What is Endowment Tax?

An endowment tax is a tax levied on endowments, which are sums of money used to maintain institutions like schools and charities. Usually, endowments are subject to special rules and tax authorities often treat the parent institution as a nonprofit, qualifying it for tax exemptions like elimination of endowment tax. In harsher economic times, governments may look on large sums of money retained by institutions as a potential revenue source, arguing that these groups should pay taxes on the money.

A typical endowment tax kicks in when endowments rise over a certain amount. This allows smaller institutions to avoid taxes, making the most of their endowments, while organizations with a great deal of money will incur some tax liability, typically a low flat rate, on funds over the limit. The institution must declare the size of the endowment and provide supporting documentation showing how they invest monies to grow the fund and how they arrange disbursements out of the endowment to make sure it still qualifies for special tax treatment.

Institutions resist taxation on endowments, arguing that the taxes would eat into the money they use to support themselves. Organizations use this money for activities like funding scholarships, improving facilities, attracting star guest speakers and faculty, and so forth. The money is used to advance the aims of the organization and to help it maintain a high profile so it will stay operational. Additionally, people may be less inclined to donate if they know their donations will be taxable, thus potentially exposing institutions to loss of revenue.

Depending on the nation, changing the tax law to assess an endowment tax or change the portions of the tax code discussing endowments can be a lengthy process. The changes may require approval in the legislature and could be attached to a larger bill or discussed on their own. Organizations often lobby against proposed changes in the tax code to protect their endowments and members of the legislature may have to vote against the expressed wishes of potentially powerful members of their constituency like major charities and universities, along with their donors.

Donors receive an endowment tax credit. People donating to qualified charities get tax deductions for their contributions, as long as they keep the documentation. This provides an incentive for people to donate to charities. Tax authorities may have a cap on total deductions to prevent situations where people attempt to evade as much tax liability as possible through charitable donations, particularly donations of a more dubious nature.