OpenAI Obliterates the Prohibition Against Private Inurement and Private Benefit; Commerciality and UBIT Implications

The darlings of generative artificial intelligence, Sam Altman and his band of techno-geeks at OpenAI, continue to find work-arounds for private benefit and private inurement.  And now they are pushing UBIT and Commerciality concerns.  Recall that the developers of ChatGPT-4 and predecessors entered a joint venture with a buncha millionaires, explicitly allowing private investors to take a share of potentially astronomical profits.  On these pages I have railed against this 21st Century whole hospital joint venture.  But in an forthcoming article I reversed course, concluding that OpenAI at least avoids summary judgement and has a better than arguable case that its new joint venture is consistent with tax exemption.  I'm just trying out ideas on theories on these pages and its a good thing the article is still in draft form.  Because these guys are really pushing the envelope.  Consider this from the WSJ:

OpenAI is talking to investors about a share sale that would value the artificial-intelligence startup behind ChatGPT at between $80 billion to $90 billion, roughly triple its level earlier this year. The startup, which is 49% owned by Microsoft , has told investors that it expects to reach $1 billion in revenue this year and generate many billions more in 2024, people familiar with the discussion said.  The deal is expected to allow employees to sell their existing shares as opposed to the company issuing new ones to raise additional capital. OpenAI representatives have begun pitching investors on the deal, the people said, though it is possible the terms could change.

So here is the tax exemption jurisprudence translation.  OpenAI is still a 501(c)(3), last I checked.  Their whole hospital joint venture already raised eyebrows, but it didn't obviously make multi-millionaires out of its tax subsidized employees until now.  Most of them would qualify as insiders but they pledged not to take a dime from the profits, instead paying themselves reasonable salaries, and paying investors for their capital (as if taking a variable interest rate loan and therefore defensible).  Those insider salaries are already extremely high, maybe not by Palo Alto standards, because the employees are in possession of very scarce intellectual capital.  That's how the market works.  I also argue that if the market demands the sort of financing available only via a "capped profit" joint venture, tax exempt jurisprudence should not be offended.  I still think OpenAI has good and charitable motives.  But doggonit there limits to how far I am willing to bend over backwards, legally speaking, to facilitate those good motives.  By giving themselves equity in the venture, and then allowing themselves to sell that equity on the open market, the insiders are deriving profit indirectly with the same effect as if they were taking a slice right off the top. Buyers are merely fronting the profit, and insiders are reaping that profit.  Now wait just a minute, fella!

And another thing!  Taking equity and selling it on the open market, like any other investor, is not quite an unrelated trade or business, but it sure seems to implicate the same concerns Ronzoni might have had about NYU's pasta business.  

darryll k. jones