On April 25, 2013, the IRS released its College and University Compliance Project Final Report, which updates the interim report issued in 2010. The Final Report focuses on the unrelated business income activities and executive compensation paid by colleges and universities throughout the country, but notes that these issues may be present throughout the tax-exempt sector.
The IRS launched its college and university compliance project by distributing a questionnaire to 400 colleges and universities in 2008. The IRS selected 34 of these colleges and universities for examination. Over 90 percent of these audits have been completed. The Final Report provides additional analysis of the questionnaire responses and results of the examinations. Highlights of the Final Report are summarized here.
Unrelated Business Income (UBI) Underreporting
The IRS found that 90% of the colleges and universities audited were underreporting their unrelated business taxable income in an amount nearly equaling $90 million. The IRS disallowed more than $170 million in losses and net operating losses. The underreporting of UBI was primarily due to these four reasons:
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Absence of legitimate business activity due to lack of a profit motive, evidenced by years of sustained losses from the activity;
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improper expense allocation to the UBI activity;
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errors in computation or substantiation of net operating losses; and
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misclassification of related activities. The majority of the activities for which adjustments occurred related to fitness and recreation centers, sports camps, advertising, facility rentals, arenas, and golf activities.
Compensation
The Final Report also provides new information on the results of the IRS examinations of the executive compensation paid by colleges and universities. Because public institutions do not have to provide compensation information to the IRS, only the information from private colleges and universities are included in the report. Here are some of the findings regarding executive compensation from the examined institutions.
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Investment managers, on average, received the highest compensation followed closely by sports coaches;
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The Final Report notes that, to "a large extent," colleges and universities followed practices consistent with meeting the rebuttable presumption of reasonableness in setting compensation for all officers, directors, trustees, and key employees;
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Deficiencies in actually meeting the rebuttable presumption of reasonableness included weaknesses in comparability data (such as including institutions that were not similarly situated) and using compensation surveys that contained data for non-similar institutions and that did not specify whether amounts reported included only salary or also included other types of compensation; and
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Compensation for most positions was set using the 75th percentile, and compensation set at or above the 90th percentage was more common than compensation set in the 50th percentile range.
Outcome of Examinations
The IRS opened several employment tax examinations, which resulted in adjustments for
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Failure to include in income the value of the personal use of automobiles, housing, social club memberships, and travel;
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Misclassification of employees as independent contractors;
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Failure to withhold taxes for wages paid to non-resident aliens; and
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Failure to include in income the value of certain graduate tuition waivers and reimbursements.
The IRS also opened several retirement plan audits, which resulted in wage adjustments for matters such as the current inclusion in income of wages that were not conditioned on the future performance of substantial services (no risk of forfeiture), loans from 403(b) plans that exceeded statutory limits, and deferrals for and additions to 403(b) plans that exceeded statutory limits.
The IRS issued written advisories to 24 institutions for matters such as
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Characterization of income and expenses as related or unrelated;
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Attribution of expenses that are not primarily or proximately related to income; and
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Continuing losses that may indicate a lack of profit motive.
Next Steps
Due to the significant UBI and compensation issues identified, which the IRS notes "may well be present elsewhere across the tax-exempt sector," the IRS plans to focus on both matters. Regarding UBI, the IRS plans to look at UBI reporting more broadly and will focus on recurring losses and expense allocation. Regarding compensation, the IRS, through education and examinations, wants to ensure that tax-exempt organizations are aware of the importance of using appropriate comparability data in setting compensation.
For More Information
If you have questions about this E-Alert and its subject matter, please contact any member of Polsinelli's Nonprofit Organizations practice group or:
