Endowment Tax on Wealthiest Universities Netted a Fraction of Predictions in 2021

This is the first year the IRS broke out any details on payments of the tax, which was created in 2017 as politicians criticized wealthy schools for raising tuition while their endowments ballooned. It generally went into effect for the 2018-2019 school year. 

The figures represent tax returns processed in calendar 2021 for schools including Princeton University, the University of Notre Dame, Duke University and Grinnell College. They are mainly based on schools’ tax returns for fiscal years that ended in mid-2020, which included poor market performance during the first few months of the pandemic that may have lowered collections.

“It’s a rounding error for the schools, a rounding error for the government, and really just a thumb in the eye more than anything,” Alex Reid, a tax lawyer and partner at BakerHostetler who represents nonprofit groups, said of the amount of taxes collected. 

When Congress created the tax, the Joint Committee on Taxation estimated that it would generate about $200 million annually, but subsequent IRS guidance allowed for significant carve-outs. Schools are subject to the 1.4% levy on net investment income if they have at least 500 tuition-paying students, more than half of whom are in the U.S., and their endowment is at least $500,000 per student. 

The IRS data doesn’t identify which schools paid the tax. Most colleges that paid the excise tax in the past few years didn’t disclose specific dollar figures in their audited financial statements or publicly available federal tax returns. Nor did they share such details when asked by The Wall Street Journal, though many provided statements expressing their opposition to the tax. 

Princeton, Yale University, the Massachusetts Institute of Technology, Stanford University and Harvard University, which have among the highest per-student endowments based on data from the National Association of College and University Business Officers (NACUBO), all declined to detail their excise tax payments. 

Williams College said it paid $1.1 million based on its fiscal 2021 return and $550,000 the prior year, while Swarthmore College made a $2 million payment in 2021, based on that fiscal year’s tax statement, and $1.4 million the prior year. Rice University paid $2.5 million and $2.6 million for fiscal 2021 and 2020, respectively. 

Excise taxes are generally used to create behavioral changes, like adding taxes on cigarettes to lower smoking rates, Mr. Reid said. 

“It forces universities to think about why they have the endowment and what their end goal is,” said Jennifer Bird-Pollan, a law professor at the University of Kentucky who has written about the endowment levy. 

Even if universities can’t or don’t want to spend down more of their endowments, the tax can prompt them to think about guiding new donations toward immediate spending to benefit students rather than increasing the endowment, where income is subject to the tax, she said. 

Some critics of the levy say it isn’t big enough to force behavioral changes, at least not regarding how schools set tuition. Schools say the tax hurts their ability to benefit students, siphoning off funds that could otherwise be used for scholarships or academic programs.

The excise tax is “a direct penalty on both the gratitude of our donors and a tax on our students,” a Claremont McKenna College spokeswoman said. “Our endowment is not a hedge fund for private gain; our returns are invested in the future of our students.” 

The California school didn’t disclose the size of its excise tax payments, just that it made such payments in its two most recent tax years. 

NACUBO, a lobbying group for school finance chiefs, opposes the tax and would like to see it repealed or rewritten to allow schools to make lower payments if they address tuition costs, said Liz Clark, the organization’s vice president for policy and research.

Some lawmakers have tried to repeal the tax, but thus far their efforts have made little headway in Washington as public sentiment turns increasingly skeptical over rising college costs and the potential payoff of a degree. 

Three Republican House members proposed a bill last month that would tax dozens more schools by using a lower per-student endowment threshold, and would raise the tax to 10%, or 20% if the net price of attendance at applicable schools increased faster than inflation. Rhode Island lawmakers also proposed a 2% tax on endowments, with proceeds earmarked for local public schools.

The Treasury Department initially expected about 40 schools to be taxed. Elinor Ramey, who worked on the rules at Treasury and is now a partner at Steptoe & Johnson LLP, said one reason why the tax may be raising less revenue than projected was because the rules excluded some kinds of income that universities receive that are tied to their mission. Those include royalties from intellectual property created by students and faculty and interest income from student loans, she said. 

Because the tax is based on net investment income, the amount it brings in could fluctuate from year to year, rising along with corporate profits and the stock market as schools receive dividends and sell appreciated investments. And over time, more schools will have to pay the tax because the $500,000-per-student threshold isn’t indexed to inflation. 

Mr. Reid said the full impact of the tax likely isn’t yet clear, as schools could just now be recalibrating how they track and record income and losses and what their investment portfolios include. They may even rethink how many students they enroll, he said, to stay under the $500,000-per-student threshold. 

Write to Melissa Korn at Melissa.Korn@wsj.com and Richard Rubin at richard.rubin@wsj.com

This is the first year the IRS broke out any details on payments of the tax, which was created in 2017 as politicians criticized wealthy schools for raising tuition while their endowments ballooned. It generally went into effect for the 2018-2019 school year. 

The figures represent tax returns processed in calendar 2021 for schools including Princeton University, the University of Notre Dame, Duke University and Grinnell College. They are mainly based on schools’ tax returns for fiscal years that ended in mid-2020, which included poor market performance during the first few months of the pandemic that may have lowered collections.

“It’s a rounding error for the schools, a rounding error for the government, and really just a thumb in the eye more than anything,” Alex Reid, a tax lawyer and partner at BakerHostetler who represents nonprofit groups, said of the amount of taxes collected. 

When Congress created the tax, the Joint Committee on Taxation estimated that it would generate about $200 million annually, but subsequent IRS guidance allowed for significant carve-outs. Schools are subject to the 1.4% levy on net investment income if they have at least 500 tuition-paying students, more than half of whom are in the U.S., and their endowment is at least $500,000 per student. 

The IRS data doesn’t identify which schools paid the tax. Most colleges that paid the excise tax in the past few years didn’t disclose specific dollar figures in their audited financial statements or publicly available federal tax returns. Nor did they share such details when asked by The Wall Street Journal, though many provided statements expressing their opposition to the tax. 

Princeton, Yale University, the Massachusetts Institute of Technology, Stanford University and Harvard University, which have among the highest per-student endowments based on data from the National Association of College and University Business Officers (NACUBO), all declined to detail their excise tax payments. 

Williams College said it paid $1.1 million based on its fiscal 2021 return and $550,000 the prior year, while Swarthmore College made a $2 million payment in 2021, based on that fiscal year’s tax statement, and $1.4 million the prior year. Rice University paid $2.5 million and $2.6 million for fiscal 2021 and 2020, respectively. 

Excise taxes are generally used to create behavioral changes, like adding taxes on cigarettes to lower smoking rates, Mr. Reid said. 

“It forces universities to think about why they have the endowment and what their end goal is,” said Jennifer Bird-Pollan, a law professor at the University of Kentucky who has written about the endowment levy. 

Even if universities can’t or don’t want to spend down more of their endowments, the tax can prompt them to think about guiding new donations toward immediate spending to benefit students rather than increasing the endowment, where income is subject to the tax, she said. 

Some critics of the levy say it isn’t big enough to force behavioral changes, at least not regarding how schools set tuition. Schools say the tax hurts their ability to benefit students, siphoning off funds that could otherwise be used for scholarships or academic programs.

The excise tax is “a direct penalty on both the gratitude of our donors and a tax on our students,” a Claremont McKenna College spokeswoman said. “Our endowment is not a hedge fund for private gain; our returns are invested in the future of our students.” 

The California school didn’t disclose the size of its excise tax payments, just that it made such payments in its two most recent tax years. 

NACUBO, a lobbying group for school finance chiefs, opposes the tax and would like to see it repealed or rewritten to allow schools to make lower payments if they address tuition costs, said Liz Clark, the organization’s vice president for policy and research.

Some lawmakers have tried to repeal the tax, but thus far their efforts have made little headway in Washington as public sentiment turns increasingly skeptical over rising college costs and the potential payoff of a degree. 

Three Republican House members proposed a bill last month that would tax dozens more schools by using a lower per-student endowment threshold, and would raise the tax to 10%, or 20% if the net price of attendance at applicable schools increased faster than inflation. Rhode Island lawmakers also proposed a 2% tax on endowments, with proceeds earmarked for local public schools.

The Treasury Department initially expected about 40 schools to be taxed. Elinor Ramey, who worked on the rules at Treasury and is now a partner at Steptoe & Johnson LLP, said one reason why the tax may be raising less revenue than projected was because the rules excluded some kinds of income that universities receive that are tied to their mission. Those include royalties from intellectual property created by students and faculty and interest income from student loans, she said. 

Because the tax is based on net investment income, the amount it brings in could fluctuate from year to year, rising along with corporate profits and the stock market as schools receive dividends and sell appreciated investments. And over time, more schools will have to pay the tax because the $500,000-per-student threshold isn’t indexed to inflation. 

Mr. Reid said the full impact of the tax likely isn’t yet clear, as schools could just now be recalibrating how they track and record income and losses and what their investment portfolios include. They may even rethink how many students they enroll, he said, to stay under the $500,000-per-student threshold. 

Write to Melissa Korn at Melissa.Korn@wsj.com and Richard Rubin at richard.rubin@wsj.com