The proposed rule by the Internal Revenue Service titled Racial Nondiscrimination in Private Schools was published on September 4. We previously shared attorney Alex Reid’s comments about the proposal before the rule was published (a link to his formal comments is listed below). Since its publication, nearly 2,500 comments have been submitted as of 8:00 pm EST November 3 (though it seems like additional comments have not been uploaded since about 5:00 pm EST). The deadline for public comments is 11:59 pm EST November 3. A public hearing will be held on December 2.
This post starts with some quotes from the Federal Register where the proposed rule has been published (note, however, that the headings are my own and the footnotes have been excluded). Some Q&A and a resource list which includes several comments to the proposed rule follow.
Federal Register
Proposed Rule Summary
This document contains proposed regulations that would update existing regulations to provide that a private school is not described as an organization exempt from Federal income tax if it discriminates on the basis of race, color, or national or ethnic origin in administration of its educational, admissions, scholarship, athletic, or other policies, based on the fundamental public policy of the United States against such practices. These proposed regulations would affect private schools in taxable years beginning after May 31, 2027, which is after the final regulations are expected to be published.
Key Provision in the Proposed Rule
§1.501(c)(3)-2 Racial nondiscrimination requirement for private schools.
(b) Nondiscrimination requirement. A private school is not operated exclusively for exempt purposes if it adopts, maintains, or enforces any policy or practice that discriminates on the basis of race, color, or national or ethnic origin in the administration of any educational policy, admissions policy, scholarship or loan program, athletic program, or other school-administered or school-supported program. For purposes of this section, discrimination on the basis of race, color, or national or ethnic origin includes any discrimination on the basis of race, color, or national or ethnic origin for any purpose.
Key Parts of the Explanation of the Proposed Rule
These proposed regulations would provide that all forms of racial discrimination in education, regardless of the intent behind or the legality of such discrimination (for example, where such discrimination is defended as serving remedial or diversity-related objectives), are against a fundamental public policy of the United States and thus preclude a school’s exemption from Federal income tax under section 501(c)(3). In so doing, the proposed regulations would make clear that discriminating based on race, color, or national or ethnic origin for any purpose by a private school is contrary to a fundamental public policy of the United States. This public policy is evidenced by antidiscrimination law such as the Equal Protection Clause of the Fourteenth Amendment, the Civil Rights Act of 1964, Supreme Court case law such as Brown to Runyon to Bob Jones to Students for Fair Admissions, and the actions taken by the Executive Branch to ensure racial nondiscrimination is instituted throughout the United States.
…
For the avoidance of any doubt, the proposed regulations would not preclude a private school from maintaining a religious mission, curriculum, or program of observance, or from selecting students on the basis of religious affiliation or membership. Use of a religiously based selection criterion does not become discrimination on the basis of race, color, or national or ethnic origin merely because members of the relevant religious community may also share ancestry or ethnic characteristics (so long as the selection criteria is based solely on religion and not on shared ancestry or ethnic characteristics). Similarly, the proposed regulations would not disturb the continued ability of an organization (including a private school) to take actions or adopt policies intended to eliminate prejudice and discrimination, consistent with existing § 1.501(c)(3)-1(d)(2), provided the organization achieves these purposes by means other than actions or policies that discriminate on the basis of race, color, or national or ethnic origin.
… The proposed regulations would achieve this result by stating a clear, enforceable standard: private schools cannot qualify as “operated exclusively for exempt purposes” within the meaning of section 501(c)(3) if they adopt, maintain, or enforce any policy or practice that discriminates on the basis of race, color, or national or ethnic origin in the administration of any educational policy, admissions policy, scholarship or loan program, athletic program, or other school-administered or supported program.
…
The Treasury Department and the IRS estimate that the proposed regulations may affect the 18,000 private elementary, secondary, and post-secondary schools in the United States that currently qualify for tax exempt status and the 750,000 students attending these schools who may qualify for scholarships allocated on the basis of racial, ethnic, or national identity. In addition, the Treasury Department and the IRS estimate that the proposed regulations may also affect taxpayers who donate to scholarship funds administered by private schools, and that use racial criteria to determine eligibility to receive scholarship funds. The Treasury Department and the IRS do not have readily available parameters and models to quantify the number of taxpayers who make charitable contributions to support race-based scholarship funds administered by private schools.
Q&A
What is the Proposed Rule Trying to Change?
The federal administration wants to prohibit race-conscious admissions, programs, educational policies, scholarships, and loans with respect to 501(c)(3) private schools regardless of whether they accept any federal funding, regardless of any remedial intent behind the race-conscious criteria, and regardless of the legality of those criteria. Not surprisingly, its reference to “any policy or practice that discriminates” is extraordinarily vague.
The proposed rule doesn’t make the race-conscious criteria illegal, but it provides that a private school using such criteria is not operated exclusively for a 501(c)(3) purpose because such race-conscious criteria violate fundamental public policy. As written, it doesn’t align with the 501(c)(3) Operational Test because there is a failure to describe how the IRS would apply a substantiality threshold. Would one race-based scholarship, even if insubstantial in the context of a university’s overall activities, be the basis for revocation of its 501(c)(3) status?
Does the Proposed Rule Make a Strong Argument For Its Claim of Fundamental Public Policy?
No. It’s vague, overreaching, and insufficiently supported. See the Comments referenced under the Resources heading below.
Can a Rule Change What is Considered Fundamental Public Policy?
The simple answer is (or should be) no as it relates to what may be lawful but still a violation of fundamental public policy that constitutes a reason for disqualifying an organization from meeting the requirements of tax-exemption under 501(c)(3). The more complicated answer is that such a rule, if promulgated, could be enforced by the IRS, and it might even be supported by a mistaken court decision. Ultimately, however, it could then be repealed if not adequately supported, particularly after the Loper Bright Supreme Court case overturned Chevron deference applied to agency determinations of ambiguous law. See, e.g., Once and Future Revocation of Tax Exemption: Public Policy, Illegality, Terrorism, and Charitable Purpose (Ellen P. Aprill, The Tax Lawyer, American Bar Association).
Is there a Fundamental Public Policy Test to Qualify for 501(c)(3) Status?
The oft-quoted Bob Jones Supreme Court case from 1983 provided that “a declaration that a given institution is not “charitable” should be made only where there can be no doubt that the activity involved is contrary to a fundamental public policy.” The Supreme Court did not state that Section 501(c)(3) contains a fundamental-public-policy test under which exemption can be denied by Treasury/IRS whenever an organization’s activities violate fundamental public policy. Such a conclusion would require Treasury/IRS to determine what is fundamental public policy, and they are clearly not the appropriate body to make such conclusions, particularly when it relates to areas far out of their areas of oversight and expertise (e.g., types of racial discrimination that violate fundamental public policy). Loper Bright reinforces the inappropriateness of such delegation of authority even if assertions of fundamental public policy go through the process required for creation of a federal regulation.
Can the Rule be Practically Implemented?
No. It can’t be reasonably interpreted, doesn’t provide enough time to modify existing systems, doesn’t account for donor intent and cy pres problems, and lacks an agency that can reasonably and evenly enforce it. See the Comments referenced under the Resources heading below.
Can the Rule be Challenged?
The proposed rule seems likely to be challenged in court. Under the Administrative Procedure Act (APA) Section 706, a reviewing court must hold unlawful and set aside agency action found to be –
(A) arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law;
(B) contrary to constitutional right, power, privilege, or immunity;
(C) in excess of statutory jurisdiction, authority, or limitations, or short of statutory right;
(D) without observance of procedure required by law;
(E) unsupported by substantial evidence in a case subject to sections 556 and 557 of this title or otherwise reviewed on the record of an agency hearing provided by statute; or
(F) unwarranted by the facts to the extent that the facts are subject to trial de novo by the reviewing court.
As other respected commentators have concluded, the proposed rule should be set aside on several of these grounds.
Resources
Why the Trump administration’s bid to end diversity efforts at nonprofit schools is likely to get tied up in court (Elizabeth Schmidt, Conversation)
Comments to the Proposed Regulations
(all of the comments below require a download from the linked page)
Comment from Loeb & Loeb LLP and Miller & Chevalier Chartered
Let us be clear: the purpose of the Proposed Rule is not to abolish race discrimination—which the undersigned States actively seek to end, including with programs, policies, and practices that acknowledge the lasting impacts of this country’s long history of legalized race discrimination and remedy those effects. On the contrary, the Proposed Rule is yet another effort by this Administration to eradicate lawful diversity, equity, and inclusion programs and policies, even as court after court has held the Administration’s prior efforts unlawful, in particular federal agencies’ efforts to condition federal funding on eliminating such programs.
Comment from Independent Sector
Comment from National Council of Nonprofits
Comment from National Association of College and University Business Officers
Comment from ABA Tax Section, Exempt Organizations Committee (to be added once the comments field on the government website is updated)