CONTINUING EDUCATION FOR TAX & FINANCIAL PROFESSIONALS

Tax Byte

The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, fundamentally restructures the excise tax landscape for private higher education institutions. For tax practitioners advising universities or handling their compliance, understanding these changes is critical for 2026 planning.

From Flat Tax to Tiered Structure

The legislation replaces the existing flat 1.4% excise tax on net investment income with a tiered system ranging from 1.4% to 8%, based on the institution’s “student-adjusted endowment.” This represents a significant departure from the Tax Cuts and Jobs Act framework that has governed university endowment taxation since 2017.

Note: The 1.4% rate applies specifically to university endowments under Section 4968. Private foundations face a separate 1.39% tax under Section 4940(a).

New Rate Structure:

  • 1.4% for student-adjusted endowments of $500,000 to $749,999 per student
  • 4% for $750,000 to $999,999 per student
  • 6% for $1,000,000 to $1,999,999 per student
  • 8% for $2,000,000 or more per student

ARTICLE CONTINUES BELOW

Key Definitional Changes

Student-Adjusted Endowment Calculation

The new “student-adjusted endowment” is calculated by dividing the endowment value of a private college or university, and its related entities, by the total number of “eligible students.” Notably, eligible students are those who meet the requirements of section 484(a)(5) of the Higher Education Act of 1965, which typically includes U.S. citizens and permanent residents.

Raised Student Threshold

The legislation requires at least 3,000 tuition-paying students (up from 500 under current law), potentially exempting smaller institutions from the excise tax entirely.

Expanded Tax Base

The definition of net investment income broadens under the OBBBA. Institutions must now include student loan interest income and certain royalty income in their net investment income calculations. This expansion could significantly impact institutions with substantial student lending operations or intellectual property portfolios.

Enhanced Reporting Requirements

Private colleges and universities subject to the endowment tax must report on their annual Form 990 both the number of eligible students and the number of tuition-paying full-time equivalent students. This dual reporting requirement creates new compliance obligations that institutions should prepare for now.

Public Universities Exempted

Public colleges and universities are not subject to the endowment tax. This exemption continues under the OBBBA, creating a competitive advantage for state institutions and potentially influencing donor behavior toward public university foundations.

Impact on Educational Mission

The increased tax burden will directly reduce funds available for core educational activities. For some higher education institutions, there is concern this tax will disproportionately impact typically unrestricted budget categories, including financial aid, faculty and university maintenance and infrastructure. While the tax aims to encourage universities to spend more from their endowments, it simultaneously reduces the total resources available for educational purposes.

Private Foundations Distinction

The OBBBA endowment tax changes apply specifically to private colleges and universities under Section 4968, not to private foundations. Private foundations remain subject to a flat 1.39% excise tax on net investment income under IRC Section 4940(a). The distinction between operating and non-operating private foundations doesn’t affect the university endowment tax calculation.

However, university-related private foundations that provide scholarships or research funding may see increased pressure as their university partners face higher tax burdens and seek alternative funding sources.

Financial Impact Examples (Estimated)

Harvard University – Maximum Tax Impact: Harvard, with its $53.2 billion endowment and approximately 25,000 students ($2.1 million per student), faces the highest tax burden. With $2.4 billion in annual endowment distributions, assuming similar net investment income:

  • Old tax: $33.6 million (1.4%)
  • New tax: $192 million (8%)
  • Additional annual cost: $158.4 million

Duke University – Middle Tier Impact: Duke, with its $11.9 billion endowment and approximately 15,500 students (roughly $769,000 per student), falls into the second tier. However, when only domestic students are counted under the OBBBA (excluding international students), Duke’s per-student ratio exceeds $1 million, placing it in the 6% tax bracket. Assuming $600 million in net investment income:

  • Old tax: $8.4 million (1.4%)
  • New tax: $36 million (6%)
  • Additional annual cost: $27.6 million

Georgetown University – No Tax Impact: Georgetown, with its $3.3 billion endowment and 20,392 students (approximately $162,000 per student), falls well below the $500,000 threshold. Georgetown does not meet the tax criteria and remains exempt from the endowment tax.

Planning Considerations for 2026

Immediate Action Items:

  1. Student Count Verification: Confirm whether the institution has 3,000+ tuition-paying students on a full-time equivalent basis
  2. Endowment Valuation: Calculate current student-adjusted endowment to determine applicable tax tier
  3. Income Source Review: Identify student loan interest and royalty income that will now be subject to tax
  4. Documentation Systems: Establish processes to track eligible students versus total enrollment for reporting
Strategic Planning Opportunities: Given the tiered structure, institutions near tier breakpoints should evaluate timing strategies for endowment distributions or capital transactions. Portfolio managers may consider converting dividend-paying stocks to non-dividend-paying alternatives or other structural changes to mitigate tax impact.

Effective Date and Transition

The OBBBA endowment tax provisions take effect for tax years beginning after December 31, 2025. This provides institutions with a limited window to assess their position and implement any necessary operational changes.

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