How the College Admissions Scandal Is Rocking Foundations

SMITH BRAIN TRUST – Of all of the potential repercussions of the college admissions scandals – expulsions, arrests, tougher scrutiny on admissions practices – this one you probably didn’t see coming.

The scandal may trigger big changes for the way private foundations operate in the United States, says Maryland Smith’s Samuel Handwerger. And maybe that’s not altogether surprising.

The truth is, private foundations were a focus of both the IRS and Congress long before they were ensnared in the bribery and cheating mess, says Handwerger, who teaches in the accounting and information assurance department at the University of Maryland’s Robert H. Smith School of Business.

The admissions scandal, he says, can only help to sharpen that focus. Here’s the story.

The crux of the scandal involves well-to-do (and sometimes famous) parents of college-bound teens allegedly paying for phony SAT and ACT test scores, for bribes made to college administrators, and for other frauds aimed at making sure their children were admitted to elite universities.

But under those headlines was a lot of interesting tax stuff, says Handwerger.

The payments those parents made typically went to a charity known as the Key Worldwide Foundation, according to court filings. KWF, which claims to “provide education that would normally be unattainable to underprivileged students," is accused of being a conduit for those rich parents to pay bribes. The wealthy parents then allegedly claimed those payments as charitable deductions on their personal income tax returns, despite, Handwerger notes, likely knowing very well that KWF wasn’t a charity at all, and even it was, the gift they were making shouldn’t qualify for a tax deduction since there is a personal benefit. “They had to know that the gift wasn’t gratuitous – the first rule for charitable gifts. They oinked,” he says, or, got greedy, like pigs, gaining a tax deduction on top of the illegal activity itself.

And the tax benefits to those parents would have been sizable.

For those who made their so-called donation to KWF in stocks, the benefits would be multiple. “They’d get their kid into the school they want, plus they’d get the charitable deduction on the value of the stocks, and they’d avoid the capital gain tax.”

This month, the Senate Finance Committee wrote a letter to the IRS, urging the tax agency to “be vigorous” in enforcing the tax laws in the case. Not only was KWF likely not a legitimate charitable organization, but payments to it should likely not have been treated as “legitimate charitable deductions,” the letter states. “And we expect the IRS will enforce the law accordingly in this regard, both as to KWF as well as to the parents who may have claimed such payments as deductions on their personal income tax returns.”

But it’s the next paragraph that grabbed Handwerger’s attention.

“It appears,” the letter states, “that several of the parents involved in the scandal may have misappropriated funds from private foundations over which they have financial control in order to make illicit payments to KWF.”

“That doesn’t work,” says Handwerger.

If the allegations are true, the transfers from a private foundation are not qualifying transfers and violates the self-dealing concept of these entities. . “There can be no direct ‘private benefit,’” says Handwerger. Plus, money in foundations already has been subject to a tax deduction. “The rule is that whenever you give out money from a private foundation it has to go to another 501(c)(3) charitable organization or at least for legitimate charitable purposes like a grant. Money into the private foundation is charity money has to stay in that world.”

“What they did doesn’t work tax-wise,” he says again. “The scheme is severely in violation of the law.”

The scandal “dovetails nicely,” Handwerger says, with one of the IRS’s latest priorities – unearthing self-dealing in private foundations “IRS examiners are instructed to review transactions that involve disqualified insiders and the charity. They’ll look at contracts, minutes from foundation meetings, rental and other agreements, payroll records, listings of assets on the balance sheets, depreciation schedules and more. They’ll also check for loans from the foundation to disqualified persons and whether insiders otherwise used the charity’s property.”

In other words, it’s a whole thing.

“Foundations are a major concern because they usually lack the type of broad public oversight that public charities often have,” he says. Foundation boards often consist entirely of family members or are dominated by family members. Oversight on those boards like that is almost non-existent. Who wants to stand up to the family?

“Basically, nobody from the public is watching, and the IRS knows this,” he says.

So does Congress. There has occasionally been talk in Congress about doing away with private foundations entirely because there are so many and because they are so hard to police.

“You can’t expect the IRS to regulate and patrol each one closely,” says Handwerger. “But this new scandal, it does have me wondering whether this brings us just one step closer toward nixing private foundations altogether.”