Regulation of Nonprofits by Proxy

A new(ish) challenge in the US District Court (D. Mass.) to the federal Public Service Loan Forgiveness (PSLF) program highlights an increasingly important development in nonprofit law: Regulation of nonprofit activity through programs that are not, strictly speaking, part of nonprofit tax law at all. States, cities, and nonprofit organizations have asked the federal court to invalidate a Department of Education rule that would allow the government to disqualify certain nonprofit employers from PSLF eligibility based on whether the agency determines the organization has engaged in activities with a “substantial illegal purpose.” 

The litigation raises familiar administrative law claims—alleged violations of the Administrative Procedure Act and the Higher Education Act—but its nonprofit-law implications run deeper. PSLF has long operated as an indirect subsidy for nonprofit labor markets, helping §501(c)(3) organizations recruit and retain professionals willing to accept lower salaries in exchange for loan forgiveness after public service employment. By redefining which employers qualify, the rule effectively conditions access to that subsidy on agency judgments about organizational conduct and mission. 

Plaintiffs argue that the rule introduces vague and subjective eligibility standards and permits viewpoint discrimination by excluding organizations whose advocacy positions conflict with administration priorities on immigration, diversity initiatives, or public protest. 

Whether or not the court ultimately agrees, the dispute illustrates how executive agencies may influence nonprofit behavior through eligibility criteria embedded in federal benefit programs rather than through traditional enforcement mechanisms such as revocation of tax exemption under 26 U.S.C. §501(c)(3).

The whole situation underscores a broader regulatory trend. Increasingly, the legal constraints shaping nonprofit activity arise outside the Internal Revenue Code—through grant conditions, funding eligibility rules, and professional incentive programs that structure organizational labor markets. These mechanisms can exert powerful behavioral pressure while avoiding the procedural and political constraints associated with direct tax-exemption enforcement. If access to workforce subsidies like PSLF can be conditioned on contested assessments of organizational purpose, nonprofit regulation may be shifting toward a model of indirect governance.