Jill Warren Lucas
Various compliance concerns are specified in the IRS’s final report of the College and Universities Compliance Project, which was announced Thursday at the 30th annual Georgetown Law School Continuing Legal Education Conference, “Representing and Managing Tax Exempt Organizations.” The report is being viewed broadly as an indicator of potential issues across the tax-exempt sector, especially in regard to executive compensation.
The study, which began in 2008, describes the agency’s multi-year project on a major segment of tax-exempt organizations. More than 400 colleges and universities were sent a questionnaire at the start of the project, which ultimately included audits of 34 unnamed academic institutions. The audits included public and private institutions; about two-thirds were large, with 15,000 or more students.
“The audits identified some significant compliance issues at the colleges and universities examined,” said Lois Lerner, Director of the IRS Exempt Organizations division. “Because these issues may well be present elsewhere across the tax-exempt sector, all exempt organizations need to be aware of the importance of accurately reporting unrelated business income and providing appropriate executive compensation.”
Lerner’s complete remarks from Thursday’s conference are available online.
The final report focuses on two primary areas within the examinations: reporting of unrelated business taxable income, and compensation, including employment tax and retirement plan issues.
Unrelated Business Taxable Income
Lerner stated that analysis of unrelated business income (UBI) “routinely” found 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.”
“Because unrelated business taxable income (UBTI) is calculated by totaling the income from all unrelated business activities, and then subtracting total allowable deductions, losses from one activity can offset profits from another,” Lerner said. “For example, if a college earns a lot of unrelated income from one activity, say a parking lot, but takes a big loss on a different unrelated activity, such as a hotel, it can offset the parking lot gains with the hotel losses and end up having no UBTI.”
According to the report’s Executive Summary, examinations of UBTI have resulted in:
- Increases to UBTI for 90 percent of colleges and universities examined totaling about $90 million;
- More than 180 changes to the amounts of UBTI reported by colleges and universities on Form 990-T; and
- Disallowance 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;
- Errors in computation or substantiation; and
- Reclassifying exempt activities as unrelated.
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;
- Arenas; and
Compensation and Comparability Data
Lerner stated that the examinations “focused mainly on compliance with IRC section 4958, which provides that organizations may pay no more than reasonable compensation to their disqualified persons.”
The Executive Summary states that 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; and
- Contemporaneously documenting the compensation-setting process.
Lerner said about 20 percent of the examined schools used inappropriate comparability data, meaning that “the schools failed to meet the requirements of rebuttable presumption of reasonableness.”
“Because of the wide use by the sector of the rebuttable presumption, 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,” she said. “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.”
For the complete report, visit http://www.irs.gov/pub/irs-tege/CUCP_FinalRpt_042513.pdf.