Thursday, January 11, 2001
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Posted on: Thursday, January 11, 2001

Kamehameha Schools to pay $29 million in IRS tax settlement

By Sally Apgar
Advertiser Staff Writer

Previous stories:
State hands over $14 million to Kamehameha trust
Estate to get $14 million from settlement
In a move that brings Kamehameha Schools closer to a resolution with the Internal Revenue Service, the charitable trust announced yesterday that it will pay $29 million to the federal government to settle tax claims involving its for-profit businesses.

The trust, formerly known as Bishop Estate, had expected to pay closer to $46 million, according to a 1999 financial statement. In addition, the estate already has paid $13.8 million to settle tax issues stemming from its not-for-profit operations.

Estate spokesmen Kekoa Paulsen was pleased yesterday that the IRS negotiations are almost over. The IRS still must decide whether part or all of the $1.5 billion the estate earned when it sold a stake in Goldman Sachs Group Inc. is subject to taxation.

"All of these negotiations have been a distraction from our real job" of educating children, said Paulsen. "It’s very positive that this has been taken care of. And a lot of the credit should go to the interim trustees for taking this on."

The settlement announced yesterday covers tax-related issues arising from the estate’s for-profit subsidiary formerly known as Pauahi Holdings. The for-profit subsidiaries, which many experts said contained the estate’s thorniest tax problems, have operated a variety of far-flung investments from shopping centers to a Southern California bank to a Virginia golf course and a Chinese carpet factory.

During its extensive eight-year audit of the estate, the IRS investigated how the trust moved money-losing ventures from its nonprofit arm to its for-profit subsidiaries which allowed it to lower its tax bills.

Experts said yesterday that the former board was overly aggressive in making those shifts and the IRS decided in some cases that taxes should have been paid. Sources familiar with the audit said questions arose over the timing of the shift from nonprofit to for-profit and the method used to value the losses.

Amount whittled down

The $29 million is far less than the $46 million the trust had at one point expected to pay. And initially, the IRS reportedly had demanded $165 million. Experts said yesterday the IRS often starts such complicated tax negotiations at a high number that gets whittled down.

Last year, the $6 billion charitable trust agreed to pay the IRS $13.8 million. That settlement preserved the estate’s crucial tax-exempt status but covered tax issues related solely to its nonprofit operations. That negotiation also started out higher with the IRS initially demanding $65 million.

The $13.8 million covered penalties incurred by the not-for-profit operations that benefited from unrelated business income that the IRS said was not tax-exempt.

Kamehameha Schools was established by the 1884 will of Princess Bernice Pauahi Bishop, who directed that her wealth of royal lands be used solely to establish and operate schools to educate the children of Hawaii.

Today, the schools educate close to 4,000 students from preschool through high school and have campuses on Oahu, Maui and the Big Island. In past years, the annual school budget has been about $100 million. But with recent expansions, the budget for this year is $200 million.

The IRS audit resulted in 2,500 pages of preliminary findings that boiled down to two themes of alleged wrongdoing: The former trustees did not operate the charitable trust exclusively for educational purposes, and they derived excessive personal benefits.

Last month, the IRS reached an agreement with the five former trustees, but the terms were not disclosed. An earlier settlement between the attorney general’s office and the five former trustees over their alleged mismanagement of the estate resulted in an insurance company paying the trust more than $14 million. That settlement was contingent on the IRS agreement, which cleared the way for the payment to the trust.

The remaining issue

With the resolution announced yesterday, the only significant issue remaining is whether all or part of the estate’s $1.5 billion in profits from its investment in Goldman Sachs is tax-exempt.

In 1999, the trust placed its 11 percent stake in Goldman Sachs in a tax-exempt holding company called Kamehameha Activities Association in anticipation of the investment firm going public.

When Goldman Sachs went public in May 1999 the estate made more than $477 million after it sold 9 million of 30.9 million shares it owned. Last summer, the trust sold an additional 11 million shares for about $1 billion.

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