A Sunsetting Tale

Sunsetting Foundations

Once upon a time, there was an American billionaire who amassed a fortune in retail but continued to live frugally despite his enormous wealth. He said long ago that he wanted to “die broke.”

Unlike most other philanthropists in the kingdom, he created a foundation with a name – gasp! – that did not include his own. And many years back, he let it be known throughout the land that this organization would not hover around in perpetuity like a meddling fairy godmother doling out bits and pieces of largesse here and there. It would make billions of dollars of “high-risk, high-impact” donations worldwide (much of them anonymously) and sunset in 2020.  

And, lo and behold, on September 14, 2020, 89-year-old Charles (Chuck) Feeney “closed up shop” on The Atlantic Philanthropies, having given away “all his money.”  See Exclusive: The Billionaire Who Wanted To Die Broke . . . Is Now Officially Broke (September 15, 2020) Steven Bertoni, Forbes.

And he lived happily ever after.  

       Sunsetting Foundations: Not a Radical Idea

The COVID-19 pandemic has apparently begun to trigger shockingly revolutionary thoughts and actions in certain previously staid and traditional foundation boardrooms. Paltry annual payouts along with paternalistic grantmaking practices and procedures are no longer sacrosanct.

And now the “Big P” word – perpetuity – may be heard in hushed whispers when trustees discuss how to confront the here and now “rainy day” they’ve all said is the raison d’etre for their massive and growing endowments. It’s pouring buckets everywhere and new thinking is in order.

“There was a time,” we wrote in The Sunsetting Foundation: Trend of the Future (June 9, 2017), “when families who were establishing private foundations rarely thought about an end to the foundation. They assumed what they had created would last (as intended) in perpetuity from generation to generation. What they discovered, as John D. Rockefeller observed years ago, is that ‘perpetuity is a very long time.’”

While the “notion of ‘perpetual foundations’ remains the majority position in American philanthropy today,” the idea of changing away from this model has picked up steam in the past few years. In any event, it’s not a new idea. See our discussions in A Sunsetting Foundation In Its Twilight Hours (September 19, 2019) and A Plea for Higher Foundation-Payout Rules (January 15, 2020). 

The “sunsetting” concept “dates back at least to the 1920s and 1930s.” For example, Sears founder Julius Rosenwald “devoted the lion’s share of his philanthropic resources to building schools for black students in the South, and was publicly vehement in his opposition to permanent endowments.” And during the debates on the new private foundation rules in the Tax Reform Act of 1969, there was a proposal made – but not included in the final statute – to sunset all foundations after forty years.

       A Call to Action

Several foundation leaders have recently banded together to issue a call for action right now. See There Is No Better Time Than Now for Philanthropy to Spend Itself Out of Existence (July 28, 2020), Ellen Friedman (Compton Foundation) Glen Galaich (Stupski Foundation) &  Pia Infante (Whitman Institute), The Chronicle of Philanthropy. 

They speak from the experience of their own sunsetting organizations and against the background of the current dire circumstances. “As our nation grapples with a confluence of crises,” they explain, “philanthropy is abuzz with how best to respond. Some are increasing payouts. Others are allowing grantees more flexibility in how they spend funds. A few have issued bonds to increase their charitable giving without tapping endowments. These are all useful steps, but none do enough to uproot historical inequities and upend power structures in society and philanthropy.”

They “offer an alternative solution,” encouraging “foundations to join the growing movement to distribute all their philanthropic assets within the next few years.” The goal is to “encourage grant makers to redistribute private philanthropic wealth back into communities instead of holding on to funds so their institutions can exist indefinitely.” It’s a matter of “living our values,” they assert. After all, they ask: “What are we saving our endowments for?”

Specifically, they urge philanthropists to take “bold collective action to respond to this historic moment…”; that is, to “spend every dollar on transformational change” and “upend traditional power structures.” 

       Conclusion

Read more about these intriguing and important ideas in The Whitman Institute blog: 

 

Final “Net Investment Income” Excise Regs

Regulations Affecting NPO's

Not to put too fine a point on it: The Tax Cuts and Jobs Act of 2017 was a mess. 

At the time the Senate majority rushed it through Congress in late December 2017, we reported in detail on the chaos, confusion, speed, and rancor that dominated the process. Making matters worse, the leadership omitted the customary transition period between a presidential signature and the law’s taking effect. Even in legislation that is well-crafted and thoughtfully debated, there are inevitably kinks and problems which Congress can quickly remedy with technical-corrections amendments or other relief.  

In the TCJA ’17, the nonprofit sector took quite a hit from several unexpected provisions. These new laws either “fixed” problems that never existed or addressed with a sledgehammer legitimate issues. Almost at once, our sector made pleas to revoke or rework the most troublesome and confusing of these statutes and has continued this pressure in the two and a half years since then.  

We’ve had success on at least one front: In late December 2019, lawmakers retroactively repealed the “hugely unpopular” tax on parking and other transportation-related fringe benefits paid by nonprofits for their employees. It “never made sense to anyone and … forced thousands of front-line nonprofits to divert two years of attention and millions of dollars away from their missions.” This lovely holiday gift was accomplished by legislators quietly tossing it into an eleventh-hour compromise appropriations bill. See Poof! The Nonprofit Parking Tax is Gone (January 7, 2020).

As for the remaining (controversial) changes that directly affect the nonprofit sector, the Treasury Department and the IRS are proceeding, under their lawful regulatory authority, to interpret and implement them.  They have drafted and published proposes regulations, inviting public comment for sixty days or – sometimes – longer.  The philanthropy community, professional advisors, and academics are participating robustly in this process. 

       New: Final 4968 Excise Tax Regs

There have been proposed regulations pending for some time on several items:

  • Excise tax on net investment income of certain higher education institutions (IRC sec. 4968) 
  • Excise tax on excess compensation (IRC sec. 4960)
  • New rules on the unrelated business income tax (IRC sec. 512(a)(6)) 

On September 18, 2020, the federal tax authorities announced release of final regulations for determining the section 4968 excise tax that applies to the “net investment income of certain colleges and universities. The new statute imposes on each “applicable educational institution” an excise tax equal to 1.4% of the institution’s “net investment income.” 

The final regulations under section 4968 “include guidance on the scope of applicable educational institutions to which the excise tax applies, including determining who will be counted as a ‘tuition-paying student,’ which institutions will be treated as ‘located in the United States,’ and which assets will be included in determining whether an institution meets the $500,000 per student threshold in the statute.”

Each of these points was vague and confusing under the language of new section 4968. Without adequate clarification, it would work a hardship on all potentially affected institutions as well as on the government in its monitoring and enforcement efforts.  These final regulations include considerable changes and improvements by the tax authorities over the rules set out in the earlier proposed regulations.

Among the highlights of the concessions made by the government are:

  • Expanding the definition of “student” to include not only those in degree programs but also individuals taking courses for academic credit;
  • Clarifying the definition of “tuition paying”: includes students with 3rd-party scholarships but excludes ones receiving only government grant funds;
  • Making it easier to calculate “net investment income” and differentiating it from the rules that apply to private foundations under section 4940; 
  • Modifying certain “capital gains net income” calculations;
  • Providing guidance on rules for treating specified assets and net investment income of certain related organizations. 

        Conclusion 

These final regulations under section 4968 will apply beginning with the publication date in the Federal Register. 

Still outstanding are the government’s final regulations under Internal Revenue Code sections 4960 and 512(a)(6).  There has been considerable pushback – via the public-comments route – to both sets of proposed rules. 

There is another announcement (unrelated to the Tax Cuts and Jobs Act of 2017) that the nonprofit sector awaits. After about forty years, the government issued a proposed revenue procedure earlier this year revising the existing rules for obtaining and maintaining group tax exemptions.  So far, the reaction – in the submitted public responses reported so far – can fairly be characterized as comprehensive and stinging.  

COVID-19 Giving Data: New Report

COVID Giving

On March 31, 2020 – just about two weeks into the catastrophe that has enveloped the world – staff writer Dan Parks of The Chronicle of Philanthropy interviewed nonprofit heavyweights to gain their assessment of what it might take to survive this crisis. 

Brian Gallagher, CEO of United Way Worldwide, characterized the COVID-19 crisis as “a slow-moving hurricane hitting every country in the world simultaneously.” Although early data showed that in those first days, “donors responded quickly” by “stepping up their giving,” he said that “private giving … can’t possibly make up” for what American society including its (now vulnerable and hurting) nonprofits would need. 

According to preliminary data available at the time, giving by foundations stood at$2 billion worldwide and climbing.” Congress had enacted a “$2 trillion stimulus law” on March 27th with “important benefits for nonprofits, but it’s not nearly enough.” 

Goodwill Industries International CEO Steve Preston had served in HUD during the financial crisis of 2008. Comparing that crisis – which “was largely confined to the housing and financial industries” – to the COVID-19 pandemic that “is hobbling nearly every part of the economy,” he said that the impact “is much more widespread, immediately.” He added that he didn’t “think any level of philanthropic giving” would “fix this problem over the next 90 days.” It will need a “… much bigger response. Nobody’s seen anything like this before.”

       Philanthropy Steps Up

Over the next few months, there were many anecdotal and news reports about the nature and extent of philanthropic giving. This information has been valuable but it’s best to rely on hard data. That’s where a newly published, 20-page joint report by Candid and the Center for Disaster Philanthropy (CDP) comes in: Titled Philanthropy and COVID-19 in the first half of 2020, it presents facts and figures through about July 7, 2020. 

In COVID Giving Beats Most Other Disasters (September 1, 2020), staff at The NonProfit Times write: “Although not a complete picture of the global philanthropic response, due to the ever-changing response to the pandemic, the report offers some insight into ‘funding flows’ so far.” Data shows that just short of “$12 billion was awarded for COVID-19 relief globally during the first half of 2020….” Of course, that reference to the “first half of 2020” in the report title is a bit misleading since philanthropic activity related to the pandemic didn’t begin until about the middle of March.

In her Foreword to the Report, CDP’s president and CEO, Patricia McIlreavy, acknowledges the “central role that governments and the United Nations hold in the coordination of preparedness and response activities within any major crisis.” But she particularly lauds the “critical contribution of philanthropy” to the pandemic relief. 

“As the pandemic continues to ravage the globe, with millions of confirmed cases and hundreds of thousands of lives lost, philanthropy has provided a consistency of hope,” she explains, adding: “[P]hilanthropic donors were generous. Not only did they give with exponential generosity but they also demonstrated a willingness to challenge their own restrictions on accessibility to their funds.” 

       Key Giving Data

Researchers pinpointed “more than $11.9 billion awarded for COVID-19 globally,” with corporations giving more than two-thirds of the funding. In addition, “community foundations awarded more grants than any other grantmaker type (49 percent of total awards).” Moreover, high-net-worth people made gifts of at least $1.6 billion, and a “combined $452.9 million was donated to COVID-19 response through the donor-advised funds of Fidelity Charitable, Schwab Charitable, and Vanguard Charitable.”

But “proportionately little institutional funding was explicitly designated for specific populations and vulnerable communities.” That needs to be substantially improved. Longer-term funding needs to go to the most affected areas around the world.” So far, this distribution has been lacking. 

The report authors offer some suggestions for continued “effective giving” based on flexible and innovative practices adopted already by some funders. These include: 

  • Provide unrestricted support 
  • Expand on existing giving
  • Support local nonprofits and information—in the U.S. and internationally—that focus on communities of color and other vulnerable populations 
  • Give to (rapid response) funds
  • Partner with other funders
  • Fund land trusts (for long-term housing recovery needs)

       Conclusion

Of course, this is interim data. There will be a follow-up report in February 2021. “The Center for Disaster Philanthropy and Candid will continue to track the COVID-19 crisis, its impacts, and disaster giving. This report presents the first step on that journey.”

Until then, Candid will provide the latest funding data on its coronavirus special issue web page. 

Nonprofits & CA’s “Take 2” Reopening

CA NPO's Reopening

Throughout the United States, the summer months were a frenzy of rushed “reopenings” followed by all-too-predictable rollbacks as COVID-19 outbreaks surged.  Disease hotspots erupted even in some jurisdictions like California that had imposed early lockdowns.

Now, in September 2020, state and local governments around the nation face wrenching decisions on whether and when to attempt a new round of more careful reopenings. In this post, we’ll focus on California. But there are a number of helpful (and periodically updated) online compilations of U.S. statewide reopening rules and regulations; see, for example, here.  

Where do nonprofit organizations fit into these complex laws and rules that have popped up since the COVID-19 pandemic swept across the United States last spring? As a general rule, tax-exempt organizations are subject to them the same as profit-making entities and individuals because these new provisions are largely health and safety measures. 

       CA Reopening The Second Time Around

California’s governor, Gavin Newsom, took action in mid-March with tough stay-at-home orders designed to – and which did for a while – tamp down the spread of COVID-19. But there was intense pressure to loosen up some of the restrictions. By early May, 2020, Gov. Newsom agreed to a staged reopening plan that went into effect in the following weeks with whiplash-inducing speed. By June, though, the disease spiked in many parts of the state, causing the government to pull back a bit.

One of the (many) problems with the first reopening scheme was that it “relied on local officials to attest to their own readiness to reopen. But instead of requiring counties to meet the benchmarks outlined in his plan, Newsom permitted dozens of counties to move forward as long as local officials said they could increase testing capacity or train more contract tracers in the weeks and months after their businesses opened their doors again.” 

In late August 2020, California’s governor announced a second try at a revamped and more cautious reopening plan. The new effort is called Blueprint for a Safer Economy; that is, the method for reducing “COVID-19 … with revised criteria for loosening and tightening restrictions on activities.”  

The latest and best information is collected at the state government’s COVID-19 master reference site: https://covid19.ca.gov/ (updated almost daily). This plan has four “tiers” and is based on a requirement that counties “… show consistent progress in stemming transmission of the coronavirus before they can advance to the next tier of reopening.  

This more “robust” plan is “designed to correct some of the mistakes made during California’s initial reopening attempt in May.”  The tiers are “ranked by the percentage of positive COVID-19 tests and the number of new cases.”  Generally, the state sets certain rules that are effective within each tier for the counties that are assigned to that tier. But counties and municipal governments have some leeway to impose variations that are stricter than the statewide provisions. 

       Reopening for Each County

On the announcement date (August 28, 2020) the majority of California’s 58 counties were in the most stringent “Tier 1.” Color-coded purple, it represents a “widespread” county risk level in which “many non-essential indoor business operations are closed.”  On that date, all of Southern California was in Tier 1 except for San Diego County which had placed in Tier 2, color-coded red, representing a “substantial” risk level in which “some non-essential indoor business operations are closed.” San Francisco has also been in Tier 2 from the beginning of this new plan.

On the state’s master site, there is an interactive chart to view and understand each county’s current tier status. Another helpful reference source is the Los Angeles Times: Which California counties are reopening? (updated almost daily). There’s been some movement among counties since the first week of this new plan when 38 of the counties were in the most restrictive category. As of September 12, 2020, just 33 counties with some 71% of California’s population are “rated too risky to reopen.” Key changes include Orange County, Santa Clara County, and Santa Cruz County which moved from Tier 1 to Tier 2 while San Diego is in some danger of being sent down to Tier 1 from Tier 2. Changes are scheduled to be announced each Tuesday.

[Update 9/16/20 : San Diego County has received official notice it may be moved back to purple next week if numbers continue in the wrong direction. A major spike is related to an outbreak on the SDSU campus. The County asked Governor Newsom to separate out the SDSU cluster for purposes of evaluation of the county-wide tier status. So far, the answer is no.]

The only counties currently in Tier 3 (nine) and Tier 4 (two) are in the most rural northern and eastern parts of the state. The Los Angeles Times’s chart has a section called “How it shakes out” with a color-coded map of the entire state.

        What About Nonprofits? 

The Los Angeles Times’s chart includes another useful section titled “What’s open in your county?” The default section is Los Angeles County which started out and remains in Tier 1; you can type in your own county to bring up that information. 

What’s particularly helpful with this chart is that it lists the rules for certain activity categories including a number of ones that are mostly nonprofit in nature. For instance, there is information about: libraries, museums, zoos, places of worship & cultural ceremonies, higher ed, K-12 schools, and – of course – “nonessential business offices.” 

These charts also indicate when there is a “stricter” variation in a county from the state’s standard within a particular tier.  Check, too, with your local government’s websites for information about variations closer to home.

        Conclusion

A final note for now: Just because the government permits you to reopen doesn’t necessarily mean it’s a good idea to make that move at the earliest allowable opportunity. There are many considerations including liability issues and well as the nonprofit board’s fiduciary duties to its own personnel as well as the general public. We’ll take a stab at those topics in upcoming posts. 

 

 

Foundations: IRS Launches Review Project

IRS Launches Change

About a decade ago, the Internal Revenue Service launched an initiative targeting “high net worth families.”  This project was designed to look well beyond just the individual 1040s of the nation’s very wealthy to their related entities including private foundations. It “lasted a little while and then fizzled out a few years later,” according to law professor Phil Hackney who was in the IRS Chief Counsel’s Office at the time. This push apparently ended “… without much to show for itself.” 

But Professor Hackney and others – including the IRS itself – now tell us that the agency had planned (even before COVID-19 shut down most of the agency’s operations for a few months) to “take another cut at this issue.”  

       Probes of Foundations: Reasons

This effort “appears to be in reaction to various factors” including criticism (from a number of quarters) to disclosures that the IRS had, for several years, focused much of its audit activity on lower-income taxpayers instead of on the much more productive target of the financial elite. 

In early March 2020, Treasury Secretary Steven Mnuchin appeared before the House Ways and Means Committee. Responding to questions by Rep. Judy Chu (D-CA) on this problem, Mnuchin said: “I have specifically directed the IRS commissioner to come up with a plan to increase the amount of funding so that we can audit more high-income earners, so that is specifically in our plan.” 

In addition to Congressional scrutiny of this odd audit strategy, there was a recommendation by a Treasury Department inspector general that the agency “… increase its focus on certain high-income taxpayers.”

The recently announced project has also been described as “complement[ing] other initiatives at the IRS focused on high-income individuals, and those aimed at better understanding taxpayer behavior to improve future audit practice.” 

During the COVID-19 quarantine,  enough activity continued – virtually – to produce  evidence that the Internal Revenue Service “… is making good on that promise” by Secretary Mnuchin.  At an NYU Tax Controversy Forum on June 18, 2020, Douglas O’Donnell, the Commissioner of the IRS Large Business and International (”LB&I”) Division, told conference attendees in cyberspace that the agency will open “several hundred new audits involving high-income individuals” beginning at the previously announced July 15th reopening date.

These tax examinations will focus on the wealthy “who have a connection with at least one pass-through entity such as a partnership or S-Corporation, or a connection with a private foundation.” The IRS’s Global High Wealth Industry Group – known more colloquially as the “Wealth Squad” and housed within the LB&I Division – will take the lead on these audits. The enterprises targeted by the Wealth Squad typically “are generally controlled by individuals with assets or earnings in the ten of millions of dollars.”

This new audit project will span several IRS divisions including the Tax-Exempt and Government Entities (TE/GE) Division that has responsibility for oversight of private foundations. Director Tamera Ripperda has announced that over “1,000 cases of private foundations that are connected to high income or high net worth individuals” have been identified and audit case files have been opened. 

       The Foundations Angle

So far, there seems to be “limited guidance” on the scope and extent of the examination of the private foundations connected with the targeted high-wealth individuals and families. But it’s been reported that the Internal Revenue Service is “particularly interested in auditing whether those private foundations have engaged in prohibited ‘self-dealing,’ such as making loans to a disqualified person.” 

Of course, the definition of “self-dealing” within the Internal Revenue Code includes acts far broader than insider loans. It can include as well transactions between a private foundation and a disqualified person involving – just to name some: (1) the sale, exchange, or leasing of property, (2) providing goods, services, or facilities, (3) paying compensation or reimbursing expenses, or (4) transferring foundation income or assets to, or for the use of benefit of, a qualified person.” There is also “indirect self-dealing” which includes transactions between organizations controlled by a private foundation. 

       Conclusion

Of course, the examinations may go well beyond issues of direct and indirect self-dealing to matters otherwise regularly raised in audits of private foundation.

And those who receive audit letters in connection with this new initiative should also understand that the private-foundation element – even if conducted by TE/GE agents – will be just a part of a more comprehensive examination of a target individual’s financial picture.

Philanthropy Funders: Bending the “Moral Arc”

Funders and the "New Normal"

“We need to stop quoting Dr. King, feeling good about ourselves, and then continuing to do the same old crap that hasn’t worked for generations.” 

That was the urgent plea of prolific nonprofit commentator Vu Le in It’s 2020. Be bold or get the hell out of the way (January 20, 2020), Nonprofit AF Blog.  That (dare we say justified) rant was over six months ago, well before we knew how monumentally bad this brand new year was going to turn out to be. 

        Funders and the Pandemic

In early August 2020, we began to explore the seemingly benign theme of the nonprofit sector “…anxiously await[ing] the time it can return to ‘normal.’” See Philanthropy Thinkers On Not Returning to “Normal” (August 4, 2020). In that first of several related posts, we wrote about the many warnings by experts and commentators against simply trying to turn back the clock. The “pre-pandemic ‘normal’ was imperfect at best….and the deep inequalities and structural deficiencies in our society have come into painfully crisp focus.”

We promised to return to this subject and probe it more deeply. In Funders Urged Not to Return to “Normal”  (August 26, 2020), we presented advice specifically on how philanthropy’s funders and grant-makers should approach the weeks and months ahead. We discussed the thoughtful article by foundation veteran David Morse a few months ago in The Chronicle of Philanthropy. There, Mr. Morse urges foundations and philanthropists to “help create the better normal” by continuing “… what they’re now doing to provide support to their grantees who desperately need it, just more of it and quicker.” He adds: “And just do it; it’s a waste of time, space, and money to crow about it.”

Since the outbreak of the COVID-19 crisis, blogger Vu Le has continued – and dramatically enhanced – his pre-pandemic pleas to foundations to radically transform their funding levels and practices.  But Mr. Le cautions – along with David Morse and many others – that funders will fail to meet the challenge of this catastrophe by merely tweaking the old system around the edges. They must  address the core problems of power and privilege in society and in philanthropy itself.          

As commentator Arundhati Roy points out in The Pandemic is a Portal (April 3, 2020), Financial Times, “[n]othing could be worse than a return to normality.” There can be opportunity amidst the crisis. “Historically, pandemics have forced humans to break with the past and imagine their world anew. This one is no different. It is a portal, a gateway between one world and the next….” 

       “Bending the Arc Toward Justice”

In It’s 2020. Be bold or get the hell out of the way, Vu Le chose the occasion of MLK Day to drill down his continual message that funders as well as nonprofit organizations should stop with the endless intellectualizing and move on to action to bend the “arc of the moral universe” toward justice. What’s the “definition of equity?” he asks rhetorically. “Here’s my revised definition: Equity is about restoring power and resources to the people and communities who have been most harmed by the ongoing legacy of colonization, slavery, and injustice based on white supremacy and toxic patriarchy….There. Let’s move on. It’s not perfect, but we don’t have years to debate it like we have been. Our sector needs to think, speak, and act more boldly.”

He was sadly correct; we didn’t have “years to debate it.” It was just six short weeks until the COVID-19 pandemic engulfed us.  

While Mr. Le’s more recent writings laud those funders which have stepped up to the plate early in this crisis by pumping out much more money than usual with fewer hurdles and restrictions, he emphasizes they must do much more. They must commit to not rebuilding the flimsy and flawed institutions that were the building blocks of the old “normal.” See, for example: 

Along similar lines, see articles of note by other authors:

        Participatory Philanthropy

 About a year ago, in What is Participatory Grantmaking? (September 10, 2019), we wrote about a “recent school of thought” described by New Zealand’s Lani Evans in her essay and report titled “Participatory Philanthropy: An Overview” (2015). Her “deep interest in philanthropy” moved her to consider “whether or not philanthropy hinders social change” because it is so grounded in the “…culture-laden belief, often unconscious but seldom questioned, that possession of a greater material wealth or professional expertise is necessarily accompanied by superior skills to make things better no matter what the circumstance. This “top-down” assumption that “… people with these assets know more… extends to narrow beliefs about the identification, measurement, and evaluation of effective philanthropic practice.”  

Recent writings pick up this topic with greater urgency and renewed consideration under our current turbulent circumstances. See, for instance: 

       Conclusion

Returning again to author Arundhati Roy’s The Pandemic is a Portal, philanthropy funders must “rethink the doomsday machine we have built for ourselves,” choosing – now – not to “drag… the carcasses of our prejudice and hatred, our avarice, our data banks and dead ideas,… behind us.” 

 

 

Universities’ Exempt Status: Political Threat

University and Exempt Status

It was September 8, 1971.  

In the Oval Office, Richard M. Nixon chatted with his chief domestic-policy adviser, John Ehrlichman, about the upcoming 1972 election still fourteen months away. Mentioning potential Democratic rivals by name, the President asked: “Are we going after their tax returns? I … you know what I mean? There’s a lot of gold in them thar hills.” 

We know about this incident and Nixon’s express directive to weaponize the Internal Revenue Service because – (to paraphrase a more recent government official) – “Lordy,” there were “tapes.” These secret recordings were among the evidence used to support the 1974 Bill of Impeachment including Article II: “He has, acting personally and through his subordinates and agents, endeavoured to… cause, in violation of the constitutional rights of citizens, income tax audits or other income tax investigations to be initiated or conducted in a discriminatory manner.”

Fast forward almost fifty years. 

Now there are presidential tweets: out in the open, an undeniably direct line from the Oval Office to the Treasury Department and the Internal Revenue Service:  “Too many Universities and School Systems are about Radical Left Indoctrination, not Education. Therefore, I am telling the Treasury Department to re-examine their Tax-Exempt Status … and/or Funding, which will be taken away if this Propaganda or Act Against Public Policy continues. Our children must be Educated, not Indoctrinated!” 

Tweets come and go, of course, but this one from the morning of July 10, 2020, did not quickly evaporate into the fog of the 24/7 news cycle. There have been concerning developments.  Despite reassurances from leading experts that there are legal barriers to any real tax-exemption jeopardy from the Administration, the nation’s colleges and universities – and, indeed, the nonprofit community generally – have felt a distinct chill in the air well in advance of the official date when summer turns to autumn.  

       Universities Push Back 

The Tweet in Question surfaced against a backdrop of rising tensions between higher education and the Administration including presidential rhetoric on Independence Day at Mt. Rushmore and other recent comments complaining “about schools being driven by what he describes as a radical left-wing ideology” and “‘far left-fascism’ controlling American schools, newsrooms and other institutions.” 

On July 6, 2020, the Administration (through the U.S. Immigration & Customs Enforcement) announced an abrupt change in policy on the status of international student-visa holders. Despite assurances the government offered earlier in the COVID-19 pandemic, there was to be a new rule that these students would have to attend at least one in-person class in the upcoming semester in order to stay in the United States. (Many colleges and universities had announced plans to hold online-only courses in the fall.) 

“Trump’s tweets set off a firestorm of reactions focusing on the implicit political threat against free speech.” The higher-education community pushed back immediately including well-publicized tweets from individual professors vowing to hold at least one in-person class in the coming semester even if it meant everyone would be sitting outside in the snow. And by July 14th, a group of 20 colleges and universities in the Western U.S. filed a lawsuit over this rule change. (That same day, “… what Trump had dubbed “Propaganda” resulted in his administration changing its policy.”) 

In the July 10th Tweet, the president did not name specific institutions whose tax-exempt status he wants the Treasury Department to review. And notwithstanding that the Administration later officially withdrew the immigration-rule change, the threat remained to review tax-exemptions and also withdraw federal funds. 

Among those asking for specifics – and perhaps reassurances that this matter would not be pursued any further – was Rep. Richard Neal (D-MA), chair of the House Ways and Means Committee. On July 15th, he sent letters to the Internal Revenue Service and to the Treasury inspectors general

In their formal written responses at the end of July, these officials, in appropriate bureaucratese, hemmed and hawed about what had happened or what may happen. For instance, the Deputy General Counsel replied that “the Secretary of the Treasury expects that Treasury’s Office of Tax Policy will conduct a policy review of the generally applicable regulations and guidance implicated by the President’s comment.”  And, on July 31st, Treasury Secretary Steven Mnuchin announced there would be some kind of “review” coming, and that the issue of federal funding had been forwarded to the Department of Education for consideration. 

Representative Neal wrote back to Treasury making clear he is not pleased with this state of affairs. 

       Legal Obstacles and Defenses

In Trump tweets, tax law and alleged university ‘propaganda’ (7/19/20) Professors Ellen P. Aprill and Samuel D. Brunson, provide an important and detailed legal analysis of the issues arising from, and defenses to, this threat to meddle.

A few weeks later, on August 2, 2020, Professor Brunson posted additional thoughts, summarizing the key points made earlier; see IRS Investigation of Universities’ Tax-Exempt Status, Nonprofit Blogger. The “…Treasury and the IRS face three significant problems in investigating universities.” 

First, “…even if you assume that universities are politically biased–and even if you assume they teach that bias to students–that doesn’t mean they can’t be exempt. Tax-exempt educational institutions can endorse particular viewpoints.” 

Second, Internal Revenue Code section 7217, “… prohibits the President from requesting that the IRS audit a particular taxpayer.” (No “particular taxpayer” was mentioned in The Tweet; nevertheless, they explain how this statute generally applies; Rep. Neal also mentions this statute in his letters to the IRS and Treasury.) 

Third, “… the Consolidated Appropriations Act, 2020 … prohibits the IRS from targeting groups for regulatory scrutiny on the basis of their ideological beliefs.”

Professors Aprill and Brunson include additional arguments as well in support of their analyses. 

[Update 9/17/20]: This article has just been published, with additional detail, on SSRN under the title: The University, Ideology, and Tax Exemption.

       Conclusion

“Congressional restrictions—in addition to other legal issues—could make Trump’s directive illegal and in violation of the First Amendment, tax and non-profit groups say.” For instance, Mark Mazur, director of the Tax Policy Center and former assistant secretary of tax policy within the Treasury Department under then-President Barack Obama, agrees: “The tax code’s clear that educational institutions generally qualify for tax-exempt status,” adding “It’s not, ‘except the ones I don’t like.’” 

In What a Direct Attack on Free Speech Looks Like (July 10, 2020), The Atlantic, David Graham emphasizes the danger that should make us all shiver. In The Tweet (which he notes had that first day accumulated over 80,000 likes and 30,000 retweets), the President “… is making a bona fide threat against First Amendment speech itself, trying to use the power of the government to punish people whose expression he finds objectionable.”

Classification of Gig Economy Workers: Rideshare Companies’ Fight Against AB5

Since the enactment of California’s Assembly Bill 5 (“AB5”), many employers have struggled with classifying their workforce.  AB5, which codifies the factors set forth in the California Supreme Court case, Dynamex Operations West, Inc. v. Superior Court (2018) 4 Cal. 5th 903, changes the method of determining whether a worker should be classified as an employee or independent contractor in California. 

Those factors, better known as the “ABC” test, establish strict criteria that must be satisfied in order for a worker to qualify as an independent contractor.  How workers are classified is significant as employees are entitled to labor protections, such as minimum wage laws, sick leave, and unemployment and workers’ compensation benefits, while independent contractors are not. 

Pursuant to AB5, an employer must establish each of the following three factors to meet its burden to show that a worker is properly classified as an independent contractor:

(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact; and

(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and

(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Cal. Labor Code §§ 2750.3(a)(1)(A)-(C).

AB5 and the Gig Economy

Companies operating in the gig economy, a market system in which temporary positions are common and companies tend to hire independent contractors and freelancers instead of full-time employees, seem to have been impacted the most from AB5.  The Bureau of Labor Statistics reported in 2017 that 55 million people in the U.S. are “gig” workers.  The term “gig” being a slang word typically used by musicians to refer to a job that lasts a specified period of time, can represent a wide range of positions from handymen to freelance programmers.  It is projected that in 2020, gig workers will represent more than 40% of the entire U.S. workforce.

For companies like Uber and Lyft, which have historically classified their drivers as independent contractors, that means changing their entire business model, creating significant expense and administrative burden.  As such, they have continued to classify their drivers as independent contractors resulting in numerous lawsuits alleging that Uber and Lyft have been misclassifying their drivers as independent contractors in violation of AB5. 

Judge Schulman’s Injunction Order

On May 5, 2020, California’s Attorney General Xavier Becerra (joined by City Attorneys for Los Angeles, San Diego and San Francisco), filed a lawsuit on behalf of the People of California seeking an injunction and penalties against Uber and Lyft for their failure to comply with AB5.[1]

The People filed a motion for a preliminary injunction and on August 10, 2020, the Honorable Ethan P. Schulman, granted the motion finding that Uber and Lyft violated AB5 and misclassified their workers.  However, Judge Schulman agreed to temporarily stay his ruling for ten days to allow the parties time to appeal the decision.  Uber and Lyft both filed notices of appeal.

In his ruling, Judge Schulman addressed the contradictory positions taken by Uber and Lyft.  Specifically, “in the same breath as Defendants argue that they are not subject to AB5, they urge the Court to stay the litigation until the Ninth Circuit can decide the constitutionality of that legislation, insisting that a decision in their favor will moot this case.”[2]  As the Court further noted, “if AB5 does not even apply to Defendants, why would the Court need to stay this litigation until its validity has been determined?”[3]

More concerning for the Court was Uber’s arguments presented in a federal lawsuit filed to enjoin enforcement of AB5.  In the federal case, Uber, Postmates, and two individual drivers, argued (and presented evidence in support thereof), that the sponsors of AB5 targeted and refused to consider an exemption for gig economy companies.  “Uber contends that the same legislation it asserts in federal court ‘targeted’ its business does not, in fact, apply to it at all,” making it “difficult for the Court to take seriously such contradictory positions.”[4] 

The Court additionally offered a scathing rebuke of the rideshares’ position that their drivers perform work outside the usual course of Uber and Lyft’s business (ie., the “B” prong of the ABC test).  More specifically, the rideshare companies deny they are in the business of transporting passengers in exchange for compensation.  “Instead, they assert that they are merely ‘multi-sided platforms; that operate as ‘matchmakers’ to facilitate transactions between drivers and passengers.”[5]  The Court found that, contrary to Uber and Lyft’s creative business description, their “drivers provide an ‘indispensable service’ to [the companies] and [they] ‘could not more survive without them’ than it could without working a smartphone app.”[6]  In short, Judge Schulman found that “under any reasonable understanding of the English language, an Uber or Lyft driver can only be viewed as working in the hiring entity’s business.”[7]

The ruling would have required Uber and Lyft to immediately reclassify their drivers as employees – thus making them eligible to receive regular employee benefits – or, stop operating in California.  Rather than comply with the statute and the injunction order, Uber and Lyft threatened to cease operations in California as early as 11:59 p.m. on August 20, 2020.    However, the First District of the California Court of Appeal granted them a reprieve by further staying Judge Schulman’s injunction order pending the outcome of the appeal. 

Alternate Business Models

Uber and Lyft have indicated that they have considered various business structures as an alternate to their existing business models. One option that has been proposed recently is a franchising model.  Under a typical franchising model, a franchisee pays a fee, in addition to a portion of its ongoing revenues, to use the franchisor’s brand.  Uber is already familiar with this structure as it is similar to how Uber operated when it officially launched in 2011 (when Uber riders were only allowed to hail black luxury vehicles through its mobile app).  Uber still uses a franchise model in Europe where it works with fleet operators in Germany and Spain.  However, as compared to other business models that would allow flexibility for rideshare drivers, a franchise model would likely be a last resort for continued operations in California. Plus, even under a franchise model, Uber and Lyft could still be scrutinized if they attempt to exert too much control over the franchisees.

Introduction of Proposition 22

Proposition 22, an initiative on the November 2020 ballot, appears to be an effort to find a middle ground for rideshare companies.  Although prop 22 would consider drivers as independent contractors (and exempt from AB5), it would enact wage and labor policies specific to rideshare companies.  For example, it would limit the amount of time drivers are permitted to work during a 24-hour period.  It would also require companies to provide certain benefits such as healthcare subsidies and disability payments to their drivers.

Prop 22 has overwhelming support among police unions and business organizations – with contributions in support of prop 22 totaling over $110 million.  Contrast that with the $866,000 in opposition to prop 22 which is funded primarily by various labor unions.

Conclusion

While Uber and Lyft executives may be correct that they simply cannot change their entire business model overnight, the priority has clearly been to challenge AB5 rather than to take steps to comply with it.  Nonetheless, it is projected that in 2020, gig workers will represent more than 40% of the entire U.S. workforce. Given the size of the “gig” economy, and more importantly, the role that food delivery companies have played during the pandemic, it is anticipated that rideshare companies will continue to have a future in California.  In order to continue to operate, however, it is clear that the companies will have to offer at least some labor protections to their drivers.

[1] San Francisco County Superior Court, case number CGC-20-584402.

[2] Aug. 10, 2020 Injunction Order, pg. 19, lines 22-24.

[3] Id. at pg. 19, lines 24-26.

[4] Id. at pg. 20, lines 1-12

[5] Id. at pg. 23, lines 7-9.

[6] Id. at pg. 23, lines 15-17 (citing O’Connor v. Uber Technologies, Inc. (N.D. Cal. 2015) 82 F.Supp.3d 1133, 1141).

[7] Id. at pg. 26, lines 23-25.

Matthew Learned, Esq., M.B.A.
Matthew Learned, Esq., M.B.A.

Matthew Learned is Senior Litigation Counsel at FPLG