IRS Issues Proposed Endowment Tax Rules on Certain Universities

July 31, 2019

The IRS recently issued proposed regulations (the “Proposed Regulations”) relating to a newly enacted excise tax on net investment earnings of certain wealthy colleges’ endowment funds (the “Endowment Tax”). While the Endowment Tax does not affect every college endowment fund, it affects some of the largest endowments that often make investments into private equity, real estate and hedge funds.

The Endowment Tax, added to the Code as part of the Tax Cuts and Jobs Act of 2017, imposes a 1.4% excise tax on the net investment income of certain private colleges and universities (or their endowment funds). The Endowment Tax generally applies to private colleges and universities with at least 500 tuition-paying students and with assets (other than assets used directly for carrying out the institution’s exempt purpose) of at least $500,000 per full-time student. The Proposed Regulations define terms necessary for colleges and universities to determine whether the Endowment Tax applies to them and how to comply with it.

The Endowment Tax is an investor-level burden; accordingly, most investment funds and fund managers should not be directly affected by this tax. Affected colleges and universities should be thinking about the Endowment Tax and may wish to restructure investments. It is possible that affected investors may wish to move an investment from an onshore feeder fund to an offshore feeder fund, if it is available in the investment fund’s structure, or otherwise utilize blocker corporations. Such restructuring could result in deferral of the Endowment Tax until a redemption or other liquidity event, depending on the structure and strategy of the fund.

For additional information on the Endowment Tax or other recent tax changes, please contact please contact Ronald P. Cima (212-574-1471), Jonathan P. Brose (212-574-1615), James C. Cofer (212-574-1688), Peter E. Pront (212-574-1221), Daniel C. Murphy (212-574-1210), Brett R. Cotler (212-574-1269) or Xavier Campos (212-574-1293).