Section 70415 of Public Law 119-21 rewrote section 4968, the excise tax on the net investment income of certain private colleges and universities. The old structure is replaced by a three-tier rate schedule keyed to endowment per student: 1.4 percent, 4 percent and 8 percent. It applies to taxable years beginning after December 31, 2025, so a college with a June 30 fiscal year first meets it in the year beginning July 1, 2026.
The rate is applied to the whole of net investment income, not to a slice, so a small move in endowment per student can change the bill by a large amount. Auditors of private institutions and the CPAs who prepare their returns need the three inputs: which institutions are covered, how student-adjusted endowment is measured, and what counts as net investment income.
Which institutions are covered?
Section 4968(c) defines an applicable educational institution as an eligible educational institution, as defined in section 25A(f)(2), that meets four tests:
- It had at least 3,000 tuition-paying students during the preceding taxable year.
- More than 50 percent of its tuition-paying students are located in the United States.
- Its student adjusted endowment is at least $500,000.
- It is not described in the first sentence of section 511(a)(2)(B), which covers state colleges and universities.
All four must hold. An institution that falls below 3,000 tuition-paying students is outside the tax. Section 6033(o), added by the same section of the act, requires covered institutions to report their tuition-paying student count and total student count on their return.
How are the tiers set?
Section 4968(b) imposes a tax equal to the applicable percentage of net investment income, with the percentage set by student adjusted endowment:
| Student adjusted endowment | Applicable percentage |
|---|---|
| At least $500,000 and not over $750,000 | 1.4 percent |
| Over $750,000 and not over $2,000,000 | 4 percent |
| Over $2,000,000 | 8 percent |
An institution below $500,000 per student is not an applicable educational institution. The boundaries are literal: $750,000 exactly is in the 1.4 percent tier and $750,001 is in the 4 percent tier.
How is student-adjusted endowment measured?
Under section 4968(d), the student adjusted endowment is the aggregate fair market value of the institution's assets at the end of the preceding taxable year, excluding assets used directly in carrying out the institution's exempt purpose, divided by the number of students.
Section 4968(e) counts students using the daily average number of full-time students, with part-time students counted on a full-time equivalent basis. The count applies to the tests in subsections (c) and (d), including counts for a particular location. The 3,000 and 50 percent tests look at tuition-paying students, while the per-student division uses the number of students of the institution. Section 6033(o) has the institution report both figures on its return, so the workpaper should keep the two counts apart.
Related organizations matter. Under section 4968(g), the assets and net investment income of a related organization are treated as the institution's, with two limits: no amount is counted for more than one institution, and unless the related organization is controlled by the institution or is a section 509(a)(3) organization, amounts not intended or available for the institution's use are excluded. A related organization is one that controls or is controlled by the institution, is controlled by the same persons, or is a supported organization or section 509(a)(3) organization. The statute directs the Secretary to issue guidance to prevent avoidance, including through restructuring of endowment funds (section 4968(h)).
What is net investment income?
Section 4968(f)(1) determines net investment income under rules similar to section 4940(c), the private foundation computation. The section adds two items to gross investment income:
- Interest income from student loans made by the institution or a related organization
- Federally-subsidized royalty income, as defined in section 4968(f)(2)(B)(ii)
The audit consequence is that student loan portfolios and royalty streams sit in the base even when they never appear in the investment pool.
What does a computation look like?
Worked example. A private university has 5,000 students under the section 4968(e) count, 4,200 tuition-paying students in the preceding year, 80 percent of whom are in the United States, and net investment income of $120,000,000 for the year. It is not a state institution. The coverage tests are met: 4,200 is at least 3,000, 80 percent is more than 50 percent. The tier depends on assets at the end of the preceding year, excluding assets used directly in the exempt purpose.
| Non-exempt-use assets | Per student (divide by 5,000) | Tier | Tax on $120,000,000 |
|---|---|---|---|
| $3,500,000,000 | $700,000 | 1.4 percent | $1,680,000 |
| $3,750,000,000 | $750,000 | 1.4 percent | $1,680,000 |
| $4,500,000,000 | $900,000 | 4 percent | $4,800,000 |
| $11,000,000,000 | $2,200,000 | 8 percent | $9,600,000 |
Moving from $3.75 billion to $3.755 billion of qualifying assets takes the per-student figure from $750,000 to $751,000 and the tax from $1,680,000 to $4,800,000, an increase of $3,120,000. A year-end valuation, an asset classification between exempt-use and investment, or a related-organization attribution can therefore move the result.
What should the audit and tax files hold?
- Coverage memo. Tuition-paying student counts for the preceding year, the U.S. share, and the section 511(a)(2)(B) status, tied to enrollment records.
- Student count schedule. Daily average full-time students plus full-time equivalents for part-time students, by location where relevant.
- Asset classification. Year-end fair value by asset, split between assets used directly for the exempt purpose and others, reconciled to the statement of financial position. See the nonprofit endowment and donor restriction audit guide for fair value and restriction evidence.
- Related organization map. Entities that control or are controlled by the institution, with the section 4968(g) inclusion or exclusion reasoning.
- Net investment income workpaper. Section 4940(c) style computation, with student loan interest and federally-subsidized royalty income separately shown.
- Tier sensitivity. A short table like the one above, so management sees how close the institution is to a boundary before the year-end close.
For related higher education work, see the higher education audit guide, the college and university Title IV audit, Form 990 reconciliation to audited financial statements, and Form 990-T for auditors.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- Cornell Law School Legal Information Institute, 26 U.S.C. 4968: https://www.law.cornell.edu/uscode/text/26/4968
- U.S. Government Publishing Office, Public Law 119-21, section 70415: https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm
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