges and universities pursue an investment return of inflation plus spend (historically around 8% and not always easy to achieve), compensating for an increased tax burden will lead to changes in investment strategy.

Conclusion

Legislators are closely examining the nonprofit sector to generate funding for other projects and ensure that wealthy educational institutions contribute more to public finances. Forecasting the future of the tax landscape is difficult and as a result, colleges and universities are beginning to prepare for the unknown. Those responsible for overseeing the endowment are engaging in several activities to prepare:

• Maintaining communication with the college and university’s tax and legal counsel to stay informed about developments in tax law.
• Forming advocacy consortiums to ensure their collective point of view is heard around the role and benefits of endowments.
• Discussing with the business office the implications of possible tax law changes on the college and university’s budget and spending.
• Exploring tax-efficient investment strategies that could help mitigate a larger potential tax burden.

While the direction of tax reform is uncertain, TIFF is prepared to assist higher education institutions in meeting their financial needs. For more information, please contact info@tiff.org.

The materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute an offer or advertisement of TIFF’s investment advisory services or investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

These materials may contain forward-looking statements relating to future events. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of such terms or other comparable terminology. Although TIFF believes the expectations reflected in the forward-looking statements are reasonable, future results cannot be guaranteed.

[i] Endowments impacted under the current tax include Harvard University, Yale University, Princeton University, Stanford University, Massachusetts Institute of Technology (MIT), the University of Pennsylvania, Northwestern University, Washington University, Duke University, and Vanderbilt University per https://nehls.house.gov/media/press-releases/rep-troy-e-nehls-introduces-bill-hold-elite-university-endowments-accountable.

[ii] 21% is proposed in Rep. Troy Nehls (R-TX)’s Endowment Tax Fairness Act, which would match the federal corporate income tax rate. The House Ways & Means Committee’s Chair Jason Smith (R-MO) outlined a 14% rate. Rep. Michael Lawler (R-NY)’s Endowment Accountability Act proposes 10%.

[iii] https://lawler.house.gov/news/documentsingle.aspx?DocumentID=3716

[iv] Rep. Troy E. Nehls (R-TX-22)’s Endowment Tax Fairness Act states its objectives as “The revenue derived from the amendment made by this section shall be deposited in the general fund of the Treasury and shall be used to reduce the national deficit, to the extent thereof, and thereafter to reduce the national debt.”

The NACUBO-Commonfund Study of Endowments FY24 average 1-year performance for all institutions is 11.2%, bringing the 10-year average return to 6.8%.

1. For the second year in a row, the biggest performance driver was the allocation to private equity and venture vs. public equities. Private equity returned 5.8%, and venture returned 1.7%, while the S&P 500 returned 24.6%, a spread of 19-23%.
2. High allocations to public equities, and in particular the “Magnificent 7” outperformed. Portfolios with more S&P 500-like investments (passive or US Large Cap active managers with low tracking error). Many active managers underperformed as they were underweight the Mag 7.
3. Real estate exposure continued to hurt larger endowments, which tend to have larger allocations. Private real estate returned -1.3%, as the industry continues to reconcile with higher interest rates and the reduction in office demand post-Covid.
4. Hedge funds continued to outperform fixed income and bonds. Diversifying Strategies such as hedge funds (+8.7%) continued to outperform both traditional fixed income as well as the broader investment grade bonds.
5. For the second year in a row, smaller endowments outperformed larger endowments, on average. Because private market allocation (private equity, venture, and real estate) tends to be positively correlated with endowment size, larger endowments with larger private allocations underperformed smaller endowments with lower private allocations and higher public allocations. The largest endowments returned 9.1%, while the smallest endowments returned 13.0%.

FY24 Asset Class Returns

Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance. There is no guarantee that any particular asset allocation or mix of strategies will meet your investment objectives.

These materials are provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute an offer or advertisement of TIFF’s investment advisory services or investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

These materials may contain forward-looking statements relating to future events. In some cases, you can identify forward looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of such terms or other comparable terminology. Although TIFF believes the expectations reflected in the forward-looking statements are reasonable, future results cannot be guaranteed.

For nonprofit organizations, the endowment/foundation’s ultimate purpose is to support the organization and its activities, accomplished through the annual spend or withdrawal (“the spend”) from the endowment to be used as funds for the operating budget. The Spend Policy is the agreed formal policy that governs how much is taken from the endowment and how the amount will be calculated. The Spend Policy is not merely a procedural requirement but a cornerstone of effective endowment management. Beyond being a hallmark of good governance, it is imperative for stewards of capital to grasp the intricacies of the Spend Policy and its impact on the institution’s financial health and mission fulfillment. With over three decades of dedicated service to the nonprofit sector, TIFF stands ready to offer expert guidance and collaboration in the development and refinement of your Spend Policy, helping you to secure a sustainable and prosperous future for your organization.

This paper outlines the fundamentals of Spend Policy, equipping any Business Officer or Investment Committee member with the information to discuss and understand this important topic.

1. Spend Policy best practices
2. Various methodologies for calculating the spend
3. Industry level data on average spend rates
4. Operating budget implications

These points are brought to life through higher education industry data from NACUBO FY23 Study of Endowments and real case studies from Ivy League schools.

The materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute an offer or advertisement of TIFF’s investment advisory services or investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

As Kane Brenan, TIFF’s CEO, reflects on his nearly five years with the firm, he takes pride in the advancements made in supporting TIFF’s clients’ organizational goals. While TIFF’s mission remains the same, there have been notable strides in strengthening the team, enhancing the investment program, offering more tailored advice, and more.

Read more about TIFF and our outlooks for the year ahead here.

The materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

At TIFF, we aim to add value to our clients in two distinct ways. First, we provide advice on Strategic Asset Allocation, or “SAA.” We define SAA as the long-term portfolio weightings that, in light of an organization’s unique financial circumstances, help it accomplish its long-term goals. Second, once we agree on an SAA and an associated benchmark, we seek to achieve net-of-fee alpha above and beyond that benchmark. If we can deliver on these two value-adds, we are likely to have success in enhancing the missions of our nonprofit clients.

SAA and benchmarking are handled very differently across the outsourced chief investment officer (OCIO) industry, with firms taking a variety of approaches. The objective of this paper is to provide some detail around our framework for each. More specifically, we will address:

• Why we define SAA as the allocations to four major asset classes, rather than a more granular and detailed universe of asset classes
• Our rationale for using risk-equivalent public market composites as benchmarks, rather than other options that may not be investable or transparent in their construction

The structure of the SAA and benchmark may not seem quite as critical as other investment decisions. We would argue however, that the downstream effects of these structures can be quite impactful over the long-term.

The materials are being provided for informational purposes only and constitute neither an offer to sell nor a solicitation of an offer to buy securities. These materials also do not constitute investment, legal or tax advice. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.