Fast Facts

A for-profit college can be converted into a nonprofit college if it's sold to a tax-exempt organization and the Education Department approves the conversion.

In about a third of cases we identified, college owners or officials held leadership roles in the college's tax-exempt buyer. If that is the case, they aren't allowed to use their influence to inflate the college's sale price or otherwise improperly benefit from the conversion.

But IRS staff didn't always follow guidance to assess the risks of improper benefit. Also, Education doesn't assess ongoing risks in its reviews. We recommended improvements in agency review processes.

A diploma and graduation cap on money

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What GAO Found

GAO identified 59 for-profit college conversions that occurred from January 2011 through August 2020, almost all of which involved the college's sale to a tax-exempt organization. In about one-third of the conversions, GAO found that former owners or other officials were insiders to the conversion—for example, by creating the tax-exempt organization that purchased the college or retaining the presidency of the college after its sale (see figure). While leadership continuity can benefit a college, insider involvement in a conversion poses a risk that insiders may improperly benefit—for example, by influencing the tax-exempt purchaser to pay more for the college than it is worth. Once a conversion has ended a college's for-profit ownership and transferred ownership to an organization the Internal Revenue Service (IRS) recognizes as tax-exempt, the college must seek Department of Education (Education) approval to participate in federal student aid programs as a nonprofit college. Since January 2011, Education has approved 35 colleges as nonprofit colleges and denied two; nine are under review and 13 closed prior to Education reaching a decision.

Figure: Example of a For-Profit College Conversion with Officials in Insider Roles

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IRS guidance directs staff to closely scrutinize whether significant transactions with insiders reported by an applicant for tax-exempt status will exceed fair-market value and improperly benefit insiders. If an application contains insufficient information to make that assessment, guidance says that staff may need to request additional information. In two of 11 planned or final conversions involving insiders that were disclosed in an application, GAO found that IRS approved the application without certain information, such as the college's planned purchase price or an appraisal report estimating the college's value. Without such information, IRS staff could not assess whether the price was inflated to improperly benefit insiders, which would be grounds to deny the application. If IRS staff do not consistently apply guidance, they may miss indications of improper benefit.

Education has strengthened its reviews of for-profit college applications for nonprofit status, but it does not monitor newly converted colleges to assess ongoing risk of improper benefit. In two of three cases GAO reviewed in depth, college financial statements disclosed transactions with insiders that could indicate the risk of improper benefit. Education officials agreed that they could assess this risk through its audited financial statement review process and could develop procedures to do so. Until Education develops and implements such procedures for new conversions, potential improper benefit may go undetected.

Why GAO Did This Study

A for-profit college may convert to nonprofit status for a variety of reasons, such as wanting to align its status and mission. However, in some cases, former owners or other insiders could improperly benefit from the conversion, which is impermissible under the Internal Revenue Code and Higher Education Act of 1965, as amended.

GAO was asked to examine for-profit college conversions. This report reviews what is known about insider involvement in conversions and to what extent IRS and Education identify and respond to the risk of improper benefit. GAO identified converted for-profit colleges and reviewed their public IRS filings. GAO also examined IRS and Education processes for overseeing conversions, interviewed agency officials, and reviewed federal laws, regulations and agency guidance. GAO selected five case study colleges based on certain risk factors, obtained information from college officials, and reviewed their audited financial statements. In three cases, GAO also reviewed Education case files. Because of the focus on IRS and Education oversight, GAO did not audit any college in this review to determine whether its conversion improperly benefitted insiders.

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GAO is making three recommendations, including that IRS assess and improve conversion application reviews and that Education develop and implement procedures to monitor newly converted colleges. IRS said it will assess its review process and will evaluate GAO's other recommendation, as discussed in the report. Education agreed with GAO's recommendation.

Recommendations for Executive Action

Agency Affected Recommendation Status
Internal Revenue Service 1. The Commissioner of Internal Revenue should assess the agency's internal controls for reviewing for-profit college applications for tax-exempt status and improve the review process to ensure that staff appropriately apply agency guidance on assessing potential improper benefit to insiders. (Recommendation 1)
IRS stated that it would assess its internal controls for reviewing applications for tax-exempt status from organizations with a for-profit history and make improvements to those controls, as appropriate. In addition, IRS stated that it would continue to educate staff on application review procedures, emphasize staff discretion to request additional information from applicants, and provide staff with sample questions about transactions with for-profit entities. IRS noted that its guidance gives staff discretion to determine whether additional information is needed to assess if an applicant will pay more than fair market value to purchase assets from insiders. However, we believe that without knowing the prices the applicants planned to pay insiders in high-risk cases in which applications for tax-exempt status stem from a for-profit college conversion, IRS staff were not well positioned to assess whether the prices were consistent with fair market value. We believe that a broader review of IRS's internal controls would help assure that staff appropriately apply guidance in these high-risk cases.
Internal Revenue Service 2. The Commissioner of Internal Revenue should collect information, for instance on the annual IRS filing tax-exempt organizations are required to submit, that would enable the agency to systematically identify tax-exempt colleges with a for-profit history for audit and other compliance activities. (Recommendation 2)
IRS stated it would evaluate the benefits and burdens of collecting information about the for-profit history of tax-exempt organizations, including colleges. IRS noted that it already asks tax-exempt organizations to report whether they have engaged in transactions with insiders. However, responses to this question do not allow IRS to isolate organizations that have engaged in conversion transactions with insiders. As a result, IRS does not have the information it needs to systematically identify and audit approved tax-exempt organizations with a for-profit history--in particular, those that have engaged in for-profit conversion transactions with insiders. IRS's compliance strategy acknowledges that these transactions pose unique risks. However, the matching techniques IRS used in the strategy to identify tax-exempt organizations that were involved in a for-profit conversion did not identify any existing organization that purchased a for-profit college from insiders. Although IRS states that its techniques were not designed to identify for-profit college conversions specifically, they were the original impetus for IRS's strategy and were included in the scope of its review. We continue to believe that IRS should collect additional information to enable it to systematically identify organizations with a for-profit history--organizations that the agency acknowledges pose a heightened risk of improper benefit--for oversight purposes.
Department of Education 3. The Secretary of Education should develop and implement monitoring procedures for staff to review the audited financial statements of all newly converted nonprofit colleges for the risk of improper benefit. (Recommendation 3)
Education agreed with this recommendation. The agency stated that it will develop new financial analysis procedures to ensure that staff review audited financial statements submitted by newly converted colleges after Education's approval. Education also stated that it will include additional reporting requirements for newly converted colleges as a condition in their provisional program participation agreements and it will closely monitor newly converted nonprofit colleges for the risk of improper benefit until the school receives its first recertification after the nonprofit conversion. For example, newly approved colleges will be required to report relevant IRS actions, changes to any existing service agreements between insiders and the college, and any new servicing or contracting agreements, among other things. We will monitor Education's efforts, which we believe will help identify indicators of potential improper benefit that can surface in audited financial statements after a college's nonprofit approval.

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