IRS Issues Colleges and Universities Compliance Project Final Report
At long last, the Internal Revenue Service has issued the final report on its Colleges and Universities Compliance Project (CUCP). The Project started in 2008 when the IRS sent a 33-page questionnaire
to 400 colleges and universities – public, private, small, large and medium sized institutions – asking them questions that ranged from the size of the institution to executive compensation practices. An interim report was issued in 2010.
The IRS took a closer examination of 34 selected schools. Upon completion of the examinations, the IRS issued its final report which focuses on two main areas: underreporting of unrelated business taxable income (UBTI) and compensation practices of the selected organizations. Although the focus of the project was colleges and universities, the conclusions of the report are clearly not limited to these institutions. In fact, the IRS Workplan
also contains projects to review the compensation practices and the unrelated business income of organizations where a large amount of gross unrelated business income has been reported on the Form 990, but no unrelated business income tax is due.
Below are the key findings of the IRS’ CUCP Final Report:
Unrelated Business Taxable Income (UBTI):
Underreporting of UBTI resulted in an increase in UBTI for the schools totaling approximately $90 million in the aggregate and disallowance of more than $170 million in losses and net operating losses (NOLs) due to:
- Disallowing expenses that were not connected to unrelated business activities because either consistent losses from the activities pointed to a lack of profit motive, which is a fundamental requirement for an activity to constitute a trade or business. If there is no trade or business, then the activity does not rise to the level of being an unrelated trade or business.
- Improper expense allocations, including where expenses for related activities were used to offset unrelated income or where an allocation of overhead to unrelated activities was unreasonable.
- Errors in computations or substantiation of NOLs.
- Misclassification of an activity as exempt when it was really unrelated.
The main areas that the IRS looked at for UBTI was fitness and recreation centers, sports camps, arenas, golf courses, and advertising and facility rentals – two sources of revenue that are more common to other exempt organizations. For organizations that engage in these activities, documentation is essential and a UBIT study could go a long way to ensure proper reporting before the IRS knocks on the door.
Compensation of the most highly paid executives and staff was also under the microscope, especially coaches, investment managers, faculty and other administrators.
In the compensation area, organizations such as colleges and universities cannot pay more than reasonable compensation to individuals who can substantially influence the organization or the Intermediate Sanctions provisions could apply (IRC 4958). Organizations can establish the “rebuttable presumption of reasonableness” that shifts the burden of proof to the IRS to prove that compensation is unreasonable. In order to establish the rebuttable presumption, an authorized independent body must approve compensation decisions based on appropriate comparability data and contemporaneously document the compensation-setting process. The CUCP Final Report indicates that although most of the private institutions attempted to establish the rebuttable presumption, the comparability data fell short of what was required as a result of the following:
- Schools were not similarly situated based on factors such as location, size of endowment, revenue, total net assets or number of students.
- Compensation studies did not document the selection criteria for the schools compared or why the schools were deemed comparable.
- The compensation studies relied upon did not specify whether the compensation amounts included benefits other than salaries, which must be taken into account for purposes of IRC 4958.
So it sounds like some compensation studies may be deficient.
The IRS also reviewed employment taxes and retirement plans of the colleges and universities. As a result of the project, there were wage adjustments totaling approximately $36 million and resulting taxes and penalties of $7 million. Also, with regard to retirement plan adjustments, there were increases in wages of more than $1 million and the assessment of more than $200,000 in taxes and penalties.
Coming at the heels of the CUCP Final Report, the Subcommittee on Oversight of the Committee on Ways and Means announced that they will be holding a hearing on May 8th to explore the root of the report’s findings and examine the causes for the widespread noncompliance. Check back for additional posts on the outcomes of the Ways and Means hearing.
If you have a comment or question about the CUCP Final Report, please comment below or send me an email at email@example.com.