The U.S. House of Representatives passed the long anticipated tax reform bill over two weeks ago on Thursday, November 16th. While the new taxation rates for both corporations and individuals have consumed the majority of headline news, the Tax Cuts and Jobs Act also incorporates several divisive provisions which may significantly impact a number of nonprofit institutions. Some of the original terms have been modified since the bill was first unveiled on November 2nd, however the final House legislation still includes certain requirements striking a chord with U.S. colleges and universities as well as other nonprofit institutions.
The Tax Cuts and Jobs Act mandates a new 1.4% excise tax on the net investment income of any private university with endowments of at least 500 students and more than $250,000 per full-time student. Approximately 70 colleges and universities fall within these parameters. Note that this final number reflects a reduction and conciliation from the initial draft in which the 1.4% excise tax would have applied to private higher education endowments with at least $100,000 per full-time student. Under the original terms, the number of impacted colleges and universities was roughly double at an estimated 150 schools.
In the most recent NACUBO-Commonfund Study of Endowments (NCSE), the 805 participating institutions reported endowment assets of $515.1 billion.1 Notably, the Congressional Research Service underscored the highly concentrated nature of endowment assets with just 11% of institutions holding 74% of all endowment assets.2 Narrowing the universe to the largest private colleges, the excise tax yields tremendous revenue potential for the U.S. With its $36 billion endowment, the largest in the U.S., Harvard University alone would generate an estimated $2-3 billion of new revenue over the next decade.
Numerous colleges and university associations have actively lobbied against the proposed excise tax citing concerns over the potential financial disruption that may result. Endowments generally support a broad range of critical areas, including financial aid for those students unable to meet tuition obligations, scholarships, student programming, research initiatives and operating expenses. Some fear these new expenses may ultimately lead to more constrained budgets and therefore, higher tuition costs, less financial support and reduced services over time. Though the majority of endowments will not be impacted by the excise tax, the current list includes several smaller private universities and liberal arts colleges, not just the Harvard’s and Yale’s of the U.S.
The House bill includes another key provision causing nonprofits much anxiety. As anticipated from earlier drafts, the standard deduction nearly doubles from $6,350 today to $12,000 for individuals. Married couples filing jointly face a $24,000 standard deduction versus $12,700 currently. The Senate’s current tax plan also aligns with the House on this matter. While some policymakers argue that the middle class will actually up their charitable giving with lower taxes, the sizeable standard deduction increase removes the incentive to itemize. It is estimated that 30% of Americans itemize today and that number would likely fall to as low as 5% under the new standard deductions.
According to an annual report by the Giving USA Foundation, charitable contributions eclipsed $390 billion last year. Individual giving comprised 72% or $282 billion of that total and all nine major philanthropic sectors realized increases in 2016 from the prior year.3 With a drastically higher standard deduction and subsequent loss of the charitable deduction for many, nonprofits of all types fear the loss of donations which are often relied upon and necessary for ongoing operations. In addition to offsetting potential cost increases (for example, tuition at universities), providing financial aid and supporting the overall mission, declines in charitable contributions may lead to budget woes and job cuts or worse, jeopardize the viability of the nonprofit institution. The Lilly Family School of Philanthropy at Indiana University estimates a $13.1 billion annual hit to charitable giving as a result of the lower top marginal tax rate and higher standard deduction.
This article in no way serves as a comprehensive review of the 400+ page House legislation and all eyes are on the Senate this week as their own tax plan is dissected. Though the two provisions addressed above pose substantial drawbacks for nonprofit institutions, final tax reform isn’t here quite yet and lofty hurdles remain. In the meantime, we advise ongoing diligence as developments dictate but caution that any short-term investment changes driven by the prospect of tax reform are a recipe for disaster. With updated capital market forecasts and asset allocation modeling on the horizon for most Committees and Boards in early 2018, tax reform, whether clarified or not by year end, presents another reminder to regularly review and scrutinize your current investment strategy, risk budget, spending policy and liquidity requirements. Should nonprofit institutions face a somewhat altered landscape in 2018 and beyond as a result of tax changes, the aforementioned policies may necessitate modifications as a result.
For assistance with asset allocation modeling and portfolio evaluation, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
