IRS Releases Final Colleges and Universities Compliance Report: Reveals Significant Underreporting

by Saul Ewing LLP
Contact

Summary

A recent report of the IRS’ Exempt Organizations (EO) division provides the results of a multi-year audit of tax-exempt colleges and universities regarding their compliance with IRS reporting requirements. The report focuses on three areas of concern for EO: underreporting of unrelated business income; executive compensation; and employment tax and retirement plan returns.

On April 25, 2013, Exempt Organizations Director Lois G. Lerner announced the release of the IRS’ Colleges and Universities Compliance Project Final Report at an annual conference in Washington, D.C. sponsored by Georgetown University. In 2008, the IRS’ EO division launched a multi-year project with the distribution of detailed questionnaires to 400 colleges and universities and the subsequent audit of 34 selected institutions.

In 2010, EO released an Interim Report with a preliminary overview of the questionnaire responses. The Final Report focuses on the exam results and provides additional analysis of the questionnaire responses. Lerner cited the study as an example of the long-term compliance projects EO will undertake, and her remarks focused on three primary areas of concern: (1) underreporting of unrelated business income (UBI), (2) executive compensation, and (3) employment tax and retirement plan returns.

Unrelated Business Income

IRS staff “routinely find that exempt organizations offset most of their UBI with deductions, and that only about half of organizations required to file a 990-T report any tax liability,” Lerner said in her remarks. According to the Final Report, UBI was underreported at 90 percent of the colleges and universities examined, with underreported amounts totaling over $90 million. The majority of audit adjustments resulted from five types of unrelated business activities:

  1. fitness and recreation centers and sports camps
  2. advertising
  3. facility rentals
  4. arenas
  5. golf courses

In total, the IRS disallowed more than $170 million in losses and net operating losses (NOLs), which could result in more than $60 million in tax liability for the impacted organizations.

The Final Report attributes underreporting of UBI to several recurring practices -- the most common practice, by far, is claiming losses from activities that do not qualify as a trade or business. “Nearly 70% of examined colleges and universities reported losses from activities where for many successive years the expenses exceeded income,” Lerner reported. Lerner further explained that continual losses from an activity for a protracted period indicates a lack of profit motive required for an activity to qualify as a trade or business. Because the examined activities did not qualify as a trade or business, the losses claimed for those activities could no longer be used to offset profits from other unrelated activities in current or future years. Accordingly, EO disallowed more than $150 million in losses and NOLs reported by the institutions under examination. Lerner also attributed underreporting of UBI to misallocated expenses (where expenses did not have the proximate and primary connection to the unrelated business activity); misclassification of certain income producing activities as exempt activities; and to erroneously calculated or unsubstantiated NOLs.

Executive Compensation

With respect to compensation, the examinations focused mainly on compliance with Internal Revenue Code § 4958, which prohibits private colleges and universities from paying unreasonable compensation to their officers, directors, trustees and key employees. An organization can shift the burden of proving unreasonable compensation to the IRS by adhering to the rebuttable presumption process, as follows:

  1. using an independent body to review and determine the amount of compensation;
  2. relying on appropriate comparability data to set the compensation amount; and
  3. contemporaneously documenting the compensation-setting process.

“Experts found that, in about 20% of the examined schools, the comparability data used to set compensation was not appropriate data, which means the schools failed to meet the requirements of rebuttable presumption of reasonableness,” according to Lerner. Problems with compensation data included:

  • use of information from schools that were not similarly situated;
  • compensation studies that neither specified the selection criteria for the supposed comparable schools nor explained how those schools were like the school relying on the study; and
  • compensation surveys that did not specify whether amounts reported included only salary or included other types of compensation, as required by Code § 4958.

“I want to stress the need for organizations to review and question the data provided by consultants or others before relying on it to determine compensation amounts. Otherwise, an organization may find itself outside of the rebuttable presumption, and be required to prove to the IRS that the compensation in question is reasonable,” Lerner emphasized.

Employment Tax and Retirement Plans

In addition to looking at Forms 990 and Form 990-T, EO reviewed employment tax returns for about a third of the colleges and universities examined and found issues at all of them, resulting in about $36 million in increased wages and over $7 million in taxes and penalties. On the retirement plan front, EO looked at reporting of about a quarter of the colleges and universities examined and found problems at about half of them. Examinations resulted in increases in wages of more than $1 million and the assessment of more than $200,000 in taxes and penalties.

The full text of EO Director Lerner’s remarks are available here.

The Final Report is available here.

Members of Saul Ewing’s Tax Practice can help you determine what this report means for you and your organization. For more information, contact the authors or the Saul Ewing attorney with whom your normally work.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Saul Ewing LLP | Attorney Advertising

Written by:

Saul Ewing LLP
Contact
more
less

Saul Ewing LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!