… there are still plenty of misuses and abuses of tax exempt law to kick around

Sean Callan, Manley Burke, sean.callan@manleyburke.com

So begins a recent story in Forbes.¹  The story is an unflattering look at how Princeton eating clubs spend charitable (i.e., tax deductible) dollars.  While eating clubs are not Greek organizations, the eating clubs fall under the same tax rules as 501(c)(7) organizations.  Indeed, the article eventually specifically mentions Greek organizations, emphasizing their status as non-charities.  So – there is no doubt that the article and the perceptions it creates will stick to fraternities and sororities.

The issue identified by Forbes is that the Princeton eating clubs have allegedly spent charitable dollars granted by foundations for physical improvements to eating club facilities.  Importantly, according to the article, these improvements were not to areas that one would normally identify as “educational areas.”  Finally, the dollars involved are huge as reported by Forbes:

the “vast majority” of $20 million in tax deductible contributions funneled since 2008 from 501(c)(3) foundations to the clubs was used for impermissible purposes—for example, building a $5 million addition at the Cap & Gown Club that even includes a tap room. (Assuming almost all the $20 million was donated by prosperous alums taxed at the top federal tax rate, the taxpayer subsidy amounted to around $7 million.)

Any Greek organization that has ever sought counsel from Fraternal Law Partners or the other firms servicing the Greek community has gotten the same sound, clear, unequivocal and unwavering advice – foundation and other charitable funds may only be spent on improvements to educational areas of a chapter house.  Providing fraternity housing is not, in and of itself, a charitable or educational activity.  Accordingly, foundations may not fund improvements to the living areas of a chapter house.

The notion that the events reported by Forbes could occur at Princeton is astounding.  We have no factual knowledge of what occurred at Princeton other than what is described in the article.  If the article is correct, however, there would appear to have been a significant spend of charitable dollars on non-charitable activities.

In the course of structuring grants from foundations to house corporations, we have heard many justifications for designating a space as educational where the space is obviously non-educational.  One of the most common is that the non-educational areas are necessary to support the educational areas and the activities conducted in the educational areas.

When asked why it was permissible for charitable dollars to be used to improve living areas, one eating club officer responded as follows:

“the mission of . . .[the foundation] . . . from day one, has been overwhelmingly to be the tax-exempt vehicle for receiving donations.” The clubs . . .  have libraries where “a lot of studying” goes on, and “You have to eat, so if you order improvements to the kitchen, that is considered educational.”

In the most basic terms, this is simply incorrect.  If audited, we believe it highly unlikely that the IRS would sustain this position.

We understand and fully agree that this area of the law is arcane, having little foothold in reality.  But the law as we understand it today would not allow funding of a kitchen simply because educational activities occur elsewhere within the same house.  The facts as reported by Forbes describe a charitable spend to fund construction of improvements that are not “exclusively used” for charitable or educational activity.  If true, these expenditures of charitable dollars were not proper.

We have always stressed the importance of engaging tax counsel when using charitable donations to fund construction projects.  The reason for this advice is twofold, at least.  First, a mistake in granting charitable funds jeopardizes a foundation’s exemption as a 501(c) (3).  If an impermissible grant is substantial, revocation of tax-exempt status is a real possibility.

Moreover, this kind of improper grant is bad for the community as a whole.  If the media, public, and importantly, the IRS believes that abuses are occurring, every housing grant will face higher scrutiny.  For the sake of everyone in the business of educating and housing young people on our campuses, we urge Greek leaders to be diligent, thoughtful and careful in analyzing these grants.

Let’s be careful out there.