Teaching Harvard and Yale a Thing or Two

In its latest quest for untapped sources of tax revenue, the Senate Finance Committee is turning its gaze on a few new targets: Harvard, Yale, and Princeton.

The Senate Finance Committee has been on a mission of late to review hedge fund taxation. Or, as it turns out, lack of taxation.

Bloomberg News reports that the committee has now moved its scrutiny from the fund managers themselves to tax exempt hedge fund investors, including pension funds, foundations--and universities.

Under current law, universities and other tax-exempt institutions don't owe tax at all on most investment income, with the exception of profits from debt-financed investing. That should include some hedge fund income.

But many of the clever money managers within these organizations have figured out a way to exploit a loophole that allows them to avoid the taxation of debt-financed investments too. Hedge funds avoid reporting income from these investments by setting up "blocker'' companies in tax havens that convert those profits into dividends, which are not taxed.

If the practice were banned, hedge fund returns on university investment would face taxes as high as 35 percent.

Harvard, Stanford, and Yale have significant portions of their endowments invested in hedge funds--as much as 23 percent, at Yale. That means they have a lot to lose if the committee cracks down on the legal, but dubious, "blocker'' strategy.

Given that scenario, would universities pull out of hedge funds altogether?

by Liz Gunnison