The Internal Revenue Service has identified several potential problems with tax-code compliance in the first of two expected reports on how colleges conduct their business.
The report, which was made public on Friday, is based on a 42-page survey the agency sent in late 2008 to 400 public and private colleges of varying sizes. The survey asked the institutions to disclose details of their finances, such as whether their many business ventures were turning a profit and what kind of perks they provided their executives. The goal of the questionnaire, IRS officials have said, is to examine potential discrepancies between colleges’ financial activities and what they report to the government.
The main concerns of this initial study is primarily on how institutions report income from the businesses they control and how they set compensation for their key employees, said Bertrand M. Harding Jr., a tax lawyer specializing in colleges and other nonprofit organizations.
The agency said it has already begun audits of more than 30 institutions based on their responses to the survey. Thirteen institutions that did not respond to the IRS questionnaire are also being examined, as well as an undisclosed number of colleges that did not answer all of the questions, the agency stated. The IRS has not identified the institutions that were sent the questionnaire nor the colleges that are being audited.
Unreported Business Activities
One key issue the IRS has identified through the survey is that many public and private institutions are involved in business activities that they are not reporting as taxable income to the federal government.
For example, 45 percent of the large colleges, with more than 15,000 students, that participated in the survey reported a controlling interest in separate for-profit businesses, such as a company to develop commercial applications for research, or nonprofit organizations, such as a foundation. But among that group, only 26 percent reported receiving any income from such an entity.
“While there may be cases in which organizations had no reportable income, the difference may suggest a possible reporting inconsistency that will be reviewed further,” the report says.
The IRS is also interested in how institutions report their profits or losses on enterprises like facility rentals, bookstores, and food services. While some of those enterprises may be completely exempt from taxes—if they are related to the core mission of the college or if the activity loses money, for example—the survey found that nearly half of the small colleges responding to the survey had never filed the appropriate tax forms reporting any such activities.
Most of the institutions surveyed also are not seeking out expert advice to determine whether to report those activities, the agency found. More than 60 percent of all the colleges responding to the survey reported that they did not rely on independent accountants or the college’s general counsel on such matters.
Questions on Compensation
Another issue that has piqued the agency’s interest is how private colleges set the salaries for their top employees, such as presidents and chancellors. Private institutions can be subject to a tax penalty if they pay key employees amounts above what is comparable for similar positions at similar organizations. Forty-five percent of small colleges and 38 percent of the largest institutions in the survey reported not using the IRS’s suggested procedures for setting the compensation of their highest-paid employees.
The IRS also noted that it is concerned that too few private colleges are using an independent survey of comparable institutions to determine salaries.
The IRS will issue a final report with a more-detailed analysis of the answers to the questionnaire after it completes the current round of audits it is conducting on colleges, Lois G. Lerner, director of the IRS’s Exempt Organizations Division, said on Friday at a meeting of the Section of Taxation of the American Bar Association.
