IRS Opens Investigation Into College Retirement Plans

May 27, 2011

For the second time in three years, the Internal Revenue Service is investigating colleges for possible tax-code violations.

Late in April, the agency announced that it would send a questionnaire to a random national sampling of 300 public and private colleges of various sizes across the country to determine how well the institutions are complying with federal rules on tax-deferred retirement savings accounts, called 403(b) plans.

The IRS says it is seeking any evidence that the retirement plans offered by colleges discriminate "in favor of highly compensated employees." Under federal rules, all employees at an institution must generally be allowed to participate if such a retirement savings plan is offered.

The agency's concern is that while a college may make such a plan available to most workers, lower-paid employees might be improperly excluded. The issue, the IRS notes, is typically high on the agency's top-10 list of problems.

Problems with 403(b) retirement plans are frequently identified in the course of audits of colleges, said David L. Raish, a lawyer at Ropes & Gray, in Boston, who specializes in the area of deferred compensation, including retirement plans. "I think they're right," he said of IRS officials, "there's a lot of mistakes made in this area."

Institutions frequently trip up when they try to take advantage of exceptions in the regulations, Mr. Raish said, for example by excluding part-time employees. Those workers can be exempted from participating only if they work fewer than 20 hours per week, he said.

Retirement plans also can run afoul of the tax code by seeking to exclude a certain category of employee, such as groundskeepers or janitorial staff members, he said. "Our advice is not to use any of the exceptions," he said.

Another focus of the IRS's questionnaire is whether all colleges have a written document detailing the terms of their plan and how the institution is meeting regulatory and statutory requirements. Until the rules changed, in 2009, many colleges did not need such a written plan, Mr. Raish said.

Another Questionnaire

The notice from the tax agency has a familiar ring to it. Late in 2008 the IRS announced that it was sending out questionnaires to 400 colleges to look into a wide variety of financial data, including what they spent on perks like housekeeping services for executives, and their income and losses on business activities like catering services and travel tours.

While the IRS said it was seeking more information on the financial activity and tax-reporting practices of colleges, the 2008 questionnaire turned into much more than an academic exercise. In addition to identifying several problems with how colleges set executive compensation and report their outside business activity, the IRS began audits of more than 30 colleges based on their responses to the questionnaire. Thirteen institutions that did not respond to the questionnaire are also being examined, as well as an undisclosed number of colleges that did not answer all of the questions, the agency stated.

A final report on the results of the 2008 questionnaire will not be released until the IRS completes all of the audits resulting from that inquiry.

In the latest instance, problems identified by the IRS will not result in an audit but "will give higher-education organizations the chance to identify problems with their plans and to correct them on their own."

But not answering the questions could lead to bigger problems, the agency warned: "Failure to provide the information requested could result in further action or examination of your plan."