Transfer of for-profit colleges to nonprofit entity held to be bargain sale

The Tax Court reduced a taxpayer’s claimed charitable contribution stemming from bargain sale treatment for his transfer of five for-profit colleges to a nonprofit entity.

Facts: Beginning in 1985, Carl B. Barney had acquired for-profit colleges. He served as the sole trustee and beneficiary of the Carl Barney Living Trust (CBLT), a revocable trust treated as a disregarded entity for federal income tax purposes and organized under California law. Through CBLT, Barney held 100% of the stock in five S corporations that operated for-profit colleges: Stevens-Henager College Inc. (SHC), CollegeAmerica Arizona Inc. (CAAI), CollegeAmerica Services Inc. (CASI), California College Inc. (CCI), and CollegeAmerica Denver Inc. (CADI). These entities collectively operated licensed postsecondary educational institutions across Arizona, California, Colorado, Idaho, Utah, and Wyoming. Each was accredited by the Accrediting Commission of Career Schools and Colleges.

Through 2012, Barney was the chairman of each S corporation, but he had appointed a new CEO for them in May 2010. In 2012, Barney sought to retire from active management of the colleges and transition the colleges into nonprofit entities. To facilitate his exit, he engaged a consultant to coordinate a merger of the S corporations with the Center for Excellence in Higher Education (CEHE), an Indiana-based public-benefit corporation and Sec. 501(c)(3) exempt organization.

The transaction closed on Dec. 31, 2012, and was structured as a combination of a bargain sale and an outright donation. Through CBLT, three corporations (SHC, CAAI, and CASI) were sold to CEHE for total consideration of $431 million. CEHE furnished the consideration in the form of two secured promissory notes: Term Note A, with a stated principal amount of $200 million, and Term Note B, with a principal amount of $231 million. The purchase notes and the associated note purchase agreement (NPA) contained rigorous mandatory prepayment terms, requiring CEHE to pay the greater of 75% of excess cash flow or 10% of total quarterly revenue.

The remaining two corporations, CCI and CADI, were donated to CEHE for no consideration.

The transaction occurred against a backdrop of extreme volatility in the for-profit education sector. From 2006 to 2010, the industry experienced explosive growth following the repeal in 2005 of the “50% requirement” that at least half of colleges’ courses be offered on campus. This led to rapid growth of online enrollment. Barney’s colleges mirrored this trend, with tuition revenue surging from approximately $55.4 million in 2007 to $218.9 million in 2010. However, by 2011, the industry faced a severe downturn due to heightened federal scrutiny. The U.S. Senate Health, Education, Labor, and Pension Committee and the U.S. Government Accountability Office launched investigations into “predatory” practices, resulting in a series of reports questioning student outcomes. By 2012, Barney’s colleges — which derived 78% of their revenue from Title IV federal student aid — saw significant drops in enrollment, and their tuition revenue fell to $198.8 million.

During the due-diligence process for the transaction, the S corporations commissioned two appraisals. First, Richard Pollak of Barrington Research Associates, using comparable-companies, comparable-transaction, and discounted-cash-flow analyses, concluded the fair market value (FMV) of the S corporations was $620.8 million. Subsequently, Matt Connors of Rocky Mountain Advisory, using the market approach and income approach valuation methods, concluded the FMV of the entities was $700 million. CEHE engaged Blue & Co. to review Pollack’s valuation of the S corporations. Based on its review, Blue found an FMV range for the S corporations of between $511.3 million and $680 million.

In 2015, the U.S. Department of Education (DOE) conducted a financial review and assigned CEHE a composite score of 0.2 out of 3.0. Under DOE regulations, a score below 1.5 indicates a lack of ability to meet required financial standards. Because of this low composite score and certain other factors, for CEHE to continue participating in Title IV programs, the DOE required it to post a $71.6 million letter of credit — representing 50% of the Title IV funds received in 2014.

This requirement significantly exceeded the 10% letter of credit Barney’s counsel had anticipated during preacquisition inquiries. To prevent a financial collapse, Barney restructured the debt in 2015, replacing the purchase notes with contingent notes and ultimately executing a confidential settlement agreement that irrevocably forgave approximately $351 million of the original debt, reducing the balance to $75 million.

In 2013, each S corporation timely filed its 2012 Form 1120-S, U.S. Income Tax Return for an S Corporation. In reporting gain from the transaction, each S corporation elected out of the installment method and used the FMV determined by Pollack in calculating the amount of its gain. SHC, CAAI, and CASI each reported its merger into CEHE as a bargain sale.

On his 2012 Form 1040, U.S. Individual Income Tax Return, Barney reported a total charitable contribution deduction of $180,922,213, representing the excess of the colleges’ appraised FMV over the consideration received. Since Barney’s 2012 adjusted gross income was $441,429,027, the charitable contribution deduction was limited to 30% of that total, $132,428,708, with the remaining amount reserved as a carryover.

The IRS audited the 2012 tax returns of both the S corporations and Barney. The Service proposed a deficiency in Barney’s return of more than $31 million and a penalty of more than $10.8 million. In September 2017, each S corporation and Barney filed an amended Form 1120-S for 2012. On his amended return, Barney reported an overpayment of $27,388,732 of his tax liability. He requested that $26,888,732 of the overpayment be refunded and that the remaining $500,000 be applied to his 2013 tax year. He based the amended returns on a new report from Willamette Management Associates stating that the purchase notes were worth only $175 million to $177 million at the time of the transaction due to a 10% discount for lack of marketability for Term Note A and a 20% discount for lack of marketability for Term Note B.

On Dec. 20, 2021, the IRS issued Barney a notice of deficiency denying the claimed refund and disallowing his entire $132,428,708 charitable contribution deduction. The IRS asserted that Barney failed to establish the FMV of the contribution and that the contribution did not satisfy the requirements of Sec. 170. Barney challenged the IRS’s determinations in Tax Court.

At trial, the government presented expert testimony from Carl Saba, who appraised the corporations for only $289 million. Saba argued that Barney’s original appraisals were “overly optimistic” and failed to account for the industry’s decline or the restrictive covenants in the NPA that further reduced the entities’ value. An additional government expert witness, Harvard professor Stuart Gilson, concluded that the aggregate FMV of the S corporations was less than $350 million.

Issues: The IRS argued that Barney was not entitled to a charitable contribution deduction for his transfers of CCI and CADI to CEHE because he failed to relinquish dominion and control over the S corporations, did not provide qualified appraisals, and received consideration equal to the value of the S corporations transferred. In addressing Barney’s refund claim, the IRS contended that Barney correctly reported gain based on the stated face values of the purchase notes he received and that the notes were not contingent debt instruments. In addition, the IRS contended that Barney’s settlement in 2015 did not allow him to amend his 2012 tax return and retroactively adjust his income as originally reported.

Conversely, Barney contended that he made qualifying charitable contributions substantiated under the Code — specifically, the donation of CCI and CADI — and that he was entitled to a refund. He asserted that the subsequent renegotiation of the promissory notes constituted a valid purchase price reduction under Sec. 108 or, alternatively, that the notes were contingent debt instruments under the applicable regulations.

Sec. 170(a)(1) allows a deduction for charitable contributions of property, generally measured by the FMV at the time of the donation (Regs. Sec. 1.170A-1(c)(1)). A charitable contribution deduction is also allowed under Sec. 170 for a part sale, part gift (bargain sale) made to a charitable organization. Generally speaking, the transferor in a bargain sale recognizes taxable gain on the sale over their adjusted basis and is entitled to deduct the excess of the property’s FMV over the sale price (see Regs. Secs. 1.1001-1(e) and 1.1011-2). A contribution of property is not a charitable contribution if it is structured as a quid pro quo exchange in which the donor receives a substantial benefit in return for the contribution (Hernandez, 490 U.S. 680, 701—02 (1989)).

In Barney’s case, to resolve whether a bargain sale occurred, the court first determined the FMV of the S corporations. While Barney’s experts valued the S corporations at between $620.8 million and $700 million, the court found these valuations excessive and “self-serving,” as they relied on unreasonable management projections that ignored industrywide headwinds and regulatory risks. Instead, the court adopted a more conservative FMV of $300 million, relying on valuations provided by the IRS’s experts, Saba and Gilson.

Regarding the consideration received, the court rejected Barney’s attempt to apply the 2015 purchase price reduction retroactively to 2012, noting that each tax year stands on its own and that Barney’s voluntary forgiveness of debt in 2015 constituted a subsequent gift rather than a renegotiation of the 2012 transaction terms. Applying Sec. 1001(b), the court determined the amount realized was the FMV of the purchase notes. Adopting Gilson’s conclusion regarding the notes’ FMV, the court found they had an FMV of $267 million. Because this amount realized ($267 million) was less than the FMV of the corporations transferred ($300 million), the court held the transaction qualified as a bargain sale, though for an amount significantly lower than originally reported. Finally, the court ruled that Barney’s role in CEHE did not constitute continued ownership of the colleges and found his intent to convert the colleges into nonprofits credible. As such, the court dismissed the IRS’s argument that Barney lacked a donative intent for the bargain sale transaction.

Holding: The court held that the 2012 transfer of S corporations to CEHE was a valid bargain sale because the $300 million FMV of the colleges exceeded the $267 million value of the promissory notes received. However, the court significantly reduced Barney’s claimed charitable deduction by rejecting his “self-serving” $660 million valuation for the colleges and replacing it with a more conservative valuation that accounted for industrywide regulatory risks. Finally, the court ruled that the 2015 debt forgiveness could not retroactively adjust the 2012 purchase price, maintaining that each tax year must be decided based on the facts existing at the time of the transaction.

• Barney, T.C. Memo. 2025-133

— Thomas Godwin, CPA, CGMA, Ph.D., and John McKinley, CPA, CGMA, J.D., LL.M., are both professors of the practice in accounting and taxation in the SC Johnson College of Business at Cornell University in Ithaca, N.Y. To comment on this column, contact Paul Bonner, the JofA‘s tax editor.