A Couple Predictions on the Proposed Reg on Nondiscrimination in Private Schools

Earlier this month, following Treasury and IRS’ proposed regulation impacting private schools, Lloyd Mayer made an informative post on this site. TLDR: under the proposed regulation, to keep their tax-exempt status, private schools–especially private universities–must ensure that their activities (of a very broad set) are nondiscriminatory. I won’t piggyback too much on Lloyd’s fine work, but I do want to forecast the practical effects of this proposed regulation.

First, this proposed regulation could substantially impact private universities’ finances. Maybe that’s the point. For starters, once-valid restrictions on gifts for everything from programs to scholarships to endowments—some of which may have been established many years ago by donors who are long gone—that violate the type of discrimination that the rule prohibits will have to be reworked or even returned. This will take time and imposes substantial internal compliance costs within affected private universities. Surely, many universities will consult with outside tax advisers and counsel to ensure compliance, raising compliance costs. In a best-case scenario, all of this compliance is completed before the rule goes into effect (Note: it is anticipated to take effect after May 31, 2027). In a more likely scenario, several such gifts cannot be reworked and are returned, resulting in an ever-shrinking resource pool for private universities.

In an equally likely scenario, some schools may ask whether the benefits conferred by keeping tax-exempt status outweigh the sum of the costs the proposed regulation imposes. They may take on additional costs to fight the proposed regulation: They may challenge the rule on the basis that it could chill protections guaranteed under First Amendment or other constitutional bases. They could do this procedurally while the rule is being considered or could bring suit after it is made final.

These are, of course, predictions. I do not have a crystal ball. But I do know that the challenges facing private colleges are considerable: a looming enrollment cliff, a change in social attitudes toward higher education, a new endowment tax (for some), and more. These challenges exacerbate the budget issues unique to private colleges and make the compliance costs of the proposed regulation particularly acute.