Keelan: A nonprofit endowment tax?

By Don Keelan

Buried deep in the U.S. Tax Code is Section 531. It is there that a dreaded tax for corporations resides — the accumulated earnings tax. The 20 percent tax is applied to excess corporate earnings that are being held by a company for no reason other than to avoid having to pay out dividends taxable to its shareholders. The tax is in addition to the corporate income tax.

Section 531 came to mind when I read Megan O’Neil and Joshua Hatch’s commentary in the August 2017 issue of The Chronicle of Philanthropy, which states, “Hundreds of nonprofits across the country are amassing huge endowments as they collect money far faster than it is going out the door, according to a Chronicle analysis.” The analysis studied 1,600 nonprofits.

Readers of my column may recall that in August 2014 I wrote about this subject (“Wealthiest (nonprofits) Keep Getting Bigger”). And according to O’Neil and Hatch, that is exactly what has taken place between 2010 and 2015.

The authors pointed out that five universities in 2015 — Harvard, Yale, Princeton, Stamford and MIT — had an endowment accumulation of more than $120 billion, an increase of $44 billion since 2010. With the Dow Jones Stock Index up over 26 percent since 2015, their endowment values are conceivably much higher in 2017.

When one looks at all of the country’s private colleges, there is over $350 billion sitting in endowment investments. Add this to the amounts held by cultural and medical institutions and the accumulated endowment funds are close to $1 trillion. It is no wonder, as the authors have pointed out, that Congress is gearing up to take a close look at what should be done with such a vast accumulation of wealth.

Nonprofit endowments, as well as corporate accumulated earnings, can serve a valid purpose. In the latter, the funds have been saved for future expansion, inventory build-up or acquisitions. Notwithstanding, in some cases companies just want to avoid having their shareholders pay additional taxes on dividends.

Nonprofit organizations may have justification to build their endowments for similar constructive reasons, with an additional caveat: to use the funds to offset operational costs by drawing down endowment investments by 5 percent annually. However, the motivation for Congress to look hard at endowments, according the Chronicle piece, will be that “dollars are being added to the funds at a much greater rate than the nonprofits are spending them.”

Presently, in the private foundation world, unless 5 percent of accumulated assets are distributed annually, a tax is levied on the difference. This would apply to nonprofits such as the Gates, Ford, Buffett, and Clinton foundations, just to name a few.

It is not a recent phenomenon that Congress has begun to take a hard look at nonprofits. This economic sector’s growth and influence over the past 20 years has invited it. Economic success does attract attention, some of which the nonprofit sector would like to avoid.

Nonprofits that have large endowments can take initiative before Congress gets involved. One suggestion would be to adopt a payout ratio that for every $1.50 earned, $1 is paid out. In the Chronicle article there are examples of nonprofits where for every $500 of earned income only $1 is paid out.

Another suggestion is for the healthiest and wealthiest endowment funds to adopt a struggling local or regional nonprofit — such as an education, health care, social or cultural nonprofit — and be its beneficiary.

Would it be conceivable for the five institutions noted above to examine their needs and determine that 10 percent of what they have accumulated is redundant? If so, some $12 billion could be set aside, and the annual income from such a fund could be distributed (subject to any donor restrictions) to nonprofits that are in need of funding to carry out their missions.

Nonprofits with huge endowments need to change. Otherwise, they, too, might be subject to Section 531 of the U.S. Tax Code.

Don Keelan writes a bi-weekly column and lives in Arlington, Vermont.

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