Colleges and Universities Compliance Project final report posted to IRS website
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The IRS launched the Colleges and Universities Compliance Project in 2008 with the distribution of detailed questionnaires to 400 randomly selected colleges and universities. The IRS subsequently selected 34 of the 400 questionnaire respondents for examination because their questionnaire responses and Form 990 reporting indicated potential noncompliance in the areas of unrelated business income (UBI) and executive compensation.
The final project report was issued after more than 90 percent of these examinations had been completed. It provides additional analysis of the questionnaire responses and focuses on the examination results. Because the IRS did not randomly select colleges and universities for examination, no conclusions should be drawn about the UBI and compensation practices of other colleges and universities based on the examination results.
Executive summary from the final report
Examination highlights: Underreporting of unrelated business taxable income (UBTI)
Unrelated business income (UBI) is the income from a trade or business regularly conducted by an exempt organization and not substantially related to its exempt purpose. Unrelated business taxable income (UBTI) is the UBI that is taxable after deducting expenses directly connected to the trade or business. Because UBTI is calculated by totaling the UBI from all activities and subtracting the total allowable deductions, losses from one activity can offset profits from another. Examinations resulted in:
- Increases to UBTI for 90 percent of colleges and universities examined, totaling approximately $90 million
- Over 180 changes to the amounts of UBTI reported by the colleges and universities on Form 990-T
- Disallowances of more than $170 million in losses and net operating losses (NOLs) (i.e., losses reported in one year that are used to offset profits in other years), which could amount to more than $60 million in assessed taxes
The primary reasons for increases to UBTI in the completed exams were:
- Disallowing expenses that were not connected to unrelated business activities: The IRS found that examined colleges and universities were reporting certain losses as connected to unrelated business activities when they were not. The misreporting occurred in two ways:
- Lack of a profit motive: The IRS found that organizations were claiming losses from activities that did not qualify as a trade or business. Nearly 70 percent of examined colleges and universities reported losses from activities for which expenses had consistently exceeded UBI for many years. UBI must be generated by a trade or business. An activity qualifies as a trade or business only if, among other things, the taxpayer engaged in the activity with the intent to make a profit. A pattern of recurring losses indicates a lack of a profit motive. The IRS disallowed reporting of activities for which the taxpayer failed to show a profit motive. Those losses no longer offset profits from other activities in the current year or in future years, with more than $150 million of NOLs disallowed.
- Improper expense allocation: The IRS also found that on nearly 60 percent of the Form 990-Ts examined, colleges and universities had misallocated expenses to offset UBI for specific activities. Organizations may allocate expenses that are used to carry on both exempt and unrelated business activities, but they must do so on a reasonable basis and the expenses offsetting UBI must be directly connected to the UBI activities. In many cases, the IRS found that claimed expenses, which generated losses, were not connected to the unrelated business activity.
- Errors in computation or substantiation: The IRS checked the calculations for all NOLs reported on returns under examination and found that NOLs were either improperly calculated or unsubstantiated on more than a third of the returns. As a result, the IRS disallowed nearly $19 million in NOLs.
- Reclassifying exempt activities as unrelated: The IRS determined that nearly 40 percent of colleges and universities examined had misclassified certain activities as exempt or otherwise not reportable on Form 990-T. Fewer than 20 percent of these activities generated a loss. The examinations resulted in the reclassification of nearly $4 million in income as unrelated, subjecting those activities to tax.
Examinations resulted in more than 180 changes to UBTI reported for specific activities by colleges and universities. More than 30 different activities were connected to the changes. The majority of these adjustments came from the following activities:
- Fitness, recreation centers and sports camps
- Facility rentals
Compensation and comparability data
The executive compensation component of the examinations focused mainly on compliance with section 4958, which provides that organizations may pay no more than reasonable compensation to their disqualified persons, i.e., their officers, directors, trustees and key employees (ODTKEs). Section 4958 applies to private, but not public, colleges and universities and imposes an excise tax on ODTKEs who received payment of unreasonable compensation, as well as on those persons who approved it.
An organization may shift the burden of proving unreasonable compensation to the IRS by following the three steps of the rebuttable presumption process:
- Using an independent body to review and determine the amount of compensation
- Relying on appropriate comparability data to set the compensation amount
- Contemporaneously documenting the compensation-setting process
Although most private colleges and universities examined attempted to meet the rebuttable presumption standard, about 20 percent of them failed to do so because of problems with their comparability data, including:
- Reliance on data from institutions that were not similarly situated with respect to at least one of the following factors: location, endowment size, revenues, total net assets, number of students, and selectivity.
- Production of compensation studies that neither documented the selection criteria for the schools included nor explained why those schools were deemed comparable to the school relying on the study.
- Use of compensation surveys that did not specify whether amounts reported included only salary or included total other types of compensation, as required by section 4958.
Compensation amounts: ODTKEs
With few exceptions, each college or university examined identified its top management official, who was usually the president, as its highest-paid ODTKE, i.e., employees covered by section 4958. Overall, the average and median base salary and total compensation for the top management official of the colleges and universities examined, both public and private, were as follows:
- Average base salary: $448,981; median base salary, $363,943
- Average total compensation: $561,135; median total compensation, $458,152
Highly compensated non-ODTKEs
Although the examinations primarily focused on ODTKEs, the IRS also looked at compensation levels for the most highly compensated non-ODTKEs. The most highly paid non-ODTKEs fell primarily into one of five categories: sports coaches, investment managers, heads of department, faculty, and administrative or managerial. As shown below, sports coaches and investment managers received the highest average compensation at the colleges and universities examined.
Compensation amounts for non-ODTKEs in the remaining categories differed based on whether or not the non-ODTKE was a medical doctor. The second column below excludes the compensation paid to medical doctors, who comprise 30 percent of ODTKEs reported in the first column. The most highly paid non-ODTKEs positions were as follows:
|Position||Average compensation||Average compensation(excluding M.D.s)|
|Heads of department||$753,738||$229,770|
|Administrative or managerial||$462,872||$381,745|
Employment tax and retirement plans
In addition to examining Forms 990 and 990-T with a focus on UBI and compensation, the IRS also reviewed employment tax and employee plan returns. These reviews covered employment tax and employee plan issues for all employees, not just for ODKTEs and the highest-paid non-ODTKEs.
Employment tax issues
- The IRS looked at employment tax returns of about a third of the colleges and universities examined.
- All the completed exams resulted in adjustments in wages, leading to the assessment of tax and, in some cases, penalties.
- Wage adjustments totaled about $36 million, while taxes and penalties amounted to over $7 million.
Retirement plan issues
The IRS looked at retirement plan reporting of about a quarter of the colleges and universities examined and found problems at about half. These examinations resulted in wage increases of more than $1 million and the assessment of more than $200,000 in taxes and penalties.
The report highlights key differences between the interim report and the final report, highlights the limitations of the data, includes a complete summary of IRS examination results, highlights in the unrelated business income area the explanation that in 90 percent of the examinations completed there was an increase to unrelated business taxable income, summarizes the main reasons for the increases to taxable income on Form 990-T for 90 percent of those colleges and universities examined, explains the compensation focus and issues with compensation measurement, summarizes items missed on W-2 reporting, and provides statistics in all related areas, including measurement of endowments.
There is a wealth of valuable information housed in the final report, titled IRS Releases Final Report on Tax-Exempt Colleges and Universities Compliance Project.
James Sweeney, Partner, Vienna,Va.
The information contained herein is general in nature and based on authorities that are subject to change. RSM LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
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