On Tax Day, President Trump publicly advocated for revoking Harvard University's tax-exempt status because Harvard rejected an “agreement in principle” the Trump administration proposed to settle disagreements over the school's policies and leadership. The Internal Revenue Service (IRS) is reportedly preparing to follow through with Trump’s proposal and revoke Harvard’s tax-exempt status in the near future. Secretary of Education Linda McMahon speculated the IRS may review the tax-exempt status of other universities.
The United States is home to over 1.8 million entities that are exempt from federal income tax, including schools, hospitals and countless other charitable organizations. Nearly all public and private colleges in the U.S. are exempt from paying taxes because they are educational organizations.
Most educational organizations are tax-exempt under Internal Revenue Code section (IRC §) 501(c)(3). To qualify as an IRC § 501(c)(3) tax exempt entity, an organization must be organized and operated exclusively for exempt purposes set forth in IRC § 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.
In addition to the benefit of not paying U.S. federal income tax, tax-exempt entities can issue tax-exempt bonds to finance capital projects such as new school buildings. Losing tax-exempt status can have disastrous consequences. For example, if the IRS revoked Harvard's tax-exempt status, Harvard could be forced to pay millions of dollars in U.S. federal income tax each year. Further, Harvard could not issue tax-exempt bonds to fund capital projects such as the $434 million in tax-exempt bonds that Harvard issued last month. Instead, Harvard would need to obtain taxable debt at a higher interest rate. A recent analysis estimated that Harvard’s tax benefits totaled at least $465 million in 2023. It is unclear whether revoking Harvard’s tax-exempt status will impact previously issued and outstanding tax-exempt bonds.
It remains to be seen whether the IRS will revoke the tax-exempt status of Harvard or any other tax-exempt entities that do not comply with the Trump administration’s demands. With the recent changes at the IRS, it is unclear if tax-exempt audit activity will increase in the near future. However, tax-exempt entities should be prepared to defend their tax-exempt status in the event of an IRS audit, as losing such status may result in significant tax consequences.
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