IRS Releases Final Report for Colleges and Universities Compliance Project
Author: Kristin Tynon
In 2008, the IRS began the Colleges and Universities Compliance Project. Four hundred randomly selected colleges and universities were issued detailed questionnaires to complete and return to the IRS. After receiving the completed questionnaires, the IRS selected 34 of the 400 organizations for examination due to their responses and Form 990 reporting. These examinations were equally divided between private and public institutions, and approximately two-thirds of the institutions had 15,000 or more students.
The final report on these exams recently issued by the IRS summarizes questionnaire responses, issues addressed and examination results. Examinations focused on compliance in these areas:
- Unrelated business income
As tax-exempt organizations, colleges and universities are not taxed on income from activities substantially related to the accomplishment of the organization’s exempt purpose. They are, however, subject to tax on income from unrelated trade or business activities. The 34 organization exams resulted in more than 180 changes to unrelated business taxable income (UBTI) reported by the colleges and universities, leading to increases in UBTI for 90 percent of those examined and totaling approximately $90 million. In addition, $170 million in losses and net operating losses also were disallowed. These activities were associated with more than half of the adjustments made:
- Fitness, recreation centers and sports camps
- Facility rentals
- Golf courses
Here are the main reasons for increases to UBTI:
- Disallowing expenses not connected with unrelated business activities
- Errors in computation or substantiation of net operating losses
- Reclassifying exempt activities as unrelated
Expenses were generally disallowed for one of two reasons. First was a lack of profit motive. An activity cannot qualify as a trade or business unless, among other things, there is a profit motive. With the exclusion of many of these profit-lacking activities from unrelated business income, organizations no longer had losses to offset profits from other activities. In addition, the IRS found that expenses had been misallocated to offset unrelated business income on approximately 60 percent of the 990-Ts examined.
The executive compensation portion of the examinations focused mainly on compliance with IRC Section 4958, which states that organizations may pay no more than reasonable compensation to disqualified persons. Section 4958 imposes an excise tax on both disqualified persons who receive payment of unreasonable compensation and those who approved the payment. This section applies only to the private colleges and universities examined.
By meeting the rebuttable presumption standard, organizations can shift the burden of proving unreasonable compensation to the IRS. However, 20 percent of the private colleges and universities examined failed to meet the rebuttable presumption standard, due mainly to problems with comparability data.
In addition to addressing Section 4958, the IRS also opened employment tax exams at 11 of the colleges and universities. These examinations addressed reporting issues for both public and private colleges and universities for all employees—not just officers, directors, trustees and key employees. The employment tax exams resulted in increases to wages of approximately $36 million, generating more than $7 million in related taxes and penalties. Wages were adjusted in these exams for a number of reasons, including:
- Failure to include in income the value of personal use of automobiles, housing, social club memberships and travel
- Misclassification of employees as independent contractors
- Failure to withhold taxes for wages paid to nonresident aliens
- Failure to include in income the value of certain graduate tuition waivers and reimbursements
At the time of the report, 31 of the 34 examinations had been closed with the majority of exams resulting in adjustments to returns. The IRS also issued written advisories to 24 of the institutions regarding activities that could result in tax liability in the future.
As increased scrutiny is placed on tax-exempt organizations, it is becoming increasingly important for organizations to take a closer look at their compliance efforts, especially in the areas specifically addressed in the recent examinations. In addition, organizations should carefully review their Form 990 to ensure it accurately reflects the activities, policies and procedures of their organization, as the IRS plans to continue monitoring the areas of UBTI and compensation.
A complete copy of the final report can be downloaded on the IRS website. If you have any additional questions, please contact your BKD advisor.