Key Points

• The safe harbor will be going away: The IRS’s proposed regulations would remove the Rev. Proc. 75-50 safe harbor that allowed programs favoring racial minority groups, so tax-exempt private schools would face a no-exceptions nondiscrimination standard for taxable years beginning after May 31, 2027.
• Certifying will get riskier: Because a school officer certifies racial nondiscrimination under penalties of perjury on Form 990 Schedule E or Form 5578, private schools should review their admissions, financial aid, scholarship, athletic and partner-run programs before they sign under the new rules.
• Schools should start with endowments and race-neutral criteria now: Schools that start reviewing donor-restricted endowments early and document the legitimate goals behind criteria like income, geography and first-generation status will be better placed to certify with confidence and defend their policies if the IRS asks.

The Internal Revenue Service's (IRS) proposed regulations for private school nondiscrimination policies, if finalized, will require tax-exempt private schools to evaluate these policies and practices before making their required annual certification of racial nondiscrimination.

Private schools should take a series of actions — including reviewing all school programs, documentation and publications, as well as donor-restricted endowments — before certifying nondiscrimination, measures that are discussed in detail later in this alert.

For a detailed discussion of the proposed regulations, see our prior client alert: IRS Proposes Regulations for Private School Nondiscrimination Policies.

Background on the Annual Certification of Racial Nondiscrimination

Since the early 1970s, private schools exempt from federal income tax (a tax-exempt school) or private schools applying for tax-exempt status have been required to show that they have a racially nondiscriminatory policy as to students. For this purpose, “school” is defined broadly — primary, secondary, preparatory, and high schools, and colleges and universities, whether a separate entity or an activity of a church or other tax-exempt organization. In this article, the term “private school” is used to mean a school that is exempt from federal income tax because it is has been determined by the Internal Revenue Service to be described in Section 501(c)(3) of the Internal Revenue Code.

A racially nondiscriminatory policy as to students means that the school admits students of any race to all the rights, privileges, programs and activities generally accorded or made available to students at that school and that the school does not discriminate on the basis of race in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs. IRS Rev. Rul. 71-447, C.B. 1971-2, 230.

How Must Private Schools Document Their Nondiscrimination?

IRS Rev. Proc. 75-50, 1975-2 C.B. 587, as modified by Rev. Proc. 2019-22, 2019-22 IRB 1250, sets forth guidelines and recordkeeping requirements for determining whether a private school has adopted a racially nondiscriminatory policy regarding students and operates in a bona fide manner in accordance with that policy. The IRS considers discrimination on the basis of race to include discrimination on the basis of color and national or ethnic origin. Under these guidelines and recordkeeping requirements:

• A school must show both that it has adopted a policy made known to the general public and that it operates in a bona fide manner consistent with that policy. The procedure does not apply to public schools.
• The policy must appear in the school's charter, bylaws or a governing-body resolution.
• The policy must appear in brochures and catalogues dealing with admissions, programs and scholarships, and be referenced in other written advertising. An acceptable short statement is: "The (name) school admits students of any race, color, and national or ethnic origin."
• Notice must reach all segments of the community. Communicating only with leaders of racial groups is insufficient. Limited exceptions exist for certain church schools (where 75% of students have been members of the sponsoring denomination for the preceding three years), schools drawing nationally and locally drawn schools that can show meaningful minority enrollment or reasonably designed recruiting. Schools must disavow any contrary statements. Schools must use one of the following three methods to satisfy this notice requirement:
  • Newspaper notice, published annually during the solicitation or registration period, at least three column inches, with a 12-point bold caption and at least 8-point text.
  • Broadcast media, with documentation of the broadcast.
  • Website homepage notice, displayed all year on the school's primary, publicly accessible homepage in a manner reasonably expected to be noticed. A link, carousel, dropdown or hover is not acceptable, and the homepage may not require a login.

The IRS provides the following sample notice as acceptable:

NOTICE OF NONDISCRIMINATORY POLICY AS TO STUDENTS

The [name] school admits students of any race, color, national and ethnic origin to all the rights, privileges, programs, and activities generally accorded or made available to students at the school. It does not discriminate on the basis of race, color, national and ethnic origin in administration of its educational policies, admissions policies, scholarship and loan programs, and athletic and other school-administered programs.

• All programs and facilities must be operated in a racially nondiscriminatory manner.
• As a general rule, all scholarships and comparable benefits must be offered on a racially nondiscriminatory basis, and their availability must be known throughout the community.
• Discrimination in hiring faculty and administrative staff is treated as indicative of a discriminatory policy toward students.
• For at least three years (beginning with the year after the records are compiled), a school must keep records of the racial composition of its student body, faculty and administrative staff for each academic year; records showing scholarships were awarded on a nondiscriminatory basis; copies of brochures, catalogues and advertising; and copies of fundraising solicitations. Estimates are allowed if the method is recorded, and student privacy law (FERPA) is respected. Failure to maintain or produce the required records creates a presumption of noncompliance.
• Failure to comply ordinarily results in a proposed revocation of tax-exempt status.

Existing Safe Harbor Language for Certain Forms of Discrimination

While private schools must maintain a nondiscriminatory policy, Rev. Proc. 75-50 has allowed programs favoring racial minority groups. The second sentence of § 3.02 provides:

"A policy of a school that favors racial minority groups with respect to admissions, facilities and programs, and financial assistance will not constitute discrimination on the basis of race when the purpose and effect is to promote the establishment and maintenance of that school's racially nondiscriminatory policy as to students."

The third and fourth sentences of §4.05 provide:

"Consistent with section 3.02, supra, scholarships and loans that are made pursuant to financial assistance programs favoring members of one or more racial minority groups that are designed to promote a school's racially nondiscriminatory policy will not adversely affect the school's exempt status. Financial assistance programs favoring members of one or more racial groups that do not significantly derogate from the school's racially nondiscriminatory policy similarly will not adversely affect the school's exempt status."

This safe harbor language that favors racial minority groups is precisely what the proposed regulations would eliminate.

How Must Private Schools Certify Nondiscrimination?

In addition to meeting the requirements for racial nondiscrimination, private schools each year must certify their racial nondiscrimination policy. For schools that file IRS Form 990 or Form 990-EZ, the certification is made on Schedule E of the form by answering “Yes” to a series of questions regarding the school’s nondiscriminatory policy. For schools that do not file Form 990 or Form 990-EZ, the certification is made on Form 5578, Annual Certificate of Racial Nondiscrimination for a Private School Exempt from Federal Income Tax, by an officer of the school signing the following statement:

“Under penalties of perjury, I hereby certify that I am authorized to take official action on behalf of the above school(s) and that to the best of my knowledge and belief the school(s) has (have) satisfied the applicable requirements of sections 4.01 through 4.05 of Rev. Proc. 75-50, 1975-2 C.B. 587, for the period covered by this certification.”

Certifying Nondiscrimination After Finalization of the Proposed Regulations

The proposed regulations would affect private schools in taxable years beginning after May 31, 2027. They would eliminate any form of discrimination regardless of the reason for the discrimination. The safe harbor language in Rev. Proc. 75-50 would no longer apply.

For the current academic year, private schools can certify racial nondiscrimination as they have done in the past. If the proposed regulations are finalized in their current form, private schools will need to carefully review all their policies and practices to confirm that they are void of any racial discrimination. The private school officer who will be certifying racial nondiscrimination will be doing so under penalties of perjury. Thus, before certifying racial nondiscrimination in future years, private schools should take the following steps:

• Review admissions, financial aid, scholarship, loan, athletic and all school-administered or school-supported programs for race, color, ethnicity, or national-origin criteria — including informal practices and programs run with third parties or partners.
• Check the charter, bylaws, board resolutions, catalogs, handbooks and the homepage notice for consistency and for any contrary statements that must be disavowed.
• Address donor-restricted endowments. A donor-restricted endowment is a fund whose use the donor has limited by the gift terms. Review gift instruments and engage donors or heirs about modifying race-based criteria. As a practical matter, modifying restricted gifts may require donor consent, court approval or state attorney general involvement under state law.
• Review admission criteria that consider income, geography or first-generation status, and document the legitimate objectives each criterion serves.

The proposed regulations will upend many private schools’ well-intended policies developed over decades that are designed to reflect community demographics and advance diversity in education. Removing these policies to enable private schools to certify racial nondiscrimination will take considerable effort. Some policies may fall into a gray area. There may be desirable policies that are seemingly race neutral but are treated by the IRS as proxies for racial discrimination. The non-racial, legitimate independent objective of each policy should be documented to defend against a contention by the IRS that a policy is racially discriminatory.

To be sure, the proposed regulations will create much work for private schools. Schools that start their inventory, donor conversations and program redesign now will be best positioned to sign with confidence when the new rules apply.

For more information about private school and nonprofit issues, including compliance with IRS regulations, contact the author Douglas Charnas at dcharnas@foxrothschild.com. 

This information is intended to inform firm clients and friends about legal developments, including the decisions of courts and administrative bodies. Nothing in this alert should be construed as legal advice or a legal opinion. Readers should not act upon the information contained in this alert without seeking the advice of legal counsel. Views expressed are those of the authors and not necessarily this law firm or its clients.