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President Trump’s musings about Harvard University possibly losing its tax-exempt status for failing to adhere to public policy crystallized May 2 into what appears to be an actual plan to revoke the school’s exemption. The move highlights a long-standing problem that the IRS and Congress should have remedied long ago.
For more than five decades the IRS has effectively dangled the threat of revocation over the heads of tax-exempt entities like the proverbial sword of Damocles, claiming extremely broad authority to revoke their status. The IRS has apparently never disclaimed its assertion from the 1970s that it has an expansive authority that isn’t clearly prescribed in section 501(c)(3). Today this position is a particularly surprising one because the IRS and Treasury now routinely identify in preambles to regulations the precise legislative source of their authority. And Congress has never acted to reclaim the authority it did not delegate.
Harvard’s president, Alan Garber, understands the effect on tax-exempt institutions: “The message that it sends to the educational community would be a very dire one which suggests that political disagreements could be used as a basis to pose what might be an existential threat to so many educational institutions,” he told The Wall Street Journal.
It isn’t an accident that the IRS has a Supreme Court-awarded veto over tax-exempt organizations that it asserts fail to conform to prevailing public policy, although Congress never expressly granted it that scope of authority. Instead, that authority was the result of a deliberate plan put in motion in 1970 by the Nixon White House. This article will discuss how we got here and what it means for the future of Harvard and other existing and prospective tax-exempt organizations.
The immediate problem for Harvard and many other tax-exempt organizations is a case from four decades ago involving Bob Jones University’s tax-exempt status. Bob Jones University v. United States, 461 U.S. 574 (1983), has the dubious distinction of having achieved a trifecta of wrongness. The university was grotesquely wrong, the IRS was procedurally wrong, and the Supreme Court was wrong about nearly everything except the outcome.
Each party was wrong in its own particular way, and the result was a bit of mischief that left far too much power in the IRS’s hands and failed to solve the problem it was supposed to. The university paid back taxes, lost its exemption, and continued its noxious policy against students interracially dating and marrying until the school’s leadership finally came to its senses and publicly disavowed the policy in 2000. The IRS does not have a similar conversion story. The agency has held onto its extraordinarily broad power even though it’s not in its best interest to have it. And the Supreme Court is stuck with a flawed precedent that could have a chilling effect on charitable and educational endeavors.
Harvard’s heroes in this fight are President Reagan, Supreme Court Justice William Rehnquist, and Supreme Court Justice Lewis F. Powell Jr. Reagan opposed — arguably too weakly — the IRS’s expansive interpretation of its own authority. He eventually hit upon the right answer, however, which is that Congress is supposed to determine public policy.
But he failed to get it implemented. Rehnquist dissented from the Bob Jones majority’s acceptance of the agency’s broad claim of authority, explaining, “In approaching this statutory construction question the Court quite adeptly avoids the statute it is construing.” And Powell agreed with the result, which is not to his alma mater’s advantage, but fretted over the “broader implications of the Court’s opinion with respect to the authority of the Internal Revenue Service (IRS) and its construction of sections 170(c) and 501(c)(3).” And that is exactly the problem for Harvard and other tax-exempt organizations today.
Nixon Steps In
It was primarily Congress’s fault that Bob Jones University was a tax case, although President Nixon also gets credit for a poor executive decision. After the Civil Rights Act of 1964 was passed, the Department of Health, Education, and Welfare under President Johnson sent documents to schools requiring them to agree to comply with the act and its regulations.
In 1965 Bob Jones Jr., then president of the university, refused. The details of what happened after are a little hazy, but evidently the agency lacked leverage to force the school to comply. In any event, the only alteration to the discriminatory policies at Bob Jones University was a change in form. The school began admitting Black students but placed restrictions on all students, forbidding interracial dating and marriage. The IRS would later explain the problem that federal agencies faced in enforcing the act in Rev. Rul. 71-447, 1971-2 C.B. 230: “Although the operation of private schools on a discriminatory basis is not prohibited by Federal statutory law, the policy of the United States is to discourage discrimination in such schools.” In other words, Congress had miserably fallen down on the job of prohibiting discrimination in education.
So the IRS stepped in at the behest of the Nixon administration, which should have had a more sophisticated understanding of the roles of the three branches of government. On July 10, 1970, the IRS issued a news release saying it could “no longer legally justify allowing tax-exempt status to private schools which practice racial discrimination.” Why the IRS was chosen for this role is not entirely clear. Why the agency chose a news release to announce this policy is even more curious, but the policy was later formalized in a revenue ruling. The news release isn’t readily available — the IRS should dig the release out of the archives and digitize it — but the previous quote was reprinted by the Supreme Court.
A White House statement issued on the same day as the IRS’s news release said that Nixon “approves of and concurs in the IRS decision regarding tax exemption for discriminatory private schools.” Nixon also candidly revealed his plan to let the courts make policy: “He believes that ultimately the tax status of racially discriminatory private schools will be determined by the courts and that this is desirable,” the statement said.
Also on July 10, The New York Times reported, “The White House press secretary, Ronald L. Ziegler, said that President Nixon had seen and cleared the Internal Revenue announcement.”
The story explained that according to the IRS news release, schools that discriminated would be given “a reasonable opportunity” to amend their policies and practices, which would extend over a few months. What Nixon should have done but didn’t was tell Congress to do its job and enact a law prohibiting discrimination in all schools.
Nixon’s IRS commissioner, Randolph W. Thrower, admitted to the Times on July 10, “We are at the threshold of a new series of problems. We need to learn much ourselves.” The paper reported that the debate over this new policy had been going on in the Nixon administration for over a year. Presumably that was primarily a political debate over the substantive issue and not the procedural ramifications.
Thrower also said he thought the announcement would moot cases regarding the continued tax-exempt status of private schools in the South — even though two months earlier the Justice Department had filed a brief in support of the continued tax exemption. The Justice Department apparently repudiated that position shortly after expressing it, which suggests that all parts of the executive branch weren’t quite working from the same playbook, at least initially, even after that year of internal discussion.
Surely it must have occurred to someone along the way that if the IRS asserted the power to deny tax exemption on the ground that an entity was being operated in a way that contravened public policy, that same rationale could be used against other entities for other reasons later on, and for different assertions of public policy.
But the IRS forged ahead, and in 1971 it formalized the policy of denying tax-exempt status to private schools that practiced racial discrimination in Rev. Rul. 71-447. The basis for that ruling was that “a school asserting a right to the benefits provided for in section 501(c)(3) of the Code as being organized and operated exclusively for educational purposes must be a common law charity in order to be exempt under that section.” Common-law charities, the ruling said, must not have a purpose that is either illegal or contrary to public policy.
There are a few problems with Rev. Rul. 71-447. First, Congress did not say in section 501(c)(3) or 170(c) that the common law of charities applied; the IRS added that gloss in revenue rulings such as Rev. Rul. 67-325, 1967-2 C.B. 113. It may be a reasonable assumption, except that Rev. Rul. 71-447 doesn’t cite any common law that provides the rule that it adopts, which is that “the purpose of the trust may not be illegal or contrary to public policy.” That language comes from the Restatement (Second) of Trusts (1959), which isn’t common law.
Second, the ruling cites one case for its assertion that a school organized and operated exclusively for educational purposes must be a common-law charity in order to be exempt, but that case doesn’t say anything about either the illegality or public policy limitations from the common law that the revenue ruling asserts. The case held that amounts put into an educational trust that provided funds for the college educations of the grandnieces and grandnephews of the trustee and devoted any leftover funds to the aid of young members of her church were not entitled to a charitable donation deduction because the trust was primarily an instrument of private beneficence. Crellin v. Commissioner, 46 B.T.A. 1152 (1942). It’s a stretch to interpolate from that a requirement that a charity not violate public policy.
The Road to the Court
According to the United States’ brief in Bob Jones University, on November 30, 1970, the IRS sent letters to approximately 5,000 organizations operating as private schools, including petitioner, announcing that it would no longer recognize as legally entitled to tax exemption or to receive deductible charitable contributions any private school that maintained a racially discriminatory admissions policy. The letter requested proof of a nondiscriminatory admissions policy and advised that tax-exempt-ruling letters would be reviewed in light of the information provided. This was what the IRS commissioner had told the Times in July that the agency would do.
On December 1, 1970, the IRS told Bob Jones University its exemption was being revoked, and the school went to court for an injunction. The agency also denied the exemption from FICA and FUTA taxes to Goldsboro Christian Schools Inc., which had never applied for tax-exempt status but took exemptions under sections 3121(b)(8)(B) and 3306(c)(8).
In 1975 the IRS issued both Rev. Proc. 75-50, 1975-2 C.B. 587, and Rev. Rul. 75-231, 1975-1 C.B. 158. The rulings reiterated the IRS’s prior position and explained that Rev. Rul. 71-447 “concludes that an organization is not operated exclusively for charitable purposes if its activities are carried on in a manner that can be reasonably classified as contrary to well-established Federal public policy.” The revenue procedure required a private school to “show affirmatively both that it has adopted a racially nondiscriminatory policy as to students that is made known to the general public and that since the adoption of that policy it has operated in a bona fide manner in accordance therewith.”
In 1976 Congress demonstrated that it knew how to write a law to prevent discrimination by tax-exempt organizations when it added subsection 501(i). But the legislature disgracefully dodged the question of discrimination at private schools.
Jerome Kurtz was tax legislative counsel for Treasury from 1966 to 1968 and IRS commissioner from 1977 to 1980. A graduate of Harvard Law School, he offered a refinement of the prior guidance in 1978, explaining that the IRS had exercised its power to revoke a tax-exempt status under the religious purpose test of section 501(c)(3), which required consideration not only of the genuineness of the belief, but also whether the group’s actions are contrary to well-established and clearly defined public policy: “Under this test the Service revoked an exemption granted for ostensibly conventional charitable and religious purposes when we learned the group was actually organized to carry out a vicious, anti-semitic campaign.”
He further explained that the IRS’s “policy and administration in this area is developing.” Kurtz noted that there was “almost no specific statutory guidance” that the IRS could look to and that the agency had concluded that its authority and obligations derived from Brown v. Board of Education, 349 U.S. 294 (1954), and subsequent cases, and from the “broad national policy announced in the Civil Rights Act of 1964.” The Civil Rights Act didn’t mention tax benefits, the IRS, or the tax code. “Questions in this area are obviously sensitive and put the IRS, in some cases, on the cutting edge of developing national policy. But this is where we find ourselves and we will do our best,” Kurtz concluded.
What’s Sauce for the Goose . . .?
Harvard faces procedural obstacles if its exemption is revoked. It could try to obtain an injunction, but the precedent set by the litigation against Bob Jones University says that an injunction is unavailable. The latter university initially sought to keep the IRS from revoking its tax exemption. But in Bob Jones University v. Simon, 416 U.S. 725 (1974), the Supreme Court quashed that plan, holding that the suit was barred by the Anti-Injunction Act because any injunction would necessarily preclude the collection of taxes.
The litigation strategy that began under Nixon would end under Reagan, but perhaps not quite as Nixon intended. If Nixon meant for the courts to limit the reach of the litigation to discriminatory private schools only, as he claimed in the July 1970 statement, his plan failed.
Reagan ran on a platform of opposing “the IRS’s attempt to remove the tax-exempt status of private schools by administrative fiat” and “rigorously enforc[ing] laws which prohibit intentional racial segregation.” Thus, in January 1982 Treasury and the Justice Department asked the Supreme Court to drop the case against Bob Jones University as moot and vacate the previous decisions against the university.
Treasury announced that it would revoke the revenue rulings and revenue procedures dealing with private schools and racial discrimination and recognize Bob Jones University as exempt from tax. According to an IRS account, “Treasury stated that, after a thorough legal review, they were unable to support the legal authority concerning public policy asserted by the Service in denying tax exemption to racially discriminatory private schools.” It was a stunning reversal that ended with the Supreme Court allowing outside counsel to argue in support of the lower courts’ decisions. Bob Jones University objected to allowing an amicus to argue on behalf of the lower courts without also allowing an amicus to argue on its side. That request was not granted.
In the White House, Reagan’s plan to end discrimination in education through legislation resulted in the proposal, on January 25, 1982, of H.R. 5313, which would have denied tax-exempt status to organizations maintaining schools with racially discriminatory policies and denied deductions for donations to those organizations. A racially discriminatory policy was defined as a refusal to admit students of all races to the rights and activities generally made available to students by the organizations or refusal to administer their policies and programs in a manner that did not discriminate on the basis of race. Identical bills, H.R. 5412, H.R. 5518, and S. 2024, were introduced in February 1982 but not acted upon.
Treasury and the IRS never got around to revoking the revenue rulings and revenue procedure. It isn’t clear why. By February 25, 1982, the Justice Department had switched positions again and asked the Supreme Court to hear the cases against Bob Jones University and Goldsboro Christian Schools, noting that the rulings hadn’t been revoked and the exemptions had not been reinstated. But the Justice Department also argued that the IRS lacked the authority to revoke or deny the schools’ exemptions on the basis that their discriminatory policies contradicted public policy. In April the Supreme Court agreed to hear the cases and appointed special counsel to argue the IRS’s prior position. Oral arguments occurred on October 12, 1982.
As the cases moved toward resolution at the Court, the White House was still at work on its plan to encourage Congress to act. In early May 1983, Bill Barr, then White House deputy assistant director for legal policy, wrote a memo titled “Second Draft of Bob Jones Bill” and explained that the legislation could be proposed “in the event we win in the pending lawsuit.” Why he wanted to wait to win the lawsuit is unclear. The Bob Jones bill would have added to section 501 a new subsection (j) regarding “schools with racially discriminatory policies” and would have prevented those schools from being included in the description in section 501(c)(3). The Supreme Court issued its ruling on May 24. The Bob Jones bill was never enacted.
In upholding the IRS’s interpretations of sections 501(c)(3) and 170 from 1970 and 1971, the Supreme Court gave Treasury and the IRS extremely broad power. The Court agreed that “to warrant exemption under section 501(c)(3), an institution must fall within a category specified in that section and must demonstrably serve and be in harmony with the public interest.” In fact, the Court gave the IRS far greater power than Congress would have if it had adopted any of the proposed bills. If a targeted law had been enacted, the claimed public policy enhancement to section 501(c)(3) would have existed only in the revenue rulings and procedure, not in Supreme Court case law, and it would have been effectively mooted by the subsequent legislation. “The problem with the public policy power, as currently defined, is that the majority in Bob Jones University inappropriately recognized in the Treasury an implied statutory authority to operate as both determiner and enforcer of ‘established public policy,’” wrote professor David A. Brennen of the University of Kentucky College of Law in a 2000 article (Brennen, “The Power of the Treasury: Racial Discrimination, Public Policy, and ‘Charity’ in Contemporary Society,” 33 U.C. Davis L. Rev. 389 (1999-2000)). Therein lies the current problem for Harvard and the dilemma facing every other tax-exempt organization.
There isn’t much in the Bob Jones University opinion to help Harvard or any other organization that might arguably run afoul of public policy. The Court offered almost no concrete constraints on the exercise of the IRS’s new administrative power. The majority included the caveat that “these sensitive determinations should be made only where there is no doubt that the organization’s activities violate fundamental public policy,” but then the Court named itself first on its list of sources of public policy, followed by executive orders: “Over the past quarter of a century, every pronouncement of this Court and myriad Acts of Congress and Executive Orders attest a firm national policy,” the Court explained.
Likewise, the Court’s discussion of section 7805(a) emphasizes its breadth: “Congress has seen fit to vest in those administering the tax laws very broad authority to interpret those laws.” The Court noted that the IRS has to be able to “exercise its authority to meet changing conditions and new problems” and added that the IRS “in the first instance” has the responsibility for construing the tax code. Congress can always modify any rulings it deems improper, the majority wrote.
Rehnquist tried to avert the wholesale expansion of the IRS’s power. He agreed that Congress had the power to deny tax-exempt status to educational institutions that promote discrimination. But he disagreed with the majority that Congress had taken such action. “Regardless of our view on the propriety of Congress’ failure to legislate, we are not constitutionally empowered to act for them,” Rehnquist wrote.
Powell similarly tried to contain the potential consequences. “There no longer is any justification for Congress to hesitate — as it apparently has — in articulating and codifying its desired policy as to tax exemptions for discriminatory organizations,” he wrote (emphasis in original). He said that “whether organizations that violate other policies should receive tax-exempt status” should be legislative policy choices. And he said that it is “not appropriate” to leave the IRS in the position of developing national policy. “The contours of public policy should be determined by Congress, not by judges or the IRS,” he concluded.
Post-Bob Jones University
Since 1984 the IRS has mostly refrained from attempting to exercise the broad power that the Supreme Court granted it in Bob Jones University. But, as noted earlier, the agency hasn’t disclaimed that power, and Congress hasn’t acted to restrict it. And despite its general restraint, the IRS did itself few favors when it continued to make expansive assertions of its power, such as this one in LTR 8910001 (Nov. 30, 1988): “Although applying on its face only to race discrimination in education, the [‘established public policy’ rule in Bob Jones] extends . . . to any activity violating a clear public policy.”
Similarly, in a 1994 CPE (Continuing Professional Education) document, the IRS asserted that public policy is a moving target and that changes can justify a change in approach to exemptions:
“Just as the Service responded to public outrage over racial discrimination in education in Bob Jones and to possible kickbacks in GCM 39862, the Service can be expected to re-evaluate positions in other areas as the public policy considerations become more clearly focused because of Congressional action, decisions of the Executive Branch, or court actions.”
The same document observed that the sources of public policy, per Bob Jones University, are “federal legislation and executive orders.”
In 2000 another IRS CPE text said that “new questions have been raised regarding discrimination against women and various ethnic groups” and added that “the role of the Internal Revenue Service in the public policy arena remains somewhat limited.” The document explained that the IRS “may recognize the effect of public policy on exemption only in those situations where there is no doubt as to the fundamental public policy at issue.”
It may be politically expedient for elected lawmakers to allow the IRS to act as both determiner and enforcer of public policy, but that’s inconsistent with the IRS’s role as an administrative agency. That arrangement also, as Harvard’s Garber said, has a chilling effect on tax-exempt entities.
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