By Kathryn A. Bell, CPA, MBA
With the ever increasing regulatory requirements facing for-profit post-secondary schools, the thought of converting to nonprofit status may have crossed your mind. Will becoming a nonprofit ease the burden of regulations? Does it make business sense for your school? Does it make financial sense for the shareholders?
One significant tax advantage to qualification as a nonprofit (and ultimately tax-exempt “public charity” under Section 501(c)(3) of the federal Internal Revenue Code) includes exemption from federal and state income taxes, real estate taxes, and potentially sales and use taxes. Also, of significant recent interest, regulatory advantages include future exemption from 90/10 requirements starting after the first full fiscal year of operations as a nonprofit as well as the freedom from gainful employment regulations for degreed programs (at least for now).
Other advantages can include expanded state grants for students of nonprofit institutions, tax-deductible charitable contributions for donors to the school, and various library and other grant programs for nonprofit higher education institutions. Also, the ability to obtain research grants can attract talented faculty with research aspirations.
Finally, converting to a nonprofit can be viewed as a succession planning option for family-owned schools. Also, conversion could also be viewed as a vehicle to exit from an unprofitable school. However, there is a legitimate question on whether conversion as an exit strategy is a benefit or burden given the significant complexities involved in a conversion.
Potential Concerns and Disadvantages
Alternatively, converting to a nonprofit does have significant disadvantages that need to be considered. There are varying alternative structures for a “conversion transaction” but ultimately the general outcome results in a disposition of assets for “fair market value.” This presents significant difficulties and risks related to valuation, where the concepts of fair market value and arm’s-length valuation are critical to the federal tax rules applicable to tax-exempt nonprofits. Similarly, there are limitations on reasonable compensation payable to owners in the transaction as well after the transaction closes. There is also significant differences in governance as owners will lose control of the nonprofit school which requires an independent board of directors. Once a tax-exempt nonprofit, the ability to raise capital can be more limited as well.
From a tax standpoint, the IRS rules governing tax-exempt organizations/charities are significantly different than those applicable to for-profit businesses. A quick examination of the information return required for tax-exempt entities, IRS Form 990, Return of Organization Exempt from Income Tax, and all required schedules should provide significant insight into the many areas of concern and restriction, including public disclosure of financial results and compensation details, private benefit issues with related parties, the unrelated business income tax (UBIT), as well as restrictions on for-profit activities, joint ventures, political activities, lobbying, etc.
In addition to the significant business and tax complexities, the actual transaction structure and related legal and regulatory issues are of significant concern and complexity. The Cooley LLP law firm has an excellent December 2014 Client Alert that addresses many of these issues in detail and should be examined as well.
In summary, the deliberation to convert to a nonprofit involves many factors to consider from a tax, business, financial, and regulatory perspective. McClintock & Associates can provide expert guidance in these areas as a result of our specialized experience in both the for-profit and nonprofit post-secondary education sectors.
Volume 2, Issue 1