noted in last month’s issue, April 25 brought issuance of the IRS’s
final report on its colleges and universities compliance-check project,
launched in 2008 (summarized in the December 2008 issue). The IRS in
that year distributed detailed questionnaires to 400 randomly selected
private and public institutions of higher education. Thirty-four of
these institutions were selected for examination. An interim report was
published in 2010 (summarized in the July 2010 issue).
final report provides additional analyses of the questionnaire
responses and focuses on the examination results. The IRS wrote:
“Because colleges and universities were not randomly selected for
examination, no assumptions should be drawn about the UBI [unrelated
business income] and compensation practices of other colleges and
universities based on the examination results.”
Underreporting of Unrelated Business Taxable Income
IRS examinations have resulted in the following outcomes:
are several reasons for the increases in UBTI. One of them found by the
IRS is that examined colleges and universities were reporting certain
losses as being connected to unrelated businesses when they were not.
There are two causes of this misreporting.
One of these causes is the rule that losses can only be utilized where the activity involved is a business. The existence of a business, for tax-law purposes, requires a profit motive.
A pattern of recurring losses indicates a lack of profit motive. Nearly
70 percent of examined colleges and universities reported losses from
activities for which expenses consistently exceeded unrelated income for
many years. These disallowances amounted to more than $150 million of
the total losses disallowed.
may allocate expenses that are used to carry on both exempt and
unrelated businesses, but these allocations must be reasonable and the
expenses allocated to unrelated business income must be directly connected to
the unrelated business. The IRS found that, on nearly 60 percent of
examined Forms 990-T, colleges and universities had misallocated
IRS determined that nearly 40 percent of the colleges and universities
examined misclassified activities as exempt or otherwise not reportable
on Forms 990-T. These examinations resulted in reclassification of
nearly $4 million as unrelated income.
IRS checked the calculations for all net operating losses reported on
these returns under examination and found that they were either
improperly calculated or unsubstantiated on more than one-third of the
returns. The IRS disallowed nearly $19 million in net operating losses.
resulted in changes to UBTI reported for specific activities of
colleges and universities, primarily fitness and recreation centers,
sports camps, advertising, facility rentals, arenas, and golf-related
Compensation and Comparability Data
of the private colleges and universities that were examined attempted
to meet the rebuttable presumption of reasonableness in ascertaining the
reasonableness of compensation, although about 20 percent of them
failed in the exercise due to problems with their comparability data,
report differentiates between compensation paid by colleges and
universities to officers, directors, trustees, and key employees
(ODTKEs) and non-ODTKEs.
Each college or university examined generally identified its top management official,
who was usually the president, as its highest-paid ODTKE. Overall, the
average and median base salary and total compensation for the top
management official of the colleges and universities examined, public
and private, were as follows:
most highly paid non-ODTKEs were those in one of five categories:
investment managers, sports coaches, heads of departments, faculty, and
administrative/managerial positions. The average compensation for
investment managers was $894,214, while the average compensation for
coaches was $884,746.
amounts for the other non-ODTKEs differed based on whether the
non-ODTKE was a medical doctor (who comprised 30 percent of the
non-ODTKEs). Including MDs, the average compensation for department
heads was $753,738, faculty was $575,632, and administrative/managerial
personnel was $462,872. 
Employment Tax Issues
IRS looked at employment tax returns at about one-third of the colleges
and universities examined. All of the completed examinations have
resulted in adjustments in wages, leading to assessment of taxes and, in
some instances, penalties. Wage adjustments totaled about $36 million;
taxes and penalties amounted to over $7 million.
IRS reviewed retirement-plan reporting at about 25 percent of the
colleges and universities examined, finding problems at about one-half
of them. These examinations resulted in increases in wages of more than
$1 million, along with assessment of more than $200,000 in taxes and
IRS’s Look Ahead
IRS observed that these examinations of colleges and universities
“identified some significant issues with respect to both UBI and
compensation that may well be present elsewhere across the tax-exempt
sector.” As a result, the IRS reported, it “plans to look at UBI
reporting more broadly, especially at recurring losses and the
allocation of expenses, and to ensure, through education and
examinations, that tax-exempt organizations are aware of the importance
of using appropriate comparability data when setting compensation.”
report understates a most important point, which is that these matters,
such as claiming losses from nonbusiness activities, misallocation of
expenses, and use of inappropriate comparability data, are by no means
confined to colleges and universities. These are problem areas
throughout the exempt sector. In some quarters, institutions of higher
education are being singled out and unfairly criticized as if these
tax-law issues are unique to them.
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