CRS Issues Report on College, University Endowments

Date01 February 2016
Published date01 February 2016
Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc
Commentary: How absurd is this? Nearly every
public charity has employees, most of whom are
trained to do what they do. There is nothing in the
federal tax law mandating the use of volunteers (or
untrained employees, for that matter).
7. Commerciality is deemed evidenced where a public
charity does not receive charitable gifts. Commen-
tary: The federal tax law does not mandate that a
public charity receive contributions. IRC § 509(a)(2)
makes it clear that an organization can be supported
entirely by exempt function revenue and nonetheless
be a public charity.
The IRS uses all of these elements in writing adverse
private letter rulings, except number 4. Even the IRS
can’t seem to stomach that one.
Thus, the commerciality doctrine features nonsensi-
cal criteria that are being applied inconsistently. The IRS
sees fee-charging, the slightest hint of competition with
for-profit organizations, and/or marketing, and pro-
claims commerciality and squelches exemption. Courts
are too quick to follow along, slapping the label of com-
merciality on an activity just to pronounce it nonexempt.
There are other bodies of law to utilize to get to
the conclusion as to nonexempt activity, when neces-
sary, without invoking the commerciality doctrine: the
operational test, the unrelated business rules, the private
inurement doctrine, and the private benefit doctrine
(although that latter body of law is also overused by the
IRS). The commerciality doctrine should be junked.
The Congressional Research Service, in a report made
public on December 4, provided background informa-
tion on college and university endowments, and sum-
marized various options for changing their treatment
under the federal tax law.
This report discusses college and university endowment
fund basics, with the term endowment defined simply as an
“investment fund maintained for the benefit of the educa-
tional institution.” Definitions are provided for true endow-
ments, otherwise known as permanent endowments,
including those with restrictions imposed by donors. Also
referenced are term endowments and quasi endowments.
For 2014, $226.6 billion (44 percent) was held in
true endowments and $119 billion (23 percent) was in
quasi endowments. Of the true endowment balance,
$210.3 billion was donor-restricted. The term endow-
ment balance was $17.9 billion.
Other Statistics
At the close of fiscal year 2014, endowment balances
for the 832 institutions included in the National Asso-
ciation of College and University Business Officers–Com-
monfund Study of Endowments totaled $516 billion.
Endowment assets are concentrated, with 11 percent of
institutions holding 74 percent of all endowment assets.
Institutions with the largest endowments (Yale, Princeton,
Harvard, and Stanford) each hold more than 4 percent of
total endowment assets. For this fiscal year, endowments
earned an average return of 15.5 percent.
An increasing proportion of endowment funds has been
invested in alternative investments, including private equity
and hedge funds. Large endowments, the report observes,
are more likely to invest their funds in alternative strategies.
Spending from endowments, this report states,
“supports various higher education activities.” For 2014,
the payout rate for these institutions was 4.4 percent.
The report states that, “[o]n average, in recent years,
institutions with the largest endowments have tended
to have payout rates that exceeded average payout rates
for institutions with smaller endowments.”
Tax Law Treatment of Endowments
College and university endowments are tax-exempt,
either because they are components of exempt institu-
tions of higher education or they have their own recog-
nition of exemption. Contributions to these endowment
funds are generally tax-deductible. Investment earnings
of these funds generally are not taxable.
Policy Considerations and Options
The CRS report observes that there are a number of
options relating to the tax treatment of endowments
should policymakers decide to “change the status quo.”
As always, “[p]olicy options considered may depend on
the overarching policy objective.” The report notes one
of the options: “Leaving current-law tax treatment of
endowments unchanged.” Here are four other policy
options discussed in this report.
One option is to impose an annual payout requirement
on endowment funds. Often, the proposal is to have a
minimum 5 percent payout rate, similar to that required of
private foundations. In this context, of course, there are pro-
posals to force colleges and universities to use endowment
resources to reduce the cost of higher education and make
college education more accessible. As discussed in the
report, there are many complexities attending this proposal,
such as restricting a payout requirement to certain types
of endowments, tying the payout to investment earnings,
measuring a payout over a multiyear period, or associating
a payout with metrics such as tuition levels or student need.
Critics of this approach note that most endowment gifts
(around 90 percent) are restricted as to use by donors.
Another option is to tax endowment earnings. One
approach would be to follow the tax-rate regime used in

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