Private Colleges Could Risk Losing Their Tax-Exempt Status

U.S. lawmakers are threatening to introduce legislation that could jeopardize the tax-exempt status of private colleges and universities with endowments over $1 billion dollars. Members of the House Ways and Means Committee are currently fine-tuning a draft of the Reducing Excessive Debt and Unfair Costs of Education Act, which would require institutions with endowments over $1 billion to provide a portion of the profits from their investments to students from working-class families for tuition assistance. According to an outline of the bill, schools would be required to pay 25% of their endowment earnings to working-family students, defined as those whose family income falls between 100 and 600% of the poverty line. Should the universities not comply with these regulations, they would face increasing penalties over three years, including taxes and a loss of their tax-exempt status. Currently, there is no spending requirement for private colleges. The committee began its inquiry into tax-exempt endowments following lawmakers concerns that their investment earnings were not being used for educational purposes, but rather for recreational enhancements like “state-of-the-art gyms, rock walls, and even a lazy river.” Since private colleges are classified as nonprofits, they are exempt from local, state and federal taxes and thus are afforded the benefit of funding capital projects with tax-exempt bonds. Losing this tax-exempt status would almost certainly increase their cost of capital. As of fiscal year 2015, Harvard, Yale and Princeton topped the list of the largest endowments among private colleges with $36.4 billion, $26.5 billion and $22.7 billion, respectively. According to a study by the National Association of College and University Business Officers and the Commonfund Institute, all but two of the top 25 private schools with the largest endowments experienced a positive change in the market value of their investments between fiscal year 2014 and 2015. The study also found that endowments had an average return on investment of 15.5% and an average payout rate of 4.4% in fiscal year 2014. While the proposed legislation could have a significant impact on large private institutions, the effect on SNW portfolios would be limited as we prefer slightly smaller college issuers that offer higher yields and wider spreads. 

Sources: Fidelity, Bondbuyer