In Lieu of Taxes?

When a teacher at The Gow School (no relation to the author) in South Wales, New York, moved across campus and into a different township, he put up a mailbox and requested delivery. Little did he know that his small act would put the school at the center of an issue that has become increasingly vexatious - and potentially devastating - to independent schools: the issue of payments in lieu of taxes (PILOTS) and services in lieu of taxes (SILOTs).

The Gow case revolved around the question of where faculty children at the boarding school, which straddles three townships and two school districts, should be educated. For many years, most had been attending schools in nearby East Aurora, but the planting of the mailbox suddenly brought into sharp relief the school's complicated geographical situation. As a result, says Headmaster William Patterson, "a cozy relationship fell apart." In short order, the local press and two school boards and town governments had generated a modest firestorm over who would bear the cost of educating children residing on land exempt from taxation.

The proposed solution - for East Aurora to annex the entire campus into its school district - seemed simple enough, but one local school board member continued to voice vehement opposition, asking, "What's in it for us?" Referring to the education of faculty children as "the generous gift we are bestowing on The Gow School," he demanded that, if the district were to accept the untaxed school property, there would have to be "a consideration" paid by the school, a payment "in lieu of taxes."

The school's resistance to the PILOT notion drew Gow's head into the public debate over the issue. Early on, Patterson issued a detailed enumeration of the benefits that the school, as a major employer and as a provider of a number of services, educational and otherwise, brought to the community. As a nonprofit institution, the school maintained that it was legally bound to resist any infringement on its tax-exempt status by acknowledging a responsibility to make any contribution "in lieu of taxes." Such an action, in Patterson's words, would have "jeopardized the independence of independent schools." Public opinion proved to be on Gow's side and the annexation proceeded (although not before a subsequent request for a building permit generated another set of provocative headlines: "Gow has money to spend on squash courts"), but the case of The Gow School is typical in the annals of PILOTs and SILOTs.

Exemption and Threats

For any nonprofit institution, one of the most tangible operating benefits is the freedom from the tax liabilities that weigh on profit-driven enterprises. "Tax-exempt" status is as central to the well-being of most independent schools as a healthy endowment or a long waiting list. And, from time immemorial, most schools have gone about their business with relatively little concern for the tax code. Any head, board chair, or CFO can cite the federal laws that ensure the rights of nonprofit schools to exist, and they can discourse loftily on the historical basis of this status and the social benefits of supporting a diversity of service-based institutions. It has long been generally understood that to tax such institutions threatens both their independence and their very existence.

Of course, not-for-profit independent schools have never been absolute tax havens. Payroll taxes, licensing and inspection fees, and assessments for water, sewer, and other municipal services have always been a fact of life, and strict property tax codes in some locales have encroached on schools' tax exemptions. For example, in New Hampshire, a state with no income or sales tax (and, thus, heavily dependent on property taxes), towns are permitted to tax any facilities of a school not devoted exclusively to educative purposes. Dining and dormitory space, as well as faculty housing, may be taxed, with results that might well chill the blood of any CFO. In 1999, Phillips Exeter Academy, the largest taxpayer in the town of Exeter, footed a tax bill in excess of half a million dollars. This huge commitment, according to Julie Quinn, Exeter's director of communication, has a distinct effect on town-gown relations and keeps "our facilities-management people working closely with the town on all matters."

In the last three decades, the specter of taxation has made its appearance in communities across the country, although slumping tax bases in the Northeast and rising populations and demand for services on the West Coast have tended to center the taxing-of-nonprofit issue on those regions. At each outbreak of interest in taxation, larger institutions - primarily colleges and universities - have tended to feel the pressure first. As a result, the annals of higher education are filled with alarms, defenses, defeats, and compromises. "From a college or university perspective," Sheldon Steinbach, the general counsel of the American Council on Education (ACE), was quoted as saying in 1997, "this is Armageddon."

The prospect of the erosion of tax-exempt status has been just as terrifying at the elementary and secondary levels, and many schools have had close encounters with the tax collector. These encounters have taken a number of forms: receipts of outright bills for taxes, requests from ad hoc "citizens' committees" (in one case written on city council stationery!) requesting contributions in specific amounts, and, most commonly, a shadowy suggestion hovering over the table as a school takes on a new project that must pass through local or regional regulatory bodies.

Sometimes, the issue starts near the top; in 1998, the Massachusetts legislature seriously considered a bill that would have severely restricted property-tax exemptions for independent schools. In the fall of 2001, Baltimore Mayor Martin O'Malley proposed levying an "energy tax" on all nonprofits in that city. Only changes in the political climate of the moment caused these issues to subside. Nevertheless, driven by ever-fluctuating local circumstances, the issue remains volatile. "Right now, we're okay," says the CFO of one Massachusetts school, "but tomorrow we could be the front-page news." (Concern about this topic runs so high that several people interviewed for this article expressed concern that the mere public airing of the issue might inspire a new wave of PILOT/SILOT requests.)

A 1999 NAIS white paper published on the association's website ("PILOTs and SILOTs," www.nais org) offers a comprehensive overview of threats to tax-exempt status and menu of general advice to schools. The report is based on a survey conducted by NAIS, and it should be required reading for any school official likely to be involved in the decision-making process around a PILOT/SILOT solicitation.

With few exceptions, PILOT/ SILOT controversies begin with some small event (like the seemingly trivial placing of a mailbox) that alters a school's profile in the community. As Gow School's William Patterson notes, the situation does not generally begin with a "school doing something heinous; it's usually the school being naïve." Often the impetus is something that the school is excited about, even euphoric, such as a well-publicized capital campaign or the need to expand facilities. The euphoria can quickly turn into a migraine when the blip on the community's radar turns into a major brouhaha with one immutable element: the insinuation that the extravagantly affluent school does not do enough to make itself a good community citizen. In some instances, the issue has clearly been personal, based on the animus of a single individual toward a school or someone involved with it. The request can generate its own animosity; one board chair referred to such a request made to her school as "absolute extortion." Indeed, such requests are often nothing more than thinly disguised demands for a quid pro quo.

Even so, schools must closely examine the legal and social issues embedded in the request, and a school approached for such a contribution has several choices. On advice of counsel, some schools simply ignore the request, a tactic that does meet with occasional and probably short-term success. Other schools pay up, considering the payment a cost of doing business that is offset by improved community relations that will yield benefits in time.

An absolute refusal to respond to a community's request may be the most principled stand, but, according to Peter Tacy, schools take this course "at their peril." A school may choose to defend its nonprofit status, but even a sound legal victory will not necessarily make the issue go away. Universal advice is for schools to avoid any action that might appear aggressive or elitist. "If schools show arrogance," says William Patterson, "then we get a comeuppance."

The perhaps equally perilous course of acceding to a PILOT/SILOT request may or may not expose a school to loss of tax-exempt status, but it certainly runs the risk of being considered a precedent. Schools are conscious that their actions may redound upon other schools and nonprofits. "We can't do anything that would affect other independent schools," says the head of one school recently embroiled in PILOTs battle. "It's not just [our school] we have to consider; it's the world." Although no stories of one contribution opening a floodgate of requests were uncovered in the preparation of this article, concern that a single payment might mean a community's hand in a school's pocket forever may not be entirely groundless. Certainly it's easy to see how it could happen.

Middle-ground responses by schools can take any number of forms. "Every situation is different," says Peter Tacy, to which ACE's Sheldon Steinbach adds, "Each accommodation is different." Typically, a school might calculate its share of the emergency services it receives from a community, or offer services to the community that can take any form - from free or discounted use of facilities to offering scholarships to local children. All agree that any payment made or service offered must be explicitly described and clearly understood as being entirely voluntary. Tacy suggests going even a step further: schools should insist that the town or city "publicly acknowledge the act," making sure that contribution is seen as an expression of the school's support for the community.

The School's Part to Play

In an ideal world, PILOTs and SILOTs would be a non-issue, not simply because of the questionable nature of the practice itself, but because schools themselves would be paying more attention to the implicit underlying issue, which is the school's relationship to the community at all levels. This means developing and following a two-pronged strategy: one, improving what is traditionally thought of as "community relations" and, two, developing a deep, sympathetic, and active understanding of the local political scene.

"The initiative is coming from the wrong corner," asserts Peter Tacy, noting that schools invariably find themselves on the defensive in PILOTs and SILOTs situations. Steve Clem sees the issue as being entirely about the nature of a school's efforts to engage its community. "Ideally, we would hope that a school would have such positive, ongoing reciprocal arrangements with the town that you shouldn't have to get to the point of a demand for a PILOT," Clem says. "Schools need to be smart and have a sense of obligation because they're public charities, and they need to be engaged in the lives of their communities in a meaningful way."

Jefferson Burnett, NAIS director of government relations and white-paper coauthor, agrees. "Schools should be proactive in community relations," he says, even in parts of the country "where this may not be an issue yet."

There is extensive literature on what schools can do to maintain positive community relations, but it is imperative that a school make its efforts as public as possible. In addition, the universal recommendation is that every effort be made to document each and every contribution a school makes to its community. Schools must be prepared to answer a PILOT/SILOT challenge by responding not just to the solicitation but to the question that is usually at the heart of such a request: What is your school doing for the community?

The NAIS PILOTs and SILOTs webpage suggests data that can be useful to a school in supporting its claim to be a contributor. They range from complex economic impact models that include payroll, expenditures, and the multiplier effect to more straightforward listings of services provided to the town by the school, even adding in community-service hours provided by students. A number of school officials said that they maintain, and urge other administrators in their schools to maintain, comprehensive records of community-related services and expenditures, all ready to be brought forth at a moment's notice in response to a challenge - or better still, to be publicized on a regular basis. In one case, the presentation of such material by several schools in a community - where local politicians had been making noise about private schools not contributing to the town - caused one official to explode, "How dare you keep this a secret from us!"

Lesson: Trumpet your school's efforts to be a good citizen.

But, sadly, good community relations, even of the most sophisticated sort, are not always enough. When a municipality sees its tax base shrinking and the cost of services growing, sooner or later someone - the assessors, the voters, the press, or an ambitious politician - will look to "the school on the hill," with its high tuition, rosy endowment, and spanking new science building, as a source of revenue, and the warmest of relations may not forestall a desire for cold, hard cash. By the same token, a school's contributions are not always enough to ensure good community relations. Peter Tacy sees "no correlation between schools that pay and schools that report good community relations." Schools must take their efforts to the next level.

The most effective approach a school can take, according to Ronald Goldblatt, executive director of the Association of Independent Schools of Maryland, is for school leaders to engage themselves deeply in the political life of their communities - to "become their own lobbyists at the local level." Steve Clem urges school leaders not to approach the issue lightly. He bluntly tells them to "get over thinking you can ignore this. If you can't name your [state] representative, senator, and local folks, you're not doing your job right." Peter Hutton, head of Beaver Country Day School (Massachusetts), states that "if you give your community the sense that local politics don't affect your school, then you give the sense that local issues don't matter, and they do." By meeting regularly with local officials and having the officials know you and your school, you can "get ahead of the curve politically," says Hutton, and avoid being perceived as "arrogant or elitist." Clem goes further, advising schools to "have a legislative network in place that can be mobilized immediately to exert influence on the political process."

Beyond this, schools can develop new attitudes toward groups that have traditionally been of only minor or instrumental consideration. Ron Goldblatt suggests that schools "view neighbors as part of the formal constituency landscape - cultivate them. Managing the neighbors can't just come out of the need for a permit." The Holton-Arms School (Maryland) has turned a contentious situation with neighbors around by working with a neighborhood liaison committee that meets quarterly with school officials to discuss issues covered by a "neighborhood reconciliation agreement." Says head of school Diana Coulton Beebe, "It was an arduous and onerous process to get there, but the process and the relationship were lauded" when the neighbors supported the school at the local board of appeals. In addition, Holton-Arms has been active in getting local schools together to educate them about political processes relating to school needs. (See related story on page 30).

Taking the initiative in the political realm is crucial, and schools should strive to make themselves known as well as possible. Include local officials in the activities of your school, says Peter Tacy. "There's nothing wrong with asking the selectmen to march in the commencement procession," he says. Steve Clem adds that schools should "cultivate political figures the way they cultivate major donors."

Of course, with the plates of most school administrators well beyond full, finding the time to do this work can be a challenge. Regional association executives are finding themselves ever more involved in state or regional political issues, although there is resistance to the idea that they should be lobbyists. But, since each PILOT/SILOT situation is unique, it is incumbent on schools themselves to look proactively after their own interests.

Independent schools are privileged bodies, but their privilege is predicated on the high-minded notion that their existence is a fundamental benefit to society. State and federal law may provide exemption from most or all taxes, but each school must consider for itself what price it is willing to pay to meet its social or even moral responsibilities - and in what currency it will make this payment. "In lieu of taxes" or not, a school needs to be clear on the nature of the contributions it needs to make to its community and how, in turn, it can best engage the community in understanding its own mission, values, and needs.