That is, according to certain U.S. lawmakers, who believe that private colleges and universities with 501(c)(3) status that have at least a $1 billion endowment should be subject to some extra rules and regulations. If these well-endowed private colleges and universities fail to abide by such extra rules and regulations, under the proposed legislation (which is still being drafted), they will be subject to penalties and may even lose their 501(c)(3) status. A private college or university that does not have 501(c)(3) status cannot be the beneficiary of qualified 501(c)(3) bonds issued by a state or local governmental unit. In addition, a private college or university that loses its 501(c)(3) status will be required to start paying federal income tax on its taxable income, and donors to such institutions of higher learning will no longer be able to receive a charitable deduction for their generosity.

The proposed legislation is called the Reducing Excessive Debt and Unfair Costs of Education Act (the “REDUCE Act”). (See the attached summary from the primary author). At the moment, the REDUCE Act would apply to 56 private colleges and universities. All 56 of these well-endowed institutions of higher learning apparently have already received a letter from certain members of Congress inquiring as to how they are currently using the funds in their endowments. Under current law, there are no requirements for how the funds in a private college or university’s endowment should be used, or when (i.e., how quickly) the funds in the endowment need to be used. Certain U.S. lawmakers would like to change that for the overly well-endowed.

The general framework for the REDUCE Act is that private colleges and universities with at least a $1 billion endowment would be required to use at least 25% of the endowment’s annual earnings to offset the tuition of students that belong to “working families.” At this point, a “working family” is defined as a family whose income is between 100% and 600% of the poverty line. For a point of reference, a family of four that makes less than $24,300 annually is below the 2016 federal poverty line. Thus, under the proposed legislation, a college student with one sibling whose family annual income is between $24,300 and $145,800 would be a beneficiary of the REDUCE Act. (It is not clear to me why college students from families whose annual income is below the poverty line are not also included in the beneficiary group.)

If a private college or university failed to utilize at least 25% of its endowment’s annual earnings to offset the tuition of students from working families, the college or university would be subject to increasing penalties. For the first year of non-compliance, the offending college or university would be required to pay a 30% penalty on the earnings that should have been used as a tuition offset but were not. If a second year of non-compliance occurs, the offending college or university would be required to pay a 100% penalty on the earnings that should have been used for tuition offset but were not. Finally, if a third year of non-compliance occurs, the offending college or university would lose its 501(c)(3) status. (In other words, three strikes and you’re out. Big time.) It is unclear at this point if the increasing penalties would only apply to violations in three successive years, or if for example, a private college or university could lose its 501(c)(3) status after having three non-compliant years over a period of more than three years.

On a related note, a legislative panel in Connecticut has decided not to introduce a bill that would have imposed a state income tax on Yale’s endowment, which is currently reported to be over $25 billion. In lieu thereof, a bill has been approved by Connecticut lawmakers that would no longer exempt certain real estate owned by Yale and used for commercial purposes (rather than educational purposes) from property taxes.