The Internal Revenue Service released its final report Thursday summarizing its audits of tax-exempt colleges and universities and found that many of them underreport taxable income from their unrelated businesses.
The final report focuses on two main areas under examination: reporting of unrelated business taxable income and compensation, including employment tax and retirement plan issues.
The IRS found increases to unrelated business taxable income for 90 percent of the colleges and universities examined, totaling about $90 million. There were over 180 changes to the amounts of unrelated business taxable income reported by colleges and universities on Form 990-T; and disallowance of more than $170 million in losses and net operating losses that could amount to more than $60 million in assessed taxes.
“Each year, IRS Statistics of Income staff analyze Forms 990-T, the form on which exempt organizations report gross [unrelated business income] of $1,000 or more,” IRS exempt organizations director Lois Lerner said in a speech Thursday at Georgetown University where she presented the results of the report. “They routinely find 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 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. 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. The IRS is curious about why there seems to be so much unrelated business activity, yet so few taxes owed. We decided to look at this issue in the colleges and universities exams.”
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 IRS also found that organizations were claiming losses from activities that did not qualify as a trade or business. Nearly 70 percent of the examined colleges and universities reported losses from activities for which expenses had consistently exceeded unrelated business income for many years.
“Continual losses from an activity year in and year out for a protracted period indicates a lack of profit motive,” said Lerner. “Because the activities involved did not qualify as a trade or business, the claimed losses could no longer be used to offset profits from other unrelated activities in the current year or in future years, which resulted in the disallowance of about $150 million in losses and NOLs.”
The IRS also found that on nearly 60 percent of the Form 990-Ts examined, colleges and universities had misallocated expenses to offset unrelated business income for specific activities.
The IRS checked the calculations for all the net operating losses 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.
The IRS also determined that nearly 40 percent of colleges and universities it 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 unrelated business taxable income 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 activities such as fitness, recreation centers and sports camps; advertising; facility rentals; arenas; and golf.
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 high, with an average base salary of $448,981 and a median base salary of $363,943. The average total compensation was $561,135, while the median total compensation was $458,152.
The most highly paid people who were not considered to be officers, directors, trustees or key employees fell primarily into one of five categories: sports coaches, investment managers, head of departments, faculty and administrative/managerial. Sports coaches and investment managers received the highest average compensation at the colleges and universities examined. For investment managers, the average compensation was $894,214, while for sports coaches it was $884,746.
Employment Tax and Retirement Plan Problems
The IRS also looked at employment tax returns at about a third of the colleges and universities examined. All of the completed exams have resulted in adjustments in wages, leading to assessments of tax and, in some cases, penalties. Wage adjustments totaled about $36 million, while taxes and penalties amounted to over $7 million.
In addition, the IRS looked at retirement plan reporting at about a quarter of the colleges and universities examined and found problems at about half of them. These examinations have resulted in increases in wages of more than $1 million and the assessment of more than $200,000 in taxes and penalties.
The IRS study of tax-exempt colleges and universities, known as the Colleges and Universities Compliance Project, first began in 2008. The IRS distributed detailed questionnaires to 400 randomly selected colleges and universities and then selected 34 of the 400 for examination because their questionnaire responses and Form 990 reporting indicated potential noncompliance in the areas of unrelated business income and executive compensation. The IRS released an interim report in 2010 that focused on results from the questionnaires submitted by tax-exempt colleges and universities.