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Not For Profit/Exempt Organizations Blog

IRS Issues Wake Up Call to Colleges and Universities — Congress to Hold Hearings

Posted in IRS Filings

The IRS released its Final Report on its five year study of the audit results of colleges and universities.  Lois G. Lerner, Director of the Exempt Organizations division of the IRS announced the “long awaited” posting of the report.

In 2008, the IRS sent a 33 page questionnaire to 400 randomly selected colleges and universities.  In 2010, the IRS released an Interim Report.  Following review of the responses and Forms 990 and 990-T, the IRS selected 34 schools for audit.  The audits were limited to two specific areas, unrelated business income tax (UBIT) and executive compensation.

The Final report was released on April 25, 2013.  The IRS points out that because the 34 organizations that were audited were not randomly selected, the schools do not represent a statistical sample.

UBIT

The IRS found that:

  • UBIT was underreported at 90% of the colleges and universities examined.
  • The underreported amounts totaled over $90 million.
  • The underreported amounts resulted from 30 different types of unrelated business activities, but the majority of adjustments resulted from only these five activities (in order of frequency):
    • Fitness and recreation centers and sports camps;
    • Advertising;
    • Facility rentals;
    • Arenas; and
    • Golf courses
  • In total, the IRS disallowed more than $170 million in losses and Net Operating Losses.

The IRS concluded that the underreporting of UBIT stemmed primarily from four practices:

  1. Schools claimed losses from activities that did not qualify as a trade or business. The majority of the schools claimed losses from activities where for many years the expenses exceeded income.
  2. Sixty percent of the schools misallocated expenses to offset unrelated business income.  Claimed expenses did not have the necessary connection to the unrelated business activity.
  3. Many schools incorrectly treated income producing activities as not subject to UBIT.
  4. More than a third of the schools reported erroneously calculated or understated Net Operating Losses.

Compensation

IRS experts found that in 20% of the schools, the compensation comparability data was not appropriate data.  The data used was not appropriate because:

  1. Information was used from schools that were not similarly situated.
  2. The compensation studies did not explain the selection criteria nor how the selected schools were similar.
  3. The compensation surveys did not specify whether reported amounts included compensation other than salary.

Not surprisingly, the IRS found that sports coaches and investment managers were the most highly compensated, with an annual average package of almost $900,000.  The average total compensation for top management officials was about $620,000 a year.

The IRS also examined employment taxes and retirement plans for some of the 34 schools.

Employment Taxes – Issues were found in each of the 11 schools examined, resulting in $36 million in increased wages and over $7 million in taxes and penalties.

Retirement Plans – The IRS examined 8 schools and found problems in four, leading to increases in wages of more than $1 million and $200,000 in taxes and penalties.

The IRS plans to look at UBIT reporting more broadly, especially at recurring losses and the allocation of expenses.

On May 1, 2013, Congressman Boustany, chair of the Subcommittee on Oversight of the Committee on Ways and Means announced a hearing set for May 8th and said:

“Given the importance of nonprofit colleges and universities, it is critical that the Subcommittee continue its review of this segment of the tax-exempt sector. The IRS’s colleges and universities compliance project suggests widespread noncompliance. The Subcommittee has an obligation to explore the root of these alarming findings on the audit of our nation’s higher education providers. 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.”