Princeton is preparing to receive thousands of alumni for its reunion weekend starting Thursday, May 28 (see story, page 32). But both Princeton University, and the eating clubs where its undergraduate students like to socialize, may soon get an unwelcome visitor in the form of the taxman.

As a nonprofit educational institution, the university does not have to pay property taxes. Instead, it voluntarily donates about $2.75 million a year to the Princeton municipal government to support local services. If the entire campus were taxed like other town property, it would have to pay $50 million a year, according to one estimate.

A lawsuit by four residents, being litigated by Princeton-based attorney Bruce Afran, is challenging the nonprofit status on the grounds that the university takes in a significant amount of money when its faculty members sell patents to companies, and because it owns the land on which Princeton Forrestal Village and Princeton Forrestal Center are built. The plaintiffs allege that the university is behaving like a “commercial enterprise” as well as a school, and should have to pay taxes.

Afran’s case cites Princeton’s highly profitable patenting of a compound invented by a faculty member and licensed to Eli Lilly to create the drug Alimta. The school received $534 million from the deal between 2005 and 2012, of which it passed $118 million to the professors involved in the research. The arrangement was made possible by the 1980 Bayh-Dole Act, which allows universities to license technologies to private companies. Previously, anything invented with the use of any federal funds had to be turned over to the government.

The case has been winding its way through the court system since 2011 and has survived several attempts by the university to have it dismissed, most recently in April, when a state appeals court allowed it to go forward to be heard in tax court.

Since February, both sides have been seeking a mediator to help negotiate a possible resolution of the case outside of court. Both Afran and the university have told reporters that the two sides were attempting to agree on a mediator, and were going to exchange lists of possible candidates.

Eating Clubs, or Cheating Clubs?

Wealthy Princeton alumni are donating millions every year to their old eating clubs, through nonprofit foundations, and it’s all exempt from taxes. Or so they claim. But an exhaustive two-year investigation by the student newspaper, the Daily Princetonian, found reason to believe the donors should be paying federal taxes on $20 million worth of dining halls, taprooms, and building renovations the foundations have funded over the last few years.

Marcelo Rochabrun, a university senior, followed a paper trail of tax records, planning board meeting minutes, tax codes, and legal opinions to report the story.

At the heart of the story is the distinction between different kinds of nonprofit groups. Under federal tax law, social clubs and fraternity-like organizations like the eating clubs — such as Tiger Inn, Cap and Gown, and Ivy Club — are nonprofit groups. They don’t have to pay federal taxes on their income. However, anyone who donates money to these clubs cannot claim an income tax deduction, because they don’t serve the public good. Donors can only claim tax deductions if they donate to a charitable group, a charitable foundation, or an educational institution that has 501 (c)3 status.

People who donated to the eating clubs directly received no tax exemption. However, the Princetonian investigation found that the clubs received a very small part of their income from direct donations, and instead got most of their money through a handful of foundations: the Prospect Foundation, the Cottage 1886 Foundation, the Ivy 1879 foundation, and the Princeton Charter Foundation, which exist to support the educational activities of the eating clubs. Unlike the eating clubs, the foundations that support them have established themselves as charitable foundations and donations to them are tax deductible.

The Princetonian reported that over the last five years, the eating clubs collectively got about $20 million from foundations. However, the reporter also found that the clubs were spending very little on educational expenses, although they have facilities like libraries, study areas, and computer labs in addition to the dining halls and taprooms.

The report cites the example of the Cap and Gown, which received $2.7 million from the Prospect Foundation in 2010 for educational grants, but the club’s only educational expenses that year were $2,225 on seminars and $1,980 on periodicals, according to IRS returns. The discrepancy between educational grants received and educational expenses reported was typical of the eating clubs’ ledgers.

In the article, leaders of the foundations argued that the IRS guidelines for what could be considered a tax-exempt donation were liberal, and that the eating clubs counted as educational facilities because of all the studying that went on there and because they included libraries and study lounges.

They also defended improvements to kitchen facilities as educational, because they are being used to feed students. Ivy Club and the Ivy 1879 Foundation gave the Princetonian a joint statement saying the club was educational as well as social.

Those assertions were disputed by Dean Zerbe, a lawyer who worked as counsel to the U.S. Senate Committee on Finance. Zerbe told the Princetonian: “The eating clubs at Princeton walk, talk, quack like exclusive private clubs. It raises real questions about whether the foundations supporting the eating clubs should benefit from charitable status and that the eating clubs should benefit from subsidies by the American taxpayer.”

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