How Can Open AI Escape Its Tax Exempt Status?

I mentioned last summer that OpenAI (c)(3) is looking to shed its tax-exempt cocoon or skin, as the case may be.  Because whether it emerges as a beautiful butterfly or a slithering snake remains to be seen.  I could be wrong but not because OpenAI (c)(3) thinks it still deserves tax exemption. It probably doesn’t.  But any attempt to escape from its tax-exempt status, even by conversion to a public benefit corporation, will not be easy.  If not done carefully, there could be a pretty big tax exit fee. 

Word has it that Sam Altman and his band of effective altruists are kicking around the idea of reincarnating OpenAI (c)(3) as a public benefit corporation. They must know by now that pretending to be a charity is no longer viable, even if they have a bunch of influential heavy hitters on their board to stave off IRS inquiries. The IRS gods warned them in Rev. Rul. 98-15 not to eat of the forbidden profit fruit but I don't think they listened.  Elon Musk certainly doesn't think so.  There is just way too much profit fruit in the joint venture known as OpenAI Operating LLC and altruists seem to be eating plenty of it.  “Capped profit,” my ass.  When the cap extends into outer space, there really ain't no cap.         

Here is a brief recap:  Microsoft enticed OpenAI (c)(3) into a mixed marriage with practically unlimited working capital with which to do good works.  And while you are at, said Microsoft, here’s some profit for you.  We call these "stock option" apples.  Go ahead, have some.  Altman took a bite, and it was good. The Board saw and kicked him out of the Garden.  Microsoft engineered a quick coup d’état reinstalling Altman and at the same time ridding itself of the Board’s effective altruists.  And since that time, the joint venture that all but defines OpenAI (c)(3) has reached a market value of $100 billion.  The capitalists are in line to reap nearly 50%, capped at 100x.  The Times and the Wall Street Journal report that Apple and Nvidia are about to invest in OpenAI too. 

In fact, when the financial world talks about "OpenAI," it doesn’t even pretend to talk about OpenAI (c)(3) anymore.  It means the thoroughly profitable OpenAI LLC Operating LLC, 49% of which is owned by Microsoft and a few other capitalists.  All of them are exploiting tax subsidized wealth for their own profit.  I am not mad at them, but its only just now that they are admitting that its time to move on. 

So I am just thoroughly dissuaded of the notion that altruism and capitalism can co-exist with capitalist taking orders from altruists.  I’ve been accused of being pollyannish before.  Even the Times throws is throwing shade on the notion:

OpenAI is also in talks with investors such as Microsoft, Apple, Nvidia and the investment firm Thrive for a deal that would value it at $100 billion. And the company is considering changes to its corporate structure that would make it easier to attract investors.  The San Francisco start-up, after years of public conflict between management and some of its top researchers, is trying to look more like a no-nonsense company ready to lead the tech industry’s march into artificial intelligence. OpenAI is also trying to push last year’s high-profile fight over the management of Sam Altman, its chief executive, into the background.

If being a PBC represents “no-nonsense,” what does the current joint venture governed by altruists represent?  The Street calls it nonsense.  I am not here to grind that axe anymore.  I’m tapping out.  Our national religion is capitalism not altruism, I get it.  I am just wondering how in the world OpenAI (c)(3) can execute an escape from (c)(3) status. 

I bet the reason we haven’t seen a conversion yet is because a bunch of well-paid associates still haven’t presented to the  partners a legal and economically feasible way to do it. Because legally, OpenAI (c)(3) can only transfer its assets for fair market value.  OpenAI Operating LLC, in which OpenAI (c)(3) has 51% vote is worth $100 billion.  Does that mean OpenAI (c)(3) must sell its share for $51 billion? Or should we conclude that OpenAI (c)(3)’s interest is worth more than an amount proportionate to its voting power? It seems to me that LLC's entire body of know-how came from tax subsidized wealth. Once those assets are contributed to an LLC they become community property, hardly divisible at all according to capital accounts. Whatever the case, OpenAI (c)(3) must sell, it cannot just give, its assets to a non-charitable successor.  And then Open AI (c)(3) must distribute the proceeds to a governmental entity or another exempt organization. There might be some wiggle room in the regulations on that point. How might they do that? We might expect that the distribution will be to an AI think-tank or some such, controlled by the original fiduciaries who will thereafter operate New OpenAI (c)(3) in tandem with Newco, the newly formed public benefit corporation.  We can expect, too, that the fiduciaries in New OpenAI (c)(3), will be employed by NewCo, if not Microsoft.  With stock options, of course.  It's all kinda smelly but it still might work.   

How will the purchase be structured, assuming that Altman and probably some of OpenAI (c)(3)’s insiders will want to be amongst the buyers?  Where will they get the money? A sale from OpenAI (c)(3) to OpenAI (c)(3)’s former fiduciaries will require a mechanism to ensure the price is right, and that the fiduciaries don’t simultaneously serve as sellers and buyers.   Or maybe the fiduciaries won’t be buyers but instead given ownership in whoever the buyers are.  Maybe Microsoft, Apple, and Nividia will purchase OpenAI (c)(3) and through some other mechanism give the fiduciaries ownership in one of those companies.  Still seems to me to require some excess benefit engineering. 

It was groundbreaking legal engineering when OpenAI (c)(3) got into the joint venture in the first place. It will require  equally groundbreaking legal engineering to get out.    

Darryll k. jones