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Friday, June 11, 2010

Imagine and 501(c)(3) Status

The commentary below comes from Marc Dean Millot. Millot's experience setting up a complicated nonprofit corporation may help shed some light on why Imagine is still waiting for 501(c)(3) status. I've added a brief comment at the end.
Imagine Schools is as a nonprofit corporation under Virginia state law. That only exempts the organization from the state's income tax. Five years ago the national charter school operator applied for exemption from federal income taxes under Internal Revenue Code Section 501(c)(3). They have yet to receive a determination. Why?

In "Failure of Imagination", Pittsburgh City Paper reporter Chris Young passes on Imagine executive vice president Sam Howard's explanation: "The IRS takes forever to do anything."

This issue has been bugging me for a long while. As it happens, circa 1999, leveraging the expertise of nationally recognized leaders, I set up a fairly complicated nonprofit operating in the boundary territory between public education and business. Based on that experience, Howard's explanation strikes me as glib.

The Education Entrepreneurs Fund was a subsidiary nonprofit of New American Schools, both incorporated in VA as nonprofit corporations. The Fund loaned money at low interest to for- and nonprofit CSR providers, made equity investments in for-profits, entered into joint ventures with for-profits in the school improvement space, and started a nonprofit business activity in grant research that ultimately became one of my current competitors (Red Rocks). In round numbers, we started with $1.5 million of NAS money, $3 million from a USED grant to build the capacity of CSR providers, and a $10 million, 10-year, low interest loan from Prudential Insurance.

At the time I was still a pretty new lawyer, but knew exactly what I wanted by way of business operations - a "virtual bank." The Fund's "back office" - processing loan repayments, keeping the books, doing the nightly investments of excess cash etc - was managed by Riggs National Bank trust department under contract. Loan and other investment documentation was drafted by O'Melveney & Meyers. BDO Seidman were our accountants. Education Capital served as independent investment advisors. A subset of the NAS board's executive committee was the Funds board and inverstment committee. I was the President. Two young ex-banker/educator colleagues and I handled the substantive investment issues.

For the better part of a year, I spent much of my time negotiating the various legal elements (corporate formation, loans, grant terms, outsourcing of support functions, etc) required to get this done. I worked closely with some incredibly competent banking attorneys at O&M and the head of BDOs nonprofit practice. Setting up this entity broke a lot of new legal ground, including compliance with ED and banking regulations - and in seeking 501(c)(3) status for the Fund from the IRS. I remember two lengthy meetings of our team at BDO Seidman where we reviewed the pros and cons of various options offered in the IRS application form, argued them out, and decided on an application strategy. Our preparation paid off. As I recall we were granted 501(c)(3) status as a "supporting entity" of NAS within a few months - and without incident.

Now, Imagine is a different entity with a different mission, history and context. Still, my experience suggests that the IRS' nonprofit staff is able to handle complicated structures. And I'm sure Imagine has access to the nations best advice in accounting and law. This is why the lengthy delay strikes me as odd. The basic set of facts the IRS was presented with in the Imagine application seem to be pretty much the same as five years ago. The bulk of Imagine's school operations were acquired from Chancellor-Beacon, Schoolhouse Finance has been in place a long time. The interlocking board structure is unchanged. Moreover, the IRS has had guidelines to determine the federal tax status of charter schools and charter operators for several years, and has revised those guidelines, implying they have travelled some ways along a learning curve.

So what gives? What aspect of the fact pattern presented by Imagine five years ago is so complex or what part of the law surrounding 501(c)(3) determinations so vague that the IRS can't or doesn't want to make a ruling? Its not like they are generally shy about making tax status decisions or reticent about going to court. Has the fact pattern changed in some important way, sending the IRS back to the drawing board? Has IRS experience with charters thrown the staff into a state of confusion? Does the IRS want some change in operations or structure to the Imagine network that Imagine won't give? I don't know. In any case, there's a substantive reason the IRS has not granted Imagine 501(c)(3) status, and its not "we haven't gone through the file yet."

The IRS may be under a legal obligation to refrain from discussing pending applications. Nothing prevents Imagine from offering the public or the independent charter school boards it partners with a substantive explanation for the delay. Indeed - given the sometimes bright line between for- and nonprofit operators in state charter statutes law - it is quite surprising that chartering agencies in the jurisdictions with Imagine Schools' schools have not insisted on a public clarification to support their chartering decisions. (But that is another story.)
Another interesting fact: let's say Imagine has applied for 501(c)(3) status (as they claim in multiple articles/sites). And let's say their application was denied by the IRS (again, this is just a thought exercise - we don't know if they've been denied). Imagine does not have to make this information public and the IRS, under Section 6103 of U.S.C., cannot comment on the application's denial. In other words, Imagine could continue to claim they're eagerly awaiting approval from the IRS even though they've been denied. However, this information would be made public if Imagine fought the denial in court - but there's little incentive for them to make any moves if Imagine doesn't think they could win a court case.

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