If there is one area of common ground between the Republican leadership in the U.S. Senate and House of Representatives, it is that the time has finally come for those entities that are not currently paying their fair share of taxes to step forward and be held accountable. Both the Senate and House tax reform bills propose that these entities—which have traditionally been afforded favorable tax treatment under the Internal Revenue Code—should no longer be entitled to shield their revenues from U.S. income tax. What are these taxpayer-subsidized entities that the Senate and House both agree should be subject to new tax burdens? Many readers will be surprised to hear that the answer to this question is private, non-profit U.S. colleges and universities rather than multinational, for-profit corporations.
The following is a summary of the common threads and points of departure for the portions of the Senate and House tax reform bills relating to college and university endowments and tuition assistance programs.
- Both the Senate and House bills propose an excise tax equal to 1.4% of the net investment income of an “applicable educational institution.” This proposal generally means that private colleges and universities with an annual endowment of $125 million (at least 500 students at $250,000 each student) or more would be subject to the new net investment income tax (“NIIT”) on investment income. Although the threshold for determining which institutions will be subject to the NIIT is based on the amount of the institution’s annual endowment, the 1.4% tax will apply only to the institution’s investment earnings rather than the annual total of its endowments.
- Both the Senate and House bills propose to essentially double the standard deduction for individuals, which the Tax Policy Center projects will reduce the number of taxpayers who itemize their deductions by 84%. Increasing the number of taxpayers who claim the standard deduction will generally reduce the tax incentive for taxpayers to make deductible contributions to colleges and universities, although both bills also propose to increase the income-based percentage limit for individual charitable contributions from 50% to 60%.
Points of departure
- The House bill proposes to repeal Code section 127, which excludes tuition waivers and discounts from the gross incomes of undergraduate and graduate students, whereas these waivers and discounts would continue to be tax-free for students under the Senate bill.
- The House bill proposes to replace the two standard tuition credits under current law—the American Opportunity Credit worth a maximum of $2,500 per year for each eligible undergraduate student and the Lifetime Learning Credit worth a maximum of $2,000 for each eligible undergraduate or graduate student—with a single American Opportunity Credit worth a maximum of $2,500 for each eligible four-year undergraduate student with a 50%-reduced credit in the fifth year, which essentially means that there are no tuition credits for graduate students under the House bill. The Senate bill does not propose any changes to the current tuition credit structure.
- The House bill proposes to repeal the current employer-paid tuition credit worth as much as $5,250 for each eligible student, whereas the Senate bill would retain that credit.
- The House bill proposes to eliminate tax-exempt private activity bonds (PABs), which many colleges and universities issue in order to finance major development projects by paying tax-free interest to bondholders at very low interest rates. The Senate bill does not propose any changes to the current tax treatment of PABs.
- The House bill proposes to eliminate the individual deduction for student loan interest, whereas the Senate bill retains this deduction.
Subsidizing corporate tax cuts by increasing tax burdens on universities and their students is shortsighted tax policy
The House bill and, to a lesser extent, the Senate bill include a package of comprehensive revisions to the traditional tax-exempt status of colleges and universities that would be unlikely to withstand scrutiny if proposed independently of major tax reform legislation. But in the context of so many other significant tax reform proposals—most notably, reducing the corporate income tax rate to 25% and shifting to a territorial corporate tax system—these proposed tax changes for colleges, universities, and their students fly relatively low on our collective radar.
However overshadowed these college and university tax changes may be, they will nevertheless have a major impact on endowment programs nationwide. The House bill would impose significant additional individual tax burdens by repealing tuition waivers and graduate tuition credits and would impose additional college and university-level development burdens by repealing PABs, but the Senate’s reluctance to repeal these particular tax benefits indicates that some form of compromise is likely on the horizon. In contrast to these House-specific provisions, the 1.4% tax on investment income—which would have the most immediate and detrimental impact on colleges and universities with high endowment-to-student ratios—is present in both the Senate and House bills and is therefore likely to remain in the final version of the legislation.
What are the stakes associated with these tax changes for colleges and universities? As Paula A. Johnson, president of Wellesley College, aptly states in her most recent letter to the Wellesley community, “Congress’ tax bill as proposed would take a damaging toll on Wellesley’s ability to sustain the financial aid policy that enables the college to enroll a socioeconomically diverse student body.” A healthy endowment is essential for colleges and universities to keep pace with changing technology and to recruit those students whose academic potential significantly exceeds their families’ financial means. In the midst of the pervasive narrative that the proposed tax legislation represents an across-the-board tax decrease, New England colleges and universities must vigilantly defend the position that corporate tax cuts should not even be partially subsidized by reversing tax advantages for academic institutions that have persevered as a matter of public policy for over 100 years.
Matthew A. Morris is a partner at the law firm of Bowditch & Dewey LLP, who focuses his practice on federal, state, and international tax planning and tax controversy resolution for businesses, individuals and nonprofit entities.