The Rules Beneath the Endowment: How 1969 Reshaped Every Foundation, and How 2025 Is Doing It Again

For nearly fifty years a charity owned the grandest resort in the American West. Spencer Penrose left the Broadmoor hotel, along with a mountain railway and a good deal of a copper fortune, to the El Pomar Foundation he and his wife Julie established in 1937, and for decades the foundation and the hotel were one estate. Then Congress redrew the species, and the charity had to let the hotel go. That is not a quirk of one Colorado foundation. The law that forced the sale, the Tax Reform Act of 1969, is the invisible architecture underneath nearly every foundation and endowment this series has read, and its descendants are being written into the tax code right now, one of them signed exactly a year ago today. This post is about the rules beneath the money: where they came from, what they made foundations become, and how the next round could change how these institutions function.

The abuse that provoked it

By the 1960s a private foundation had become a useful thing to own if you were wealthy and wanted to stay in control. You could put your company's stock into a foundation, take the charitable deduction, keep voting the shares, pay little or nothing out to actual charity, and keep the whole apparatus in the family forever. Congressman Wright Patman of Texas spent most of the decade documenting it, running what one archive calls "an eight-year crusade against American foundations beginning in 1961," investigating 534 of them and issuing what a contemporary called "an omnibus indictment" of foundation control of business and abuse of tax exemption (Rockefeller Archive Center; Philanthropy Daily). "More and more," Patman warned, "the cream is slipping out of our tax system as the great fortunes go into tax-exempt foundations" (Rockefeller Archive Center).

The Treasury Department's own report, delivered to the Senate Finance Committee on February 2, 1965, put numbers to the suspicion. Surveying large foundation-held business interests, it found that of 213 such holdings, "almost precisely half had no current yield whatever," and among the largest controlling stakes "more than 70 percent produced no current yield for charity at all" (Caplin and Drysdale). In plain terms, the money was parked, not given. Treasury recommended an absolute ban on insider dealing, a mandatory payout, and a hard cap on how much of a business a foundation could own (Rockefeller Archive Center). Four years later, Congress wrote all three into law.

What 1969 actually did

The Tax Reform Act of 1969, Public Law 91-172, was signed by President Nixon on December 30, 1969, and it created a whole new part of the tax code, Chapter 42, aimed squarely at private foundations (Tax Reform Act of 1969; US Code, Chapter 42). It first drew the line the tax code had never formally drawn, between a public charity and a private foundation, defining the foundation by exclusion and making that status the default: any 501(c)(3) that cannot show it is publicly supported "shall be presumed to be a private foundation" (26 U.S.C. 508; 26 U.S.C. 509). Then it hung six new excise taxes on that category, and those six are the machinery that still runs every private foundation in the country (IRS, private foundation excise taxes):

• Section 4940 taxes the foundation's investment income, a straight skim off the portfolio.
• Section 4941 bans self-dealing between the foundation and its insiders.
• Section 4942 forces a minimum payout every year, so the money cannot just sit.
• Section 4943 caps how much of any business a foundation may own, so it cannot be a control vehicle.
• Section 4944 penalizes investments that jeopardize the charitable purpose.
• Section 4945 polices improper spending, from lobbying to undocumented grants.

And it added the disclosure regime that makes this entire series possible: the Form 990-PF, the public annual return on which a foundation reports its investments, its excise tax, its assets, and its grants (IRS, about Form 990-PF). Unusually, a private foundation cannot even keep its donors secret; unlike other charities, its contributor names are not exempt from public disclosure (IRS, public disclosure). When this series reads El Pomar's investment book down to the $816 it paid the New York Stock Exchange, it is reading a document that exists because of 1969.

The rule that made the orchard let go

The provision that ended the Broadmoor arrangement is Section 4943, excess business holdings, and its purpose is exactly what its history predicts. The IRS says it was enacted to "limit individuals' ability to retain control of a business enterprise by setting up a private foundation" and moving the company into it (IRS on Section 4943). The rule is a ceiling on ownership: a foundation and its disqualified persons together generally may not hold more than 20 percent of a business's voting stock, rising to 35 percent only where unrelated outsiders already control the company, with a small 2 percent safe harbor below which nothing counts (26 U.S.C. 4943). Hold more than that and the tax starts at 10 percent of the excess and climbs to 200 percent if you refuse to sell. A charity, in short, could no longer own a resort empire, and El Pomar sold its majority interest in the Broadmoor in 1988 (Wikipedia, The Broadmoor).

The cleanest illustration of the rule at work is the Lilly Endowment. Founded on gifts of Eli Lilly and Company stock, it held a commanding position in the drug maker until, as one account puts it, "it was not until the 1969 Tax Reform Act that the foundation was forced to loosen its 25% hold on stock," down to 18.6 percent by 1979 (Encyclopedia.com). But notice what the rule does and does not do. It caps the share of a company a foundation may own, not the concentration of the foundation's own portfolio, which is why the Lilly Endowment to this day holds assets that "consist primarily of Eli Lilly and Company stock" (Wikipedia, Lilly Endowment). The law broke control, not concentration.

The revealing counter-case is the one the rule cannot touch. The Milton Hershey School Trust owns a controlling stake in the Hershey Company, and it is allowed to, because it is a public charity, not a private foundation. It files a Form 990 rather than a 990-PF, reported about $23.4 billion in assets for its 2024 fiscal year, and sits outside Section 4943 entirely (ProPublica, Milton Hershey School). When the Hershey trustees tried on their own to diversify in 2002, selling control in a deal worth roughly $12.5 billion, it was not the tax code that stopped them but the Pennsylvania Attorney General, who won an injunction that collapsed the sale (Harvard Law School). One law forces foundations out of their founding company; a different set of rules lets a public charity stay married to its. The category is the whole game.

Payout and excise: how a foundation actually functions

If Section 4943 explains why El Pomar is a diversified endowment rather than a hotel company, two other sections explain how it behaves year to year. Section 4942 is the payout rule, and it is the reason a foundation cannot simply compound in silence. A private foundation must distribute a minimum amount annually, built on a "minimum investment return" that today is 5 percent of the fair market value of its non-charitable assets (26 U.S.C. 4942). That 5 percent is why El Pomar pays out roughly $25 million a year to Colorado, and why the whole class of perpetual foundations keeps a steady stream running out the door. The figure was not always 5 percent, and was not always fixed: the Treasury regulation shows it began as a variable rate, 6 percent for 1970 and 1971, drifting between 5.25 and 6 percent, before the Tax Reform Act of 1976 fixed it at 5 percent and a 1981 amendment simplified the formula (26 CFR 53.4942(a)-2). Miss the payout and the tax is 30 percent of the shortfall, then 100 percent if you still refuse (26 U.S.C. 4942).

Section 4940 is the other one, the tax on the portfolio's own earnings, and its rate history is a quiet fifty-year negotiation. It started at 4 percent of net investment income in 1969, was cut to a flat 2 percent by the Revenue Act of 1978, grew a reduced 1 percent second tier in 1984 for foundations that gave enough away, and was finally simplified to a single flat 1.39 percent by a 2019 law (26 U.S.C. 4940; IRS on the 1.39 percent rate). It is a small number, but it is the template that matters, because the government had, in 1969, established a principle it would not forget: that a tax-exempt institution's investment income is a thing the state may tax. Forty-eight years later it pointed that principle at the universities.

The modern descendants: taxing the endowment

The 2017 Tax Cuts and Jobs Act took the 1969 idea, that the state may tax an exempt institution's investment returns, and aimed it at the richest private colleges. It added Section 4968, a 1.4 percent excise tax on the net investment income of universities with at least 500 tuition-paying students and endowment assets of at least $500,000 per student (IRS on Section 4968). Public universities were exempt; only the wealthiest private ones were caught, an estimated forty or fewer. By 2023 it reached 56 institutions and collected about $380 million (Tax Foundation). It was, in effect, the university version of the 4940 excise tax, and the schools it hit, Harvard, Yale, Princeton, Stanford, MIT, and the small ultra-wealthy colleges like Williams and Pomona, are the ones this series calls the richest endowments (Endowment tax).

Then, on July 4, 2025, the One Big Beautiful Bill Act rewrote it into something much sharper. The same law this series has already met twice, for worsening Social Security's finances by cutting the revenue the trust funds collect on benefits, also turned the flat 1.4 percent endowment tax into a tiered one (Troutman Pepper). The new rates climb with wealth per student: 1.4 percent for endowments between $500,000 and $750,000 per student, 4 percent from there to $2 million, and 8 percent above $2 million (26 U.S.C. 4968). At the same time it raised the student floor from 500 to 3,000, which produced a strange result: the very richest per-student schools, Harvard at roughly $2.9 million per student and Princeton reportedly near $3.75 million, land in the 8 percent tier, while tiny wealthy institutions like Caltech and Juilliard fall out of the tax entirely because they enroll fewer than 3,000 students (Harvard Crimson). A House version had proposed a top rate of 21 percent before the final law settled at 8 (McGuireWoods). The new rates bite for tax years beginning after the end of 2025.

What comes next, and what it would do

The direction of travel is toward more, not less. One bill in the current Congress, the Endowment Tax Fairness Act, would replace the 1.4 percent floor with a flat 21 percent to match the corporate rate (H.R. 446). A 2023 proposal from then-Senator Vance would have taxed the largest secular university endowments at 35 percent, on the theory, in his words, that these schools are "hedge funds with a university attached" (Vance press release). On the foundation side, reformers want the payout raised: the Initiative to Accelerate Charitable Giving would zero out the excise tax for any foundation distributing 7 percent or more, and a 2020 emergency proposal urged doubling the mandatory payout to 10 percent for three years (Initiative to Accelerate Charitable Giving; Institute for Policy Studies). A parallel push, the ACE Act, would stop a foundation from meeting its payout by shoveling money into a donor-advised fund that never has to distribute (Council on Foundations, ACE Act summary).

Each of these would change not just how much these institutions pay but how they function. A higher payout or a higher excise tax draws down the corpus, and the corpus is the whole point of a perpetual endowment. The Council on Foundations warns that a permanent 10 percent payout "would turn $100 million in assets into $66 million" in three years, forcing many foundations that were built "to exist in perpetuity" to instead spend themselves out of existence (Council on Foundations). The universities make the mirror argument: the American Council on Education calls the endowment tax "a scholarship tax," noting that in 2024 nearly half of all endowment spending went to financial aid (PBS NewsHour). The reformers answer that money designed to compound forever too often just sits, generating deductions today and doing little else for a generation. Both sides are describing the same machine from opposite ends.

The through-line

Here is the thing 1969 got right, and it is the thread that runs through this entire series. The law did not shrink foundations. It channeled them. It took institutions that were being used to hold operating businesses in family control and forced them, through the excess-business-holdings rule, into diversified portfolios, which is to say it pushed every foundation into the same public and security markets as every pension and endowment and retiree. It made them pay out, so the money moved. And it made them show their books, which is the only reason any of this can be read at all. El Pomar's forced sale of the Broadmoor looks, in the long ledger, like the best thing that ever happened to its mission, because it converted a single hotel into a $711 million diversified endowment that has paid Colorado a dividend for going on ninety years. The law that took the crown jewel built the machine.

The 2017 and 2025 endowment taxes are the same instinct pointed at the universities, and the proposals waiting behind them, 21 percent, 35 percent, a 10 percent payout, are arguments about the same question 1969 answered for foundations: how long should a tax-exempt fortune be allowed to compound before the public it is exempt for gets to reach into it. In 1969 the answer was, pay out 5 percent, own no more than a fifth of any company, and open your books. The next answer is being written now, and every endowment in this series will function differently depending on what it says.

Related reading

• The Orchard at the Foot of the Mountain: El Pomar, the Broadmoor, and the forced sale that turned a hotel into an endowment.
• University Endowments: the wealthy private funds now paying the tiered endowment tax.
• The Fund That Is Not Allowed to Invest: the other place the July 4, 2025 law shows up, in Social Security's finances.
• The Working Ledgers: the single market underneath every foundation and endowment 1969 pushed into it.

Fact-check notes and sources

• The Patman investigations and the 1965 Treasury Report (the 1961-1969 crusade, 534 foundations examined, the "cream is slipping out of our tax system" quote, the February 2, 1965 Treasury report, and the finding that about half of 213 large foundation-held business interests and more than 70 percent of the largest controlling stakes produced no current charitable yield): Rockefeller Archive Center, Philanthropy Daily, and Caplin and Drysdale.
• The Tax Reform Act of 1969 (Public Law 91-172, signed December 30, 1969, creating Chapter 42 and the six excise-tax sections 4940 through 4945; the public-charity versus private-foundation definition in sections 508 and 509; and the Form 990-PF disclosure regime including non-exempt donor names): Tax Reform Act of 1969, US Code Chapter 42, IRS excise taxes, 26 U.S.C. 508, 26 U.S.C. 509, IRS Form 990-PF, and IRS public disclosure.
• Section 4943 excess business holdings (the 20 percent limit including disqualified persons, the 35 percent and 2 percent thresholds, the 10-to-200 percent penalty, and its stated purpose of preventing foundation control of a business): IRS on Section 4943 and 26 U.S.C. 4943. El Pomar's 1988 Broadmoor sale: Wikipedia, The Broadmoor. The Lilly Endowment being forced to loosen its 25 percent Eli Lilly stake to 18.6 percent by 1979, while remaining concentrated in Lilly stock: Encyclopedia.com and Wikipedia, Lilly Endowment. The Milton Hershey School Trust as a public charity outside Section 4943, its roughly $23.4 billion in assets, and the 2002 sale blocked by the Pennsylvania Attorney General: ProPublica and Harvard Law School.
• Section 4942 payout (the current 5 percent minimum investment return; the variable history beginning at 6 percent in 1970-71, fixed at 5 percent by the Tax Reform Act of 1976, simplified in 1981; and the 30 percent and 100 percent penalties): 26 U.S.C. 4942 and 26 CFR 53.4942(a)-2.
• Section 4940 rate history (4 percent in 1969, flat 2 percent in the Revenue Act of 1978, a reduced 1 percent second tier added in 1984, and a flat 1.39 percent since the 2019 Taxpayer Certainty and Disaster Tax Relief Act): 26 U.S.C. 4940 and IRS on the 1.39 percent rate.
• The 2017 endowment tax (Section 4968, 1.4 percent, thresholds of 500 tuition-paying students and $500,000 per student, public schools excluded, an estimated 40 or fewer schools, 56 institutions paying about $380 million by 2023): IRS on Section 4968, Tax Foundation, and Endowment tax.
• The 2025 One Big Beautiful Bill Act (Public Law 119-21, signed July 4, 2025; the tiered 1.4, 4, and 8 percent rates keyed to endowment per student; the student floor raised to 3,000; the top tier including Harvard, Yale, Princeton, Stanford, and MIT; Caltech and Juilliard falling out under the student floor; and the House version's proposed 21 percent top rate): 26 U.S.C. 4968, Troutman Pepper, Harvard Crimson, and McGuireWoods.
• Proposed future changes and the debate (the Endowment Tax Fairness Act's 21 percent, the 2023 Vance proposal's 35 percent and "hedge funds with a university attached," the Initiative to Accelerate Charitable Giving's 7 percent payout incentive, the 2020 emergency proposal to double the payout to 10 percent, the ACE Act's donor-advised-fund provisions, the Council on Foundations' "$100 million into $66 million" warning, and the American Council on Education's "scholarship tax" framing with nearly half of 2024 endowment spending going to financial aid): H.R. 446, Vance press release, Initiative to Accelerate Charitable Giving, Institute for Policy Studies, Council on Foundations, ACE Act summary, Council on Foundations payout brief, and PBS NewsHour.

This post is informational and historical, not legal, tax, or financial advice. All figures are reproduced from the cited statutes, regulations, government reports, and public record. Institutions and public figures are described from the documented public record as nominative fair use, with no affiliation implied.