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IRS Asked to Examine 501(c)(3) Filings of For-Profit Charter Chains

(March 27, 2008) By a letter sent to the IRS today, that federal agency is being asked to examine whether charter schools managed by the for-profit corporation White Hat Management, Inc. and its affiliates can be properly registered as 501(c)(3) tax-exempt entities under federal law.

The schools at issue are managed by for-profit entities operating under the name “White Hat” and typically use the brand names “Life Skills Centers” and “Hope Academies.” White Hat affiliates operate charter school chains in Ohio, Arizona and Florida. At least 25 of the Ohio schools claim on reports filed with the Ohio Auditor of State that they have been qualified as tax exempt under Section 501(c)(3). Others claim that they have applied for such status.

“We support strong public education and local sponsorship of charter schools, and urge close examination of charters to ensure accountability,” said Ohio Federation of Teachers President Sue Taylor.

In a letter to the IRS, the Ohio Federation of Teachers and Attorney Don Mooney provide the basis for IRS action concerning the status of the Hope Academy and Life Skills charter schools.

The letter and attached documents sent to the IRS provide evidence that these schools are dominated and controlled by the White Hat for-profit entities, and are not qualified for 501(c)(3) status. The documents show that the schools were organized by White Hat to appear as if they comply with state and federal law, but actually operate as “pass throughs,” channeling 95 percent or more of all revenue to White Hat.

“White Hat-managed charter schools in Ohio receive about $84 million annually in taxpayer dollars. But neither Ohio law nor federal tax laws allow a for-profit operator to dominate or control what should be independently governed non-profit entities,” said Mooney.

Several details documented in the letter to the IRS illustrate how White Hat-managed schools fail to qualify for tax-exempt status:

·         White Hat, not the schools’ governing authorities, negotiated the charter school contracts and appear to have organized the corporations that have received or applied for 501(c)(3) status. One indication that a 501(c)(3) charter school is not qualified relates to whether the “Charter” agreement under which a school operates was actually negotiated by the non-profit entity or by a for-profit management company. A collection of documents show that White Hat and its primary owner, David Brennan, negotiated with the Ohio Department of Education for many of the original contracts for schools in the Hope Academy and Life Skills chains, even before the schools and their governing authorities were legally organized.

·         The use of boilerplate form management contracts:  Under IRS Guidelines (http://www.irs.gov/charities/article/0,,id=174946,00.html), a charter school’s board should be independent and negotiate “with the management company before signing the management agreement.” However, White Hat’s management agreements show little, if any, material variation – they are form contracts that appear to have been accepted by captive board members and not negotiated to suit the needs or desires of individual school boards.

•          Compensation of management company:  The White Hat management agreements typically require the school to pay the management company 95 percent to 97 percent of the funding it receives from the state or federal government. Because the agreement gives the management company the sole power to make decisions about the school’s costs, including the number of teachers and what they will be paid, the management company has complete discretion to manage the school in a way that will generate private benefits and profits.

IRS Guidelines provide that, “compensation based on total income irrespective of expenses creates the opportunity for the management company to reduce costs in order to increase compensation, possibly at the expense of the education of the students. This method of compensation allows for the possibility of private benefit.” (http://www.irs.gov/charities/article/0,,id=174946,00.html)

•          Comprehensive services offered by management company:  The management agreements cover all school operations and White Hat entities are also involved in leasing facilities as “middle men” between the property owner and the school, taking away the discretion of the school’s governing authority and creating opportunities for private benefit and profit.

•          The schools’ supposedly “independent” boards have no meaningful control over school operations and only very limited power to cancel the management agreement.

As examples:  White Hat’s form management agreements give it all personnel powers, including the power to hire and fire the school administrator, all teachers and other staff. White Hat decides how many teachers and support staff to hire, and sets all salaries and rates of pay. In contrast, Ohio’s traditional school boards have the sole authority to appoint and terminate school administrators and teachers.

The Ohio Auditor of State conducted his own operational review of Ohio charter schools in 2002 and concluded that “some governing authorities are not independent of school vendors and management company representatives.”

Overlapping Board memberships suggest that White Hat’s schools are not independent non-profit or public benefit corporations. Ohio law requires that each charter school must be organized either as a non-profit corporation, or a public benefit corporation. Each must have its own independent “governing authority,” or Board. Contrary to the impression created by the term “community schools”, as charter schools are also known, the White Hat schools did not spring from community or parent involvement. Parents and community activists did not create governing authorities that, in turn, chose a management company from a variety of alternative operators. Instead, documentation suggests that White Hat negotiated with the state about the creation of the schools, set up the separate corporate school entities, and also handpicked the board members, many of whom serve on a number of Hope Academy or Life Skills Centers Boards.

The overlapping board memberships were noted by the Ohio State Auditor in her audit of the Life Skills Center of Northeast Ohio for the year ended June 30, 2006: “The school is one of the 19 community schools managed by the same management company [White Hat]. Some board members of the school also serve on the boards of other schools managed by the same management company.”

•          Board compensation:  Some individuals have been members of the board of over a dozen White Hat-managed schools. For instance, during the 2005-06 fiscal year 19 school boards featured the trio of Robert C. Townsend, II, James E. Haynes, and Edward D. Wilkins, Sr. as trustees. James A. Stubbs sat on 17 of the 19 boards, and the grouping of Ted Pappas, Jr., Marco Sommerville, Charlotte Ivey, and Kurt Minson served together – and alongside Townsend, Haynes, Wilkins, and Stubbs – on 9 school boards managed by White Hat.

In many cases trustees collected a payment for each seat they occupied on the board. A state audit report for the White Hat schools covering the fiscal year ending June 30, 2006 noted that 17 schools paid board members $125 per meeting. The report continues: “Due to their similar membership, board meetings of multiple schools were often held on the same date and at the same time. As a result, some board members were paid at a minimum of $250 (2 schools served X $125) to a maximum of $2,125 (17 schools served X $125) for attending one board meeting.”

Cumulatively, some trustees earned tens of thousands of dollars during a fiscal year for their service on multiple school boards.

•          The schools are promoted as if they are a single chain or part of a franchise:  White Hat promotes, advertises and markets the schools as if they were a “chain” owned by White Hat, not individual not-for-profit schools subject to independent governing authorities.

In addition, White Hat has registered certain trademarks for the Hope Academies and Life Skills Centers under its own name. Some form management agreements provide that if the school should ever terminate its management agreement, it must “discontinue any use of the proprietary marks” including use of the name “Hope Academy”. But many of the schools were created as separate “non-profit” entities using the name and mark for “Hope Academy.”

A more recent version of the form White Hat management agreement explicitly provides that the name “Life Skills Center” and “its Educational Program and Model” are licensed to the school by the White Hat affiliated management company. As a result, schools operating under these White Hat form contracts would have to change their names if they elected to terminate the management relationship with White Hat.

For more information, contact OFT at 614-257-4195.