SCANDAL! - Arizona’s Private School Tuition Tax Credits

“This is just rife with improper action, it sounds like.”

Some charities most generous to executives

Executives at two of Arizona’s largest private school scholarship charities have used state income tax dollars to give themselves luxury cars, expensive real estate, jobs for relatives and friends, and extra cash hidden in the nonprofits’ balance sheets.

The benefits are potentially illegal under federal tax code and put the charities at risk of crippling fines and even closure, according to tax experts interviewed by the Tribune.

The newspaper’s investigation of Arizona’s Private School Tuition Tax Credits found the $55-million-a-year program has largely failed to expand access to private education for low- and middle-income families, as promised. And a pair of the scholarship charities, called school tuition organizations, which run the program, have enriched their executives and board members.

“A number of people in the system are not altruistic,” said Debra Pearson, an early tax credit supporter and former STO board member. “That breaks my heart. That discourages me. It’s like power and money corrupt all things.”

The state has 55 STOs. But two of them — the Arizona Christian School Tuition Organization and the Arizona Scholarship Fund — dominate the industry, together collecting almost a third of all tax credit donations.

The personal profits these major STOs have provided executives appear to violate federal tax code, according to several nonprofit attorneys and tax experts the Tribune interviewed. Only auditors with the Internal Revenue Service can determine if scholarship charities’ payments and purchases are “private inurement,” and therefore unlawful.

Several of the deals ACSTO and ASF struck with their directors are questionable, putting their status as tax-exempt charities at risk.

ACSTO pays out more than $10 million a year in scholarships for thousands of students’ private religious educations. Under the stewardship of state Rep. Steve Yarbrough, its co-founder and executive director, ACSTO is the state’s most prolific tax credit charity.

And the nonprofit has given generously to Yarbrough, too.

Income tax donations to ACSTO have paid hundreds of thousands of dollars to private businesses owned by Yarbrough, a Republican lawmaker from Chandler, and other members of the charity’s board of directors, federal tax records show.

To help him travel around, the scholarship charity has bought two Infiniti G35 luxury sedans.

At the third-largest STO, Arizona Scholarship Fund, ChamBria Henderson oversees a more than $5-million-a-year operation providing tuition money to campuses of all shapes and sizes.

Henderson conceived the idea of tax credits to pay for private school tuition some two decades ago and then lobbied for it at the Arizona Legislature.

Like Yarbrough, she has used the scholarship charity she operates to furnish herself more than fringe benefits.

Nepotism is ASF’s primary hiring policy. Henderson employs her three children and seven other relatives and friends, according to federal tax records.

ASF gifted Henderson money for a down payment to buy office space. The charity now rents that space from Henderson at a price well above the going rate for that class of commercial property.

The Tribune provided its findings to Yarbrough and Henderson last month. The executives confirmed the newspaper had accurate details about their benefits, though both argue the transactions do not illegally profit them at the charities’ expense.

“We think what we do is clearly appropriate under the law,” Yarbrough said.

Tax experts that the Tribune interviewed disagreed.

“The parties here are really pushing on the edge, in my judgment, by doing this kind of thing,” said Bruce R. Hopkins, a tax attorney who runs the Nonprofit Law Center in Kansas City, Mo.

When charity executives take something from their organization (like a large salary or equipment) without giving back something of equal or greater value, that is a violation of federal tax code called “private inurement,” said John D. Colombo, a University of Illinois law professor specializing in tax-exempt organizations.

Executives who receive illegal benefits face major fines of up to 200 percent of the benefits’ value. In the most egregious cases, the IRS can strip charities of their tax-exempt status, a death sentence for nonprofits.

“If you are guilty of private inurement,” Colombo said, “bad things happen to you.”

PRIVATE GAIN

Steve Yarbrough turned private school scholarships into a second career.

In 1997, when tuition tax credits became state statute, Yarbrough largely closed his family law practice. He focused his time and energy on building the Arizona Christian School Tuition Organization.

It was, at first, a surprisingly difficult undertaking, Yarbrough said, considering tax credits essentially offer schools and parents free money.

“To try to get a church to do a mailing for an outside organization is not an easy thing to do,” he said.

ACSTO is by far the most financially successful of the state’s STOs.

Yarbrough, working full time as a charity executive and state lawmaker, deactivated his license with the State Bar of Arizona in 2004. The administrative change saved him a few hundred dollars a year in fees and made it easier to turn away former clients who wanted his representation again, he said.

ACSTO is the only party that receives his legal insights now.

Yarbrough does not supply his legal knowledge pro bono, though.

The scholarship charity pays him an extra $12,000 each year as a retainer, on top of his $96,000 salary, which ACSTO counts as “legal fees” in its federal tax filings.

Maret Vessella, the state bar’s interim chief counsel, said lawyers are not permitted to do any legal work or charge fees unless they have an active license. Practicing law without that can bring censure and, in extreme cases, disbarment.

“An inactive license — it’s the same thing as if it’s suspended, in terms of you cannot practice law,” Vessella said.

Yarbrough said he considers the legal fees part of his salary, not for him to represent the scholarship charity as an attorney. “Any legal work I’m doing at this point is basically just my business knowledge, my experience in that regard,” he said.

Nonprofit charities file their own tax returns — the “Form 990” — even though they don’t pay taxes. In exchange for freedom from income taxes, charities are supposed to accurately detail their revenues and expenses, what they pay top executives, and whom they do business with.

ACSTO does not list all of Yarbrough’s compensation in the same part of the filing, as the IRS requires.

Therefore, it is impossible to know how much the charity pays its executive director.

IRS auditors have caught numerous charities attempting to hide executive pay by tucking cash and perks in different itemized expenses.

Yarbrough’s additional pay is not documented in ACSTO’s tax filings; he does disclose that he provides the charity legal services.

ACSTO’s filing for 2007 also states that David Harowitz, one of the charity’s former board members and founders, volunteered his time as its primary attorney.

However, Yarbrough acknowledged that Harowitz also receives income from what ACSTO classifies as legal fees.

That line item typically totals almost $60,000 a year, federal tax records show.

Any misstatement on ACSTO’s filings to the IRS are accidental, Yarbrough said.

Harowitz did not respond to requests for comment.

Yarbrough and Harowitz are generating more income from a different line item.

The scholarship charity pays HY Processing, a private data-entry corporation, more than $400,000 a year. Those bills take up a majority of ACSTO’s administrative spending.

The “H” stands for Harowitz, who owns the company with “Y,” better known as Yarbrough, Arizona Corporation Commission records show.

Yarbrough said the company employs up to a dozen people during its busiest times of year to process scholarship applications, entering family income information into databases and finding excerpts from letters.

The ACSTO director would not provide HY’s internal financial records to the Tribune.

Yarbrough said he and Harowitz do not take any salary from the firm, though it does generate a profit for them. He would not disclose how much profit HY provides; ACSTO is the corporation’s only client.

Yarbrough insists that HY saves the scholarship charity money on administrative expenses but did not release any evidence to support his assertion.

“It is, obviously in my opinion, an arrangement with considerable benefit to ACSTO,” Yarbrough said in a written response to the Tribune’s questions.

The firm’s employees work from the same building as ACSTO and, in everything except name, are employees of the charity.

HY’s business arrangement puts the charity in peril, said Frances Hill, a University of Miami tax law professor.

“Very, very bad situation,” Hill said. “The IRS has been busy revoking the (tax) exempt status of any number of entities that have exactly that fact pattern.”

Yarbrough’s flashiest income is also listed at the back of the charity’s tax filings.

In 2002 and 2007, ACSTO bought automobiles, the first for $36,000 and the second for $44,000. Specifically, the scholarship charity purchased Infiniti G35 sedans that Yarbrough said he uses as his personal vehicle.

ACSTO does not count the sedans in the executive’s compensation; Yarbrough said he counts it as such in his own federal income tax filings.

“For the privilege of driving that car, I get to pay taxes,” he said.

OFFICE SPACE

ChamBria Henderson

The Arizona Scholarship Fund outgrew ChamBria Henderson’s two-bedroom condo even before it made the Mesa residence its headquarters in 2004.

Regardless, the scholarship charity only searched out a place of its own in 2006 and only by force.

Henderson’s homeowners association noticed ASF employees’ cars parked all over the narrow subdivision streets and threatened legal action.

The STO was already collecting and distributing millions of dollars. Henderson launched the charity in 1998 after lawmakers established the program that allows taxpayers to take money they owe the state general fund as income taxes and give it to STOs for student tuition.

She had devised the idea of giving taxpayers control over how their tax dollars fund education through a tax credit, rather than vouchers. The scholarship charity allowed her to test the idea in the real world.

“I opened up Arizona Scholarship Fund to be a lab for this experiment,” Henderson said of private school tax credits.

Henderson also made it her own private business and ran ASF from home for eight years.

As the homeowners association moved to evict the charity in fall 2006, Henderson decided to buy office space herself, becoming ASF’s landlord and executive director.

Asked why ASF did not purchase its own office space, Henderson provided multiple, conflicting explanations.

First, Henderson said ASF’s board of directors, which includes herself and her oldest daughter, thought it was a bad idea for a charity to own property. If ASF ever dissolved, she added, the charity’s executives could not keep the buildings themselves.

“The board just felt it wasn’t a wise financial decision to have something (valued at) close to half a million dollars as an asset of the organization,” Henderson said, “to be just handed away to somebody else.”

Later, Henderson said ASF had no way to make such a purchase because her bank, Wells Fargo, does not provide mortgages to nonprofit charities.

That is false.

In fact, the bank regularly lends money to nonprofits and even seeks them out as customers, said Ferris Morrison, a Wells Fargo spokeswoman. “We do lots of business with” charities.

BALLOON PAYMENT

Henderson formed her own private, for-profit corporation — ChamBria LLC — to buy the office space with a $360,000 mortgage from Wells Fargo.

There was a problem, though. Henderson couldn’t afford to buy the 1,800-square-foot spread that she picked to be the charity’s new headquarters, near Baseline and Higley roads.

She took a second mortgage on her new condo to gather cash for a down payment. But she remained $27,000 short of the roughly $90,000 that Wells Fargo required, ASF’s federal tax filings show.

In September 2006, ASF’s board of directors agreed to lend that amount to Henderson.

The $27,000 turned out to be a gift to the chief executive, not a loan.

Henderson charges ASF $4,300 a month in rent. That includes the amount she owes ASF for the $27,000, tax and rental records show.

Put simply, ASF uses income tax donations to make the payments on the loan it gave Henderson. She pays nothing.

The scholarship charity pays Henderson $28 per square foot in rent for its office space, a fair market rate, she argues.

However, CB Richard Ellis, one of Arizona’s largest real estate firms, asks no more than $26 per square foot for its most high-end commercial space in Mesa. Katherine Hauge, a CB spokeswoman, said most of its properties rent for far less.

Units in ASF’s office complex were advertised for $16 per square foot on a Craigslist.org ad in May.

Debra Pearson, a former state lawmaker, served on ASF’s board at that time and said she urged Henderson against borrowing money from the charity.

Henderson ignored the advice.

“She would say, ‘I have the votes on the board to do it,’” Pearson said.

Henderson alone chooses who serves on ASF’s board.

ASF helped Henderson buy the office space in more ways than one; she also had the charity cosign the loan, making the nonprofit liable for Henderson’s personal debt.

Henderson provided mortgage records to the Tribune that show ChamBria LLC is required to repay the entire loan amount within five years.

Henderson will owe Wells Fargo roughly $300,000 when the mortgage comes due in September 2011, the newspaper calculated using ASF’s tax filings and Henderson’s records. The executive acknowledged she intends for the charity to pay that bill.

In June, Henderson told the Tribune that ASF’s lease promises the charity can occupy its headquarters free of charge once the mortgage is repaid.

The lease does not include any such condition. When questioned about the disparity, Henderson admitted that she has not committed to provide ASF free rent at any point.

ASF’s tax filings to the IRS do not disclose that the charity is liable for its executive’s personal debt.

Federal tax code allows executives to lease office space to the charities they run so long as the price is fair, said Hopkins, the Kansas City nonprofit attorney.

“But the IRS would be all over this,” Hopkins said of ASF. “I mean, they would be looking at this to test it to see if the loan terms are reasonable, the rental agreement is reasonable. There are hundreds of rulings where organizations are denied (tax) exemption or lose exemption because they’re doing this kind of thing.”

ALL IN THE FAMILY

Most nonprofits are mom-and-pop shops.

A charity’s founder often works simultaneously as executive director, board member, fundraiser and receptionist. Many hire relatives and friends to do work for the nonprofit, often getting services at discounted prices, which leaves more money to spend on charity work.

But not all such arrangements are for public service.

Henderson hires her family and friends, and those of ASF’s board members, to help run the operation.

The executive’s oldest daughter, Kanani, oversees finances and technology for the charity, according to federal tax filings. Her son, Enoch, works in fundraising along with his sister-in-law, Khara Taylor. ASF pays Henderson’s other daughter, Leticia, for clerical work.

Such hires are legal so long as the charity can show they were made by an independent board, the compensation is a fair market value and the employee is equipped to do the job, said Jeff Hurwit, a Massachusetts attorney specializing in nonprofit law.

Most of the relatives and friends are paid to increase ASF’s tax credit donations, regardless of whether they are qualified.

“We had some people that were obviously close to us, friends and family, that said they had some background in fundraising and would like to attempt to fundraise on behalf of the organization,” Henderson said.

Several of these hires failed to raise enough in donations to cover the cost of their salary, Henderson said, and she fired them. However, the charity’s tax filings do not show any reduction in employees with personal ties to executives.

Pearson, the former ASF board member, said she cut ties with the charity when Henderson hired Pearson’s son, then in high school, to do complicated fundraising work.

These employment practices pose legal problems for the scholarship charity, Hurwit said. “This is just rife with improper action, it sounds like.”

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