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.”

Endowments and Offshore Tax Havens

In recent years, Congress has made no secret that it has concerns about the billion-dollar endowments of certain tax-exempt colleges and universities. A particularly troubling aspect, in the view of lawmakers and many in the general public, is the rapid jump in tuition costs at American schools at a time when the wealthiest institutions appear to have comfortable cushions of cash. Lawmakers asked pointed questions and the colleges and universities pushed back hard with forceful defenses.
It is no surprise, then, one of the provisions of the recently enacted Tax Cuts and Jobs Act of 2017 is a 1.4% investment-income excise tax on the nation’s most generously funded tax-exempt schools.
An event that likely bolstered support for this special new tax was the publication last fall of the so-called Paradise Papers in newspapers around the world. Splashy headlines in the United States included provocative information that wasn’t widely known here; over 100 private and public colleges and universities have been parking large amounts of endowment cash in Caribbean tax havens.  

   Chilly Reaction to Endowments News

The Paradise Papers is the name given to a leaked stash of some 13.4 million, confidential, electronic documents showing offshore investments by the rich and famous. In early November 2017, a coalition of international investigative reporters published information sourced primarily from Appleby, a prominent and respectable offshore law firm, which routinely facilitates the funneling of money to tax-haven jurisdictions.
The 120,000 files reveal the offshore finances of some of the world’s largest companies and wealthiest people and influential people.  Among them are Queen Elizabeth II, U.S. Commerce Secretary Wilbur Ross, and other well-known names. What was particularly shocking was the disclosure of offshore activities by 104 United States universities and colleges, ranging from state schools like Ohio State and Rutgers to Princeton and other Ivy League institutions.
Many Americans, on and outside university campuses, were shocked and dismayed by headlines like these: “Endowments boom as U.S. universities bury earnings overseas: American universities are using offshore strategies to swell their coffers, skirt taxes and obscure investments that could spark campus protests.”
This reaction stems from a vague sense of “ickiness”: Is it legal or ethical? What’s with all the secrecy? What kinds of shadowy investments are being made with this money?

   So, Is it Legal?

In an in-depth investigative series, [W]hat are the Paradise Papers and what do they tell us?, British reporters from The Guardian explain that “[m]ost people do not understand the complexities of offshore tax. They have no need to ….
In the 1970s, offshore tax arrangements became a popular way for people to “hide their money from corrupt and predatory governments in unstable countries, or for banks to move cash around to avoid fluctuations in currency rates.” In these circumstances, the secrecy and generous tax advantages “made them the investment place of choice for the rich and famous who wanted legitimate but tax-efficient investments for their wealth.” Over the past decades, these tax-haven arrangements have “grown exponentially.”
The Paradise Papers reveal the many ways that entities and individuals can “avoid tax using artificial structures.” Offshore tax arrangements “are legal if run correctly.” Some are; some aren’t. “Appleby certainly has a reputation as a respectable company; … it has a blue-chip clientele that includes some of the wealthiest companies and individuals in the world.”
In The Use of Foreign Blocker Corporations by U.S. Nonprofits: Should Blockers Be Blocked?, Professors Norman I. Silber and John C. Wei, of Hofstra and Yale, present a clear and excellent – if not wonky – explanation of the law that applies to the situation just recently revealed to the general public. They also explain the policy arguments for and against it.

Legitimate tax avoidance—as opposed to illegal tax evasion—is, by definition, never abusive. As Judge Learned Hand famously noted, ‘[a]ny one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.’

Yes, there was a famous and often-quoted judge named Learned Hand.
The bottom line is that, under current law, the use of offshore tax accounts by American nonprofit institutions of higher learning – (if structured correctly, and these institutions have excellent counsel) – are legal methods of tax avoidance. Lawmakers know all about it. They have considered tweaking the tax code to curb or eliminate it, but have not done so yet – directly.
Here’s how it works. Generally, U.S. tax-exempt organizations are exempt from federal income tax. There are some exceptions, though, including the unrelated business income tax (UBIT). Ordinarily, passive investment income is outside UBIT’s reach. But if an investment is “debt-financed,” it moves back into UBIT territory: an exception to the exception, so to speak. In the offshore situation, the critical element is a “blocker corporation,”  set up under the laws of a Caribbean jurisdiction and not subject to U.S. taxation. For U.S. nonprofits, use of this device successfully shields them from any pesky UBIT exposure at all as to money parked offshore. 
“Under the current US tax structure, schools have an incentive to move offshore because it allows them legally to avoid paying federal tax on hedge fund and private equity investments.”

   Is it Ethical or Moral?

A key question going forward is whether there are reasons to look beyond the legality issue into the ethical sphere, particularly in the case of nonprofit universities which have become “big players in offshore games. In contrast to the stated mission of open discourse espoused [by them], investments are frequently held in secret entities that help them minimize their contribution to the public purse.”
Law professors Silber and Wei explore this issue from both the legal and policy angles. They “conclude that the use of offshore blocker corporations does not undermine the main purposes of the debt-financed UBIT, but that the practice nevertheless raises some serious policy concerns.” They recommend a choice of reforms: either take away the “blocker corporation workaround to the debt-financed UBIT” or repeal the “debt-financed UBIT completely” but leave in place or even expand the reporting duties relating to debt-financed UBIT.
 Professor Sam Brunson of Loyola (Chicago) University agrees that the “common university practice of investing in funds that are housed in offshore tax havens” is legal. “There may be bad things about it—I don’t like the fact that we send a lot of money through tax havens—but that’s the way the tax law is written…It’s not morally good or morally bad.”
In a recent statement responding to the news about, and criticism of, the offshore investments, Northeastern University voices the position generally taken by universities engaging in this practice: “[I]nvestments ‘were managed to maximize the opportunities for furthering our educational and research mission. It is important that we diversify our portfolio to maximize the return on these investments within the strict guidelines of the law.’”
In the recent Tax Cuts and Jobs Act, lawmakers could have but did not act on recommendations that they directly address offshore tax-haven activities through tweaks of the UBIT law. Instead, they added the 1.4% excise tax on investment income of the highest-dollar endowments. This may indirectly achieve some of the same result.

   What About the Investments?

Perhaps the most explosive aspect of the Paradise Papers revelations is that many universities’ investments in offshore tax havens relate to deeply unpopular activities.
The reaction by student groups and other vocal critics has been swift and strong, particularly at those institutions that have made a public showing of apparent support for sustainable activities and environmental concerns.
A typical example is Northeastern University which “prides itself on being at the forefront of sustainability.” Its “secret investment in an aggressive financial backer of carbon-emitting industries came as a surprise to members of DivestNU, a coalition of student groups campaigning for a fossil-fuel-free campus. “The university’s motto is ‘light, truth and virtue’,” remarked one member. “Now we learn that the leadership team has been operating in darkness, violating their own green principles by investing in oil and gas, and going offshore to pay less tax.”
Similarly, at the University of Pittsburgh, which the public now knows has investments tied to fossil fuels, a student member of the Fossil Free Pitt Coalition said, “We are concerned about the lack of transparency, as two-thirds of the endowment is just a mystery to us….We are suspicious about where that huge segment of the endowment is going.”

   Conclusion

The debate about the November 2017 Paradise Papers’ revelations and their implications for American colleges and universities is just beginning.
If “[a] university is, first and foremost, a social undertaking to create a social good,” can or should that institution “act in ways that deprive the public sector of needed resources to address social problems”?
Politicians around the world and in the U.S. are beginning to ask whether offshore tax havens should be banned. Are they fair? Are they moral? A fundamental question posed by the Paradise Papers is “has tax avoidance in all its guises gone too far?
In the United States Congress, there may be additional legislative action in the future including – for instance – laws mandating that wealthy institutions do more to help out their students meet crushing tuition and costs obligations.
 

Conflicts of Interest Can Lead to Big Problems

“The last shoe may have dropped,” according to The Nonprofit Quarterly in late July, which has been following the tumultuous tale of troubles from conflicts of interest at Kentucky’s University of Louisville Foundation.
It’s not uncommon for major nonprofit institutions like universities and healthcare facilities to form foundations to help raise funds and support the important work of the main organization. Many of these relationships proceed for decades with harmony and success, but there are sad exceptions.

   Conflicts from Overlapping Boards 

As far back as 2009, there have been problems. Since that time,

the U of L Foundation has been overspending. Their expenses were higher than revenue each year, steadily eating at their endowment. It is a mystery why the financial officer was the last to be let go when the financial woes of the organization were so pronounced.

“Any year with expenses over income is an anomaly,” observes Marian Conway of NPQ, “that a nonprofit should address. Seven years of fiscal imbalance is irresponsibility equally shared by staff and board.”
Because of the extensive and highly damaging problems, the University of Kentucky commissioned an independent forensic audit that was released to the board in early June 2017 as well as the general public. The audit was restricted to the years 2014-2016, but it describes earlier relevant events.
An independent forensic audit is “significantly different than a typical financial audit.” The report is some 269 pages; the “specific findings … are a simple statement of transactions and issues resulting in a complex and destructive situation.”
A critical problem was that James Ramsey was president of the university as well as of the foundation at the same time. There were additional overlaps of senior staff. The situation was rife with “conflicts of interest” yet “[d]espite this coziness, there was a “lack of communication and transparency.” Many board members were left out in the cold and remained unaware of key decisions, commitments, and transfers of assets.
Eventually, there were wholesale changes of personnel, but these actions dragged out over a period of time. In September 2016, President Ramsey was forced out; later his top aide was also removed. There was a full-board turnover along with the addition of some 12 new members. Many months later, the chief financial officer of the foundation was finally terminated.
Over this troubled period of time, there were significant losses in the foundation’s endowment “but the true value of the endowment was concealed by the foundation’s accounting practices, which included reporting gifts by the foundation to the university as loans on the foundation’s financial records.”
As a result of this turmoil, donations plunged also, threatening the long-term stability of foundation.

  Lessons to be Learned

The Nonprofit Quarterly’s Michael Wyland makes the important point that publicly rehashing the sordid details, while unpleasant, has value not only to the institutions directly involved but to others. “As always, a tale of abuses like those that occurred at the University of Louisville and its foundation can be educational—and cautionary—for similar public and nonprofit organizations.”

   Conclusion

The ultimate lesson to be learned from this situation is that “[w]hat is convenient for management may become tempting to management, and overreliance on an individual leader, coupled with neglect of group accountability and oversight, can be seriously damaging to an institution.”

Renewed Efforts to Rein In College Endowments

Over the past year or so, there’s been significant attention and discussion about the multi-billion-dollar endowments enjoyed by some of the nation’s most prominent colleges and universities.
There have been “growing concerns in recent years about the massive nest eggs of the nation’s most prestigious institutions of higher learning.”  

These criticisms arise against a background of record-breaking fundraising. In 2015, for instance, Harvard University, received some $1.05 billion in charitable donations. This continues a trend in which the wealthiest schools receive a disproportionate share of the philanthropic dollars flowing nationwide into higher education.

  Endowments Concerns Raised Previously

Earlier in 2016, the Senate Finance and the House Ways and Means Committee “had issued joint letters to over 50 colleges and universities, each of which has an endowment valued at $1 billion or more. In that letter, there were 13 endowment-related questions; answers were requested by April 1, 2016.”

This isn’t the first time that officials and legislators have raised concerns over these massive endowment funds. In 2008, the IRS sent out compliance questionnaires to approximately 400 colleges and universities in connection with a larger IRS review program focusing on “the  growth of endowment funds, the compensation paid to fund managers, and whether more money from such funds should be used to offset the rising tuition rates being charged by educational institutions that are ‘charitable’ organizations.”

Congress was not at all mollified by the responses from these 50 educational institutions. This included the argument that some institutions, including Harvard University, have recently suffered slower-than-usual investment returns on their massive endowment portfolios.
In September 2016, Congressional leaders announced the scheduling of additional hearings for follow-up questions. Though the House Ways and Means Committee proceedings was “nominally about the tax-exempt status of college endowments, … much of the discussion focused on college affordability — a broader issue clearly on the minds of both Republicans and Democrats on the panel.” A spokeswoman for the House committee explained: “This is another step that the committee is taking to understand what colleges are doing to address soaring college costs through their endowments and nonprofit tax status.”
Lawmakers also sent an additional round of questions to some of those institutions.
The matter was also raised during the presidential election campaigns; the Democratic platform, for instance, called for free college tuition in some circumstances for certain students.

  Current Congressional Action on Endowments

A Congressional proposal raised last year is now being pushed forward again.
New York’s Republican Representative Tom Reed had, in early 2016, called for the universities with the largest endowments to “direct 25 percent of their annual endowment income to financial aid for middle- and working-class students – or lose their tax exemption.”
As originally set out, this measure would apply to institutions with endowments of $1 billion or more – estimated to be approximately 100 universities and colleges.
Now that proposal is being given new life, thanks to Rep. Reed who was recently vice chair of the then President elect’s transition team, and has moved into a position of greater influence. These institutions with $100-billion+ endowments would be called on to –

offer steep discounts to families with annual incomes of between $24,000 and $145,000. The proposal also would require all universities receiving federal aid to provide more disclosure about administrative salaries and perks and file “cost-containment plans” designed to keep tuition increases below the inflation rate.

This news has spooked not just the targeted universities but also wealthy donors. “The super-rich often slim their tax bills by swelling the coffers of their alma maters through donations for pet projects. Now, under a tax overhaul in Washington, the tax benefits of such gifts could be curtailed.” These one-percenters and their alma maters argue that this change in the rules regarding college endowments may force them to curtail charitable giving to universities that focus on other areas than general student education.
“This kind of restriction will not address the cost of higher education,” according to University of Southern California president. “At USC, which has a $4.6 billion endowment, Oracle Corp. co-founder Larry Ellison’s recent $200 million gift in support of a cancer research center would not be fully deductible under the Reed plan.”

  Conclusion

This will be an interesting push-and-pull to watch at the beginning of this new Administration and new Congress. It’s anyone’s guess what the outcome will be.

Universities Sued for Fiduciary Breaches of Retirement Plans

Prestigious universities around the nation are facing a new legal challenge related to how they administer employee retirement plans.
In August 2016, a single law firm filed separate complaints against eight prominent educational institutions: Duke, Emory, Johns Hopkins, Vanderbilt, NYU, Yale, Penn, and MIT. The common allegations: These educational institutions have allegedly breached their fiduciary duties to employees in connection with the management of their [401(b), non-ERISA] defined contribution pension plans. There are plans to ask for permission to consolidate these cases as a class action lawsuit.  

   Background

Schlichter, Bogard & Denton, a law firm based in St. Louis, was successful recently with similar claims against for-profit companies offering 401(k) retirement plans. The firm achieved a 2015 Supreme Court victory; the justices ruled that various defendants “managing these employer retirement plans – plan fiduciaries – have an ongoing duty to monitor investments and remove bad options,” and they breached that duty by offering far too many choices and overcharging on fees. “Those 401(k) lawsuits are regarded as a major development in retirement planning…,”
After that victory, this law firm set its sight on the higher education sector. The type of retirement plan in these university cases is the 401(b), non-ERISA plan. “A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan eligible to be sponsored by employers such as Code Section 501(c)(3) organizations (otherwise known as non-profit organizations), public education institutions and certain ministers.Under current law, there are certain fiduciary responsibilities for plan sponsors and administrators.

  Allegations of Fiduciary Duty Breaches

The lawsuits against these 8 higher education institutions include allegations that “the universities did not uphold their fiduciary duty as retirement plan sponsors, effectively leaving tens of thousands of employees and retirees to pay millions in unnecessary fees.”

Nearly all of the complaints center around 403(b) plans, defined-contribution retirement savings plans that are similar to the better-known 401(k) but are available for nonprofit institutions, including colleges and universities. Generally, the suits allege that universities offered employees too many investment options in their retirement plans, which can confuse employees and also result in higher fees. Arguments also include that universities did not swap out expensive and poor-performing investments for better options and that higher-fee retail-class funds were available instead of a menu made up of only less expensive institutional funds.

Some suits also allege that universities cost employees by using multiple companies as retirement plan providers, or record keepers. An institution can negotiate lower fees by consolidating to one record keeper, increasing its bargaining power, the suits argue.”


This litigation is the first of its kind in the higher education sector. According to the law firm’s senior partner: The objective of these cases is not only to compensate university employees for what’s happened to their retirement assets, but to reform the plans and change the plans they are operating.”
An “interesting” twist to these claims is that these plaintiffs’ lawyers are arguing that there are not too few retirement planning choices – but too many.

The idea is that many options are essentially expensive false choices, that offering investments with different names from various companies is not of any benefit if those choices follow identical investing strategies and post similar returns. Under the line of reasoning, the unnecessary expenses associated with all of those choices can total many thousands of dollars for an employee over a lifetime of retirement saving.

There are, indeed, huge amounts of money at stake. For example, for the year 2014, the faculty plan for NYU, with over 16,000 participants had $2.4 billion in net assets. Yale’s plan, with a similar number of participants, had some $3.6 billion in assets.
According to the complaint filed against NYU, the institution “has about 20 large-cap domestic equity options for faculty.” –

That’s not counting other types of options — universities can have hundreds total of choices. A prospectus for each investment can run dozens of pages, meaning an employee who wants to review all investment options would be faced with an astronomical challenge.

  Conclusion

While it’s unclear whether this law firm will sue additional universities, that would fit the earlier pattern it followed in connection with the lawsuits against the for-profit 401(k) employer plans. Some observers believe these are test cases, and – if successful – will lay the groundwork for litigation against other educational institutions, large and small. Other counsel can also bring lawsuits. Columbia University, for instance, was just sued by a different law firm.

Princeton U. Settles Property Tax Exemption Challenge

“Are You Watching the Court Rulings on Property Tax Exemptions?”
In 2015, Linda M. Czipo, of the Center for Non-Profits, “the only umbrella organization for all New Jersey 501(c)(3)s,” asked this provocative question. She, herself, provided the prescient answer: “Maybe You Should.”
Recently, around the nation, state and local governments have devised clever ways to pry additional revenue from their tax-exempt nonprofits to counteract severe budget constraints.  New Jersey has emerged as a hotbed of this activity, and the most lucrative potential targets are the valuable property tax exemptions of that state’s biggest nonprofit institutions, including universities and hospitals.

First, the Hospitals

In a key test case in 2015, officials in Morristown, New Jersey, took aim at a major landowner in town – Morristown Medical Center. This direct attack on the applicability of the property tax exemption to a modern healthcare center was successful. In an 88-page – stinging – opinion, Chief Judge Vito Bianco of the New Jersey Tax Court ruled that the institution was not eligible for a property tax exemption on almost all of its 40-acre property.
“Non-profit hospitals have changed significantly,” he wrote, “from their early origins as charitable alms houses providing free basic medical treatment to the infirm poor….” The [modern] “medical center appears functionally similar to for-profit hospitals,” operating as “labyrinthine corporate structures, intertwined with both non-profit and for-profit subsidiaries and unaffiliated” entities.
Asserting that “times have changed and the longstanding tax exemption based on state law should no longer apply, Judge Bianco challenged the Legislature to change the law if it disagreed.” He also suggested that “all 72 nonprofit hospitals in the state” may have cause to worry about their property tax exemptions.
Sure enough, in late August 2016, news broke that 35 New Jersey hospitals have been sued by their local communities, based on Morristown’s success in attacking the property tax exemption of Morristown Medical Center. While a few of those hospitals have already settled with their municipalities, the remaining defendant-hospitals are in jeopardy.

  Next, the Universities

Roughly the same objections about a major landowner’s entitlement to a charitable property tax exemption can be made against institutions of higher education. Modern universities have morphed into huge, varied enterprises with enormous endowments and extensive property holdings. This sets the stage for a class “town vs. gown” showdown about how the university is a voracious public-services user without paying for those services.
In an interesting twist, recently, Princeton University became the target of a property tax challenge that was brought not by the local government itself, but directly by irate residents of Princeton, New Jersey. Their arguments and standing to sue have been based on the premise that if the university escapes the obligation to pay for municipal services it uses, then the burden disproportionately and unfairly shifts to the homeowners and businesses who are required to pay property taxes.  
The 27 plaintiffs are low-income, disabled or retirees in Princeton, an affluent town with a median household income of $116,875. “Those with the least resources…were subsidizing the nonpayment of some of the wealthiest property owners, namely Princeton University,” said a former mayor of Princeton and one of the lawsuit’s plaintiffs. The lawsuit was designed to try to stabilize the tax base, “to give these more disadvantaged families a chance to keep up.”
In addition, the plaintiffs allege that the “university participated in commercial licensing and other for-profit ventures, particularly stemming from biotech research.” As such, some of the property is not used for “nonprofit academic purposes,” They also point to the university’s investments and fee-based operations like cafes.
Under New Jersey’s property tax statutes, since 2001, some proration is allowed when a property owned by a charity is used for both charitable and noncharitable purposes. In this case, though, the plaintiffs have asked the court to revoke the University’s property tax exemption entirely.
Not only has this been a high-profile test case – watched anxiously by other universities around the nation – it features a familiar name: Chief Judge Vito Bianco.
Fields v. Princeton University has been in the courts for over a year. In a major skirmish last November, Judge Bianco ruled that Princeton has the burden to prove that it is entitled to the property tax exemption. The plaintiffs are not required to prove that Princeton is not entitled to this valuable tax break. He rejected the argument that requiring the nonprofit to bear the burden of proof in third-party cases like this would invite litigation and make the charities more vulnerable to frivolous challenges.
Because of the important issues here, Princeton has received support from allies in the nonprofit world, including New Jersey’s Center for Non-Profits, which filed an amicus curiae brief (with 5 co-signers) in support of Princeton’s appeal of the November adverse ruling.   
This lawsuit worked its way through preliminary proceedings and trial was set to begin on Monday, October 17, 2016. Seeing the proverbial “writing on its [ivy-covered] walls,” the university agreed to settle the lawsuit the previous Friday. Princeton University agreed to pay $18.2 million over six years.
The settlement has features that address the economic inequality that was a key reason for the lawsuit. For example, some $1.25 million over the next three years will go to property-tax relief in one of the town’s “historically black” communities that “has become increasingly unaffordable in recent years.”  Another $10 million will go to Princeton residents “who already get property-tax relief under the state’s homestead benefit program.”
The “underlying issue of the school’s property tax-exempt status remains unresolved, and the plaintiffs are free to bring another lawsuit in six years.”

   Conclusion

Although Princeton University officials have characterized the decision to settle the case as a pragmatic evaluation of the cost of a trial, instead of any concession about the merits of plaintiffs’ arguments, this is a significant development that has implications for many charitable organizations and institutions around the nation.
 

Congress Digs In On Huge College Endowments

“A not-so-old joke has it that Harvard is best thought of as a hedge fund with a university attached.”
The fund in question is its endowment – the largest in the United States – valued at over $35 billion. There have been growing concerns in recent years about the massive nest eggs of the nation’s most prestigious institutions of higher learning.
These criticisms arise against a background of record-breaking fundraising. In 2015, for instance, Harvard University, received some $1.05 billion in charitable donations. This continues a trend in which the wealthiest schools receive a disproportionate share of the philanthropic dollars flowing nationwide into higher education.
Critics, including some members of Congress, are asking whether endowments are doing enough to help students at a time of soaring educational debt — or if the support by taxpayers is just helping the richest schools get richer.”
Six months ago, we reported that the Senate Finance Committee and the House Ways and Means Committee had issued joint letters to over 50 colleges and universities, each of which has an endowment valued at $1 billion or more. In that letter, there were 13 endowment-related questions; answers were requested by April 1, 2016.
This isn’t the first time that officials and legislators have raised concerns over these massive endowment funds. In 2008, the IRS sent out compliance questionnaires to approximately 400 colleges and universities in connection with a larger IRS review program focusing on “the  growth of endowment funds, the compensation paid to fund managers, and whether more money from such funds should be used to offset the rising tuition rates being charged by educational institutions that are ‘charitable’ organizations.”

    Defending the Endowments Status Quo

In this year’s round, representatives of the targeted schools – as expected – didn’t give an inch. In their replies to the February 2016 letters they vigorously defend the current system. Many cited examples of community benefit and enrichment made possible by the large endowments. For example –

Duke notes it contributed $7.5 million toward the eponymous Duke Performing Arts Center. Amherst says it ‘readily consents’ to town gatherings and events on its campus. Harvard says it contributes to its host communities ‘through a broad array of direct programming, supportive services, and civic collaborations’ and that such programs in Cambridge and Boston had an estimated value of more than $18 million annually.

They also tout “their role as engines of innovation” with a “financial impact [that] is positive and profound.” These world-class learning centers “generate talent for the city, research, scholars, scholarship and money,” according to one educator.  “Students spend. Faculty earn and pay taxes. Parents visit…..”
In particular, these officials “have –

a host of arguments at the ready to justify not spending more of their money on financial aid. There is donor intent to honor. Endowments are investments representing many hundreds and even thousands of accounts, each with their own restrictions. And then there is the most common argument: preserving the institution’s wealth for the future.

There’s more: These endowment funds have been losing money in recent years. “College endowments are poised to take the worst slide in performance since the 2009 recession.” Their portfolios are shrinking.

    Lawmakers Are Not Persuaded

At the beginning of September 2016, Congressional leaders announced hearings to follow-up on the questions and answers from earlier in the year. The legislators were not impressed by the arguments and excuses from the $1-billion+ endowment folks.
The House Ways and Means Committee’s Subcommittee on Oversight announced a hearing for September 13, 2016, titled “Back to School: A Review of Tax-Exempt College and University Endowments.”  Though the hearing was “nominally about the tax-exempt status of college endowments, … much of the discussion focused on college affordability — a broader issue clearly on the minds of both Republicans and Democrats on the panel.” Republican subcommittee members complained about lack of transparency from these institutions – “on endowment spending as well as on what they consider wasteful spending on campus amenities, athletic salaries, administrative costs and other noneducation uses.
There was testimony from policy experts as well as from college officials, along with written comments submitted for the record.
“Steven Bloom, director of government relations at the American Council on Education, said in an interview that he thought the subcommittee came away with a greater appreciation of the complexity of higher ed policy.
But a spokeswoman for the House Ways and Means Committee explains: “This is another step that the committee is taking to understand what colleges are doing to address soaring college costs through their endowments and nonprofit tax status.”

     Next Up: More Questions on Endowments

The House subcommittee’s hearing was separate from the joint inquiry with the Senate Finance Committee that produced the early 2016 letters to the colleges with the $1-billion+ endowments. As a follow-up to that joint probe, lawmakers have sent an additional round of questions to some of those institutions.

     Conclusion

The battle lines have been drawn and the sides are talking at cross-purposes. Of course, Congress  holds all the cards here. The tax exemption is a privilege that can be taken away or saddled with various restrictions. One proposal is to add a surcharge to the largest endowments to help provide aid to college students. Notwithstanding activity at the federal level, these wealthy educational institutions need to be watching their backs.  The state and local governments in which these schools thrive are chomping at the bit to eat away at – or devour completely – their valuable property tax exemptions.  

Another Public University Foundation Under Fire

Sometimes called “slush funds” and “shadow corporations,” the foundations that support the nation’s public universities have been grabbing headlines recently: ones they would rather avoid. We highlighted some developments in “Foundations of Public Universities: Too Secretive?
“Public officials are raising questions about the spending practice of the nonprofit fundraising arms of public universities,” because “they control huge amounts of money with little accountability.”
In our earlier post, we discussed two cases that already received attention earlier this year.
The first example is the University of North Carolina System – and the 17 foundations connected with 11 campuses around the Tar Heel State. With assets recently estimated at almost $1.66 billion, they are fundraising powerhouses. Not for the first time, there have been concerns about the “investment practices of these foundations and how they interact with university finance and property transactions.” Complicating any inquiry is that the UNC System doesn’t even have a complete and readily accessible list of all campus foundations, much less information about how the money is raised and spent. There are suspicions that the foundations are used to circumvent the bureaucracy and oversight of the normal university finance channels. “There are ‘a lot of different colors of money in university operations’ and foundations intermingle that money.” The money flowing out “can be used for anything.”
The second example is the The UConn Foundation, the “private, nonprofit fundraising arm” for the University of Connecticut. While the foundation raised some $80 million last year, “about half of the foundation’s annual operating budget comes from UConn, and it receives ‘some $8 million a year of taxpayer funds.’” As state budget cuts increase, the University relies more and more on UConn Foundation and donations to pay for programs. But there is little transparency, in part because The UConn Foundation “is the only type of university organization in New England that is not subject to freedom of information laws” under state “sunshine” statutes.
These secretive university foundations are not isolated situation; experts believe this is a problem nationwide.

   City University of New York

Another example making headlines currently is the City College 21st Century Foundation, the principal fundraising arm of CUNY.
Earlier this year, “[t]he finances of that foundation, as well as those of City College’s president and her family” had already become the subject of an investigation by federal prosecutors in Brooklyn.
The current story, though, focuses on a specific account within the Foundation: the Martin and Toni Sosnoff Fund for the Arts. In June 2016, a $500,000 donation to the Sosnoff Fund was made; the purpose was “to bolster the humanities and arts” at CUNY’s “flagship school.”  Earlier donations to the same fund had been earmarked and “used to support more than 100 adjunct professors and lecturers in the Division of Humanities and Arts to ensure that students have access to courses they need to successfully pursue their programs of study.”
Faculty members discovered that, by July, just $76 remained in this account.  “That prompted widespread concerns, because ‘diverse programmatic initiatives, student projects and salaries for some faculty and staff depend upon the Sosnoff Fund’” and outstanding invoices were piling up. There was worry that the money had been diverted to help CUNY “close a budget deficit at the end of its fiscal year on June 30.”
The professors who had asked questions were “met with ‘stonewalling,” prompting a broad-based faculty delegation to contact the University chancellor directly. “We are deeply concerned about the practical, ethical and legal implications of the situation,” they wrote. This is a restricted gift that appears to have been diverted from the stated purpose and intent of the donors.
The chancellor, along with CUNY’s general counsel, has launched a new internal investigation specifically relating to this issue – in addition to the move made earlier to hire an outside counsel in response to the broader law enforcement investigation already underway.     

    Conclusion

In addition to following-up on these investigations, in later posts, we’ll take a look at the important topic of donor-restricted gifts.

The Other Nonprofit Discrimination Lawsuit in the News

“The nation’s colleges and universities have been on pins and needles waiting for the U.S. Supreme Court to decide whether race can be a factor in their admissions policies.”
On June 23, 2016, the United States Supreme Court issued a 4-3 decision upholding the affirmative action program at the University of Texas. Rejecting a challenge by a white student, the court concluded: “The race-conscious admissions program in use at the time of petitioner’s application is lawful under the Equal Protection Clause.”
UT’s admission policy is complicated. There is a system of guaranteed admission to the top students of every Texas high school; other students are admitted on a formula involving many factors including academic achievement, race, and ethnicity. Justice Anthony Kennedy, writing the majority opinion, made clear that the ruling “does not necessarily mean the University may rely on that same policy without refinement. It is the University’s ongoing obligation to engage in constant deliberation and continued reflection regarding its admissions policies.”
This landmark ruling “brought a sigh of relief to much of the higher education world,” although each public university against which a challenge is made must defend on the ground that “consideration of race is necessary – but narrowly tailored to create a diverse student body.”

    Discrimination Lawsuit Against Getty Foundation

Notwithstanding this good news for public higher education in Fisher v. University of Texas at Austin, there is another admissions/acceptance discrimination case just getting underway in Los Angeles Superior Court. This interesting lawsuit, filed in late May 2016, is hitting the radar of the nonprofit community and raising concerns.  

   Facts

Niemann v. Getty Foundation involves a challenge to the acceptance criteria for a prestigious and highly coveted arts internship. This case –

has generated all manner of headlines and Internet jabs after the white university student claimed she had been deterred from applying for an internship program geared toward underrepresented minorities. But the discrimination lawsuit filed in Los Angeles Superior Court is no laughing matter.

“If the case were to be decided in court,” according to an article in the Los Angeles Times, “it could be precedent-setting, affecting the ways that private foundations approach issues of diversity.”
For over two decades, the Getty Foundation’s Multicultural Undergraduate Internship program has attracted stellar young talent for internships at dozens of cultural organizations around Los Angeles County, including some placements at Getty. The program includes “vital” training about the professional aspects of arts management, a field notoriously lacking in diversity. The internship program draws applicants from top schools including the Ivy League; one former intern was a Rhodes Scholar.
The Getty Foundation “has adapted the program over the years to shifting definitions of diversity.” To apply for the internships, students must “be of a group underrepresented in museums and visual arts organizations, including, but not limited to, individuals of African American, Asian, Latino/Hispanic, Native American, or Pacific Islander descent.” (emph. added)
Suzanne Neimann, a student with a 3.7 GPA at Southern Utah University, alleged that Getty –

harassed, discriminated, and retaliated against Plaintiff due to and substantially motivated by Plaintiff’s race/national origin

in violation of: California Government Code section 12940 et seq. (prohibiting discrimination in professional training programs), and the California Civil Code section 51 (Unruh Civil Rights Act, prohibiting racial and other discrimination in private business).

I was denied an hire [sic] to an internship program because I am white and because I am not within the specified minorty [sic] groups African American, Asian, Latino, Hispanic, Native American or Pacific Islander, * * * I protested, and was still denied opportunities to work for The Getty Foundation. The getty [sic] failed to investigate and failed to take appropriate remedial action and failed to hire me.

  Analysis

“The vast majority of cases about affirmative action generally involve the government”; that is, white applicants filing suit against public universities, observes Dean Erwin Chemerinsky, dean at UC Irvine School of Law and frequent TV legal commentator. “This is an unusual situation because it’s a private foundation using its money to promote diversity through internships.”
Dean Chemerinsky believes it may be a tough case for Ms. Neimann because of “…Getty Foundation’s nuanced definition of diversity” and the fact that at least one white student (albeit with an unusual personal story and background) has been accepted into the program.

    Conclusion

This lawsuit in Los Angeles state court may be a long shot for liability; nevertheless, the Getty Foundation must defend against this lawsuit – and a different fact situation might be a problem for a different nonprofit defendant.   It will be interesting to watch this intriguing case.