Colleges and Universities Take Note: IRS Compliance Check Leads to Congressional Scrutiny

The report is based on responses the IRS received from the compliance check questionnaires it sent to 400 colleges and universities and on the results of the 34 examinations that followed the survey. Read more about the IRS Colleges and Universities Compliance Project here on the IRS Website.

According to the report, the top compliance issues for colleges and universities concern 1) the reporting of unrelated business taxable income (UBTI) and 2) compensation practices. Here are the highlights . . .

Expect More Scrutiny

Congressman Charles W. Boustany, Jr., M.D., (R-LA), Chairman of the Subcommittee on Oversight of the Committee on Ways and Means, announced on May 1 that the Subcommittee will hold a hearing on the report.

Boustany noted that “it is critical that the Subcommittee continue its review of this segment of the tax-exempt sector… The Subcommittee has an obligation to explore the root of these alarming findings. . . This hearing is an excellent opportunity to discuss the results of the compliance project and examine areas for improvement in oversight, with an eye toward comprehensive tax reform.” [emphasis added] (Click here for the press release.)

UBTI Issues

The IRS reports that its examinations of colleges and universities led to an increase in the amount of unrelated business taxable income (UBTI) for 90% of the colleges and universities examined – the uptick in taxable income totalled about $90 million.

Note: because – as the IRS notes – these examinations were not randomly conducted, and instead colleges and universities were chosen for examinations based on their responses to the questionnaires and their IRS Forms 990, these results are not necesarily representative of other colleges and universities. Even so, the IRS seems intent on focusing on these issues for future examinations of colleges and universities, and on the exempt sector at large (see parting words below).

In its report, the IRS explains the issues that generally led to the adjustments: 1) the colleges and universities were deducting expenses that were not connected to unrelated business activities; 2) the colleges and universities were making computation and substantiation errors; and 3) the colleges and universities were improperly taking the position that certain actvities were related activities (and therefore could not give rise to UBTI).

Not surprisingly, the adjustments occurred mostly with respect to the following activities: fitness, recreation centers, and sports camps; advertising; facilty rentals; arenas; and golf.

Compensation Practices

The IRS notes in its executive summary of the report that most of the private colleges and universities examined made attempts to meet the rebuttable presumption standard (this is the standard that allows private colleges and universities to follow certain procedures when setting compensation for officers, directors, trustees, and key employees so that they may shift the burden on the IRS to prove that compensation set by the college or university is unreasonable for purposes of IRC 4958, the section of the Internal Revenue Code that imposes penalties on those who receive and approve unreasonable compensation).

Despite efforts made, about 20% of private colleges and universities failed to meet the rebuttable presumption standard, generally because of problems related to their comparability data, documentation, and lack of attention to detail.

The executive summary to the report also notes that the IRS looked at employment tax returns for about a third of the colleges and universities examined and at the retirement plan reporting of about a quarter of the colleges and universities examined – the IRS noted that all of the completed exams have resulted in adjustments in wages, leading to assessment of tax (and in some cases penalties) and that there were also retirement plan reporting problems at about half of the colleges and universities examined.

Parting Words (Where the IRS is headed)

The executive summary to the report gives a clear indication of where the IRS focus remains for colleges and universities and the rest of the exempt sector:

“The examinations of college and universities identified some significant issues with respect to both UBI and compensation that may well be present elsewhere across the tax-exempt sector. As a result, the IRS plans to look at UBI reporting more broadly, especially at recurring losses and the allocation of expenses, and to ensure, through education and examinations, that tax-exempt organizations are aware of the importance of using appropriate comparability data when setting compensation.” [emphasis added]

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