IRS Investigation of Colleges and Universities Reveals UBIT and Compensation Issues

Read about IRS tax compliance problems related to UBIT and compensation found at colleges and universities.

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The IRS recently announced completion of a five-year long compliance project involving tax-exempt colleges and universities. The project focused on reporting of executive compensation and unrelated business income. The IRS sent questionnaires to 400 colleges and universities and then selected 34 schools to audit. The agency's findings in its final report are not pretty.

UBIT Underreporting

First, the IRS found that 90% of the colleges and universities made money from businesses unrelated to their educational missions that they should have paid taxes on. This included income from art galleries, hotels, conference centers, radio stations, parking lots, arenas, and recreation centers.

The institutions avoided paying such taxes--called Unrelated Business Income Tax (UBIT)--through a variety of means including taking losses they shouldn't have, misallocating expenses, and claiming losses for activities that were not businesses. (To learn how to avoid paying Unrelated Business Income Taxes legally, see Nolo's article, How to Avoid UBIT Taxes.)

The IRS ended up making more than 180 adjustments in the institutions' returns, totaling about $90 million.

Compensation

The IRS also reviewed the compensation the colleges and universities paid to their officers, directors, trustees, and key employees (ODTKEs) to determine if it was reasonable. Various excise taxes can be imposed on ODTKEs who are paid unreasonably high compensation. Such taxes can also be imposed on those who approved the compensation. All forms of cash and non-cash compensation (such as salary, bonuses, severance payments, deferred compensation, and fringe benefits) must be taken into account to determine whether compensation is reasonable.

The IRS found that the president was the highest paid ODTKE at most of the institutions. The average base salary for the highest paid ODTKE was $448,981, with total compensation averaging $561,135. The IRS also looked at compensation paid to non-ODTKEs, including sports coaches, investment managers, department heads, faculty, and administrators. Coaches and investment managers were the highest paid non-ODTKEs, with annual average compensation of almost $900,000.

The IRS found that the institutions underreported the taxable income they paid the ODTKEs and others it examined by over $35 million, resulting in more than $7 million in additional employment taxes and over $167,000 in penalties.

One common problem was failure to include in income the value of the personal use of automobiles, housing, social club memberships, and travel. Some employees were misclassified as independent contractors (find out how the IRS classifies this in Nolo's article, Independent Contractor or Employee). There were also problems with the retirement plans at a quarter of the colleges and universities.

Finally, the procedures used at about 20% of the schools to determine and approve compensation for ODTKEs were not up to snuff. The main trouble involved using comparable salary data from other educational institutions to help set compensation. Some schools used salary data from institutions that were not comparable in key areas such as endowment size, revenues, and overall size. Others failed to document the selection criteria they used to choose the comparable schools.

May 2013

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