Type: Article

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.

TIFF’s Dedicated Sustainable Strategies Mark One-Year Anniversary

RADNOR, PA – July 2021

TIFF Investment Management (“TIFF”), an OCIO manager that oversees $7.5 billion in assets, including committed capital, as of June 30, 2021, is pleased to announce the one-year anniversary of its dedicated sustainable strategies.

While the concept of “sustainable investing” has been garnering increasing interest in recent years, TIFF has long considered environmental, social, and governance (ESG) issues when performing investment manager research.  In 2020, TIFF further expanded our ESG efforts by launching multiple dedicated sustainable strategies designed to help our nonprofit members invest using an ESG-focused approach.

TIFF’s sustainable strategies seek to invest while maintaining a positive environmental and social impact.  The strategies invest in managers TIFF believes are leaders in ESG integration and corporate engagement, as well as thematic managers investing in areas such as energy transition, resource efficiency, water, and healthcare.

TIFF’s sustainable strategies currently invest in public equities, hedge funds, and fixed income.  We engage deeply with our managers and our broader network of stakeholders on ESG and diversity, equity, and inclusion (DEI) issues, seeking to promote best practices across the investment industry.  Through this work, we aim to meet our members’ investments goals while having a positive impact on the world.

For more information, visit https://www.tiff.org/sustainable-investments/.

All investments involve risk, including possible loss of principal.

Not all strategies are appropriate for all investors. There is no guarantee that any particular asset allocation or mix of strategies will meet your investment objectives. Diversification does not ensure a profit or protect against a loss.

This article is being provided for informational purposes only and constitutes neither an offer to sell nor a solicitation of an offer to buy securities. Offerings of securities are only made by delivery of confidential offering materials, which describe certain risks related to an investment and which qualify in their entirety the information set forth herein.

This article is not investment or tax advice and should not be relied on as such. Opinions expressed herein are those of TIFF and are not a recommendation to buy or sell any securities.

Now seems like a good time to share our view on where markets and investors are on the topic of Sustainable Investing today. To start, investor confusion around the terminology and why we should care seems to be ebbing. Yes, sustainability is still defined and perceived in myriad ways, but what it boils down to largely is the efficient use of resources. Any system—a company, an industry, a market, an ecosystem—requires resources to survive. To the extent those resources are harmed or depleted, the survival of that system is at risk. To the extent those resources are maintained or renewed over time, that system has what it needs to sustain itself at least and potentially even thrive. The sustainability movement is a call for change in how we manage our resources, in particular our environmental, human and social resources. Thoughtless exploitation of those resources can work for some period of time and for some portion of the population, but in the end that approach is unsustainable.

Sustainable investing is an extension of this concept. The basic idea is to invest in businesses that employ best practices around the use of all forms of capital: financial, environmental, human, and social. Those businesses possess the best chance not just to survive, but to thrive. And of course sustainable investing also means avoiding businesses with high costs and headline risks due to poor governance and exploitative behaviors. Such behaviors are less and less tolerated by consumers, governments, and regulators. Increasingly, these behaviors make them less attractive to investors, too.