Ninth Circuit Rejects DOE’s Analysis of Grand Canyon University’s Tax-Exempt Status

It’s a shame the semester is almost over, because that means it’s too late for me to assign the Ninth Circuit’s recent opinion in Grand Canyon University v. the Department of Education to my students. If you can follow the court’s logic in the case, you probably should get an “A” in my class, whether the court is right or wrong. That’s because at the heart of the opinion is the distinction between “private benefit” and “private inurement,” a distinction that bedevils contemporary federal tax-exemption law and, by extension, my students. One of the most important cases on “private inurement” is American Cancer Council v. Commissioner, in which the Seventh Circuit held that whatever was going on (very high fees to a for-profit fundraising company) was not private inurement, though it might be private benefit, and it remanded the case for an application of the private benefit standard. The parties settled the case before we could get any analysis of the private benefit issue. In the Grasnd Canyon University case, the Ninth Circuit does the reverse, holding that it doesn’t matter whether whatever is going on (very high fees to a for-profit management company) are private benefit, because the DOE should have only been asking about private inurement, not private benefit. And the court remanded the case for analysis of the private inurement question. Private benefit, private inurement, potato, potato … what’s going on?

GCU is a university that was formerly owned and operated by a for-profit company, Grand Canyon Education, Inc. (GCE). The board of GCU determined that it would be preferable to convert to a nonprofit, at least in part in order to be subject to the more favorable DOE regulations that apply to nonprofit universities. In 2018, GCE sold GCU to a nonprofit that later changed its name to GCU for $853 million dollars, which GCE loaned to GCU. After the transaction, GCU was a nonprofit, but it both owed GCE the $853 million it had borrowed, and owed substantial quantities of its revenue to GCE under a management agreement in which GCE provides management services to GCU. The agreement is complicated, but whether GCU qualifies as a 501(c)(3) organization despite the very close connection to for-profit GCE, and the fact that so much of its revenue goes to GCE, is a question normally addressed principally under the private benefit doctrine.

Why is the court saying that the private benefit doctrine doesn’t matter in this case? It’s not because the parties satisfied the private benefit standard. Instead, this case arises out of a finding by the DOE found that Grand Canyon University (GCU) fails to qualify as a tax-exempt 501(c)(3) organization because it serves a substantial private benefit. The court is holding that the DOE doesn’t get to make that determination, not that it is wrong. According to the court, the IRS is the only agency who can make a determination on that particular question. The court held that under the Higher Education Act, the DOE should evaluate (1) whether the school is “owned and operated” by a nonprofit corporation, and (2) whether any part of the net earnings inure to the benefit of any private shareholder or individual. So, it is proper for the DOE to determine whether GCU violated the private inurement doctrine rather than rely on the IRS for that. But it is not proper for the DOE to independently determine if GCU met the other requirements of section 501(c)(3) – specifically whether the organization is organized and operated exclusively for one or more tax-exempt purpose. That “purposes” clause of section 501(c)(3) is the origin of the private benefit doctrine, which holds that tax-exempt purposes must be public rather than private, and therefore an organization fails to meet the standard if it serves a substantial private benefit. The court held, as a matter of statutory interpretation, that it is irrelevant to the DOE’s analysis whether a school improperly advances a substantial private purpose, although it is relevant whether its earnings inure to any private person. By the way, the other requirements in section 501(c)(3), not relevant to this case, are the limitation on lobbying and the prohibition on intervening in an election. Presumably, under the court’s analysis, the HEA also excludes these from the purview of the DOE in its determination of whether a school should be considered nonprofit for its purposes.

So, what should happen on remand? Presumably, the DOE should develop its case about private inurement. The opinion contains several facts that suggest that GCU might have a private inurement problem, but of course not enough to make that determination. The most important analytical distinction between private benefit doctrine and private inurement is that private inurement only applies when a financial benefit flows to a person who exercises some degree of control over the nonprofit – an insider, often called a “disqualified person.” The most likely disqualified person in this case is Brian Mueller, the President of GCU, who is also the CEO of the for-profit company that manages the school (GCE). Or it is possible that GCE itself is a disqualified person with respect to GCU. In either case, the DOE would have to show that the payments made to GCE (directly) or to Brian Mueller (either directly or indirectly through GCE) are not only very high, but are excessive. Excessive payments to a disqualified person are at the heart of private inurement analysis.

Unfortunately, I’m guessing we’ll never hear the outcome of that analysis, and not just because Trump has promised we won’t have a DOE to administer the Higher Education Act. Even a fully functional DOE will likely settle this case on remand. We’ll have to wait for some other for-profit to non-profit university conversion to see how the DOE applies the private inurement rule. By the way, if GCU failed the private benefit standard, why didn’t the IRS deny it tax-exempt status? I think the answer is probably that the IRS has extremely limited resources for exempt-organizations enforcement, and it made a determination not to use those resources in this case. Because of the court’s reading of the HEA, the IRS cannot pass the cost of determining this important issue to the DOE.

–Benjamin Leff