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Non-Profit Tax Compliance Alert: IRS Report May Have Implications for Independent Schools

May 1, 2013

IRS Report May Have Implications for Independent Schools

On April 25, 2013, the IRS released its final report from its Colleges and Universities Compliance Project. Begun in 2008, this long-term study concentrated on 34 colleges and universities after the IRS reviewed questionnaire responses and Form 990s from 400 colleges and universities. These 34 institutions were selected because their questionnaires and Form 990s "indicated potential noncompliance." A comprehensive examination of all returns filed by the 34 institutions ensued. In particular, the IRS focused its examination on:

    1. Unrelated business income (UBI), which is the income from a tax-exempt organization’s trade or business that is not substantially related to its tax-exempt purpose.
    2. Compensation paid to officers, directors, trustees and key employees (ODTKE) under § 4958 of the Internal Revenue Code. Private organizations are required to ensure that ODTKE are paid only "reasonable compensation," as defined by tax law. Failure to do so results in the imposition of an excise tax.

In examining the reporting of UBI, the IRS discovered multiple types of errors. In particular, activities that constantly operated at a loss were often misreported as UBI in order to offset actual UBI income. Further, in some instances, actual UBI income was mischaracterized as tax-exempt income from related activities.

Regarding compensation, the IRS concluded that 20% of the private colleges and universities it examined failed to demonstrate that their ODTKE compensation was limited to reasonable compensation. The IRS also found reporting problems with employment taxes, for issues such as failing to include in income certain fringe benefits, failing to withhold taxes for wages paid to non-resident aliens, and failing to include in income the value of certain graduate tuition waivers and reimbursements.

These findings may have implications across the tax-exempt sector, such as independent schools. The IRS has already stated that it plans "to look at UBI reporting more broadly" and "to ensure, through education and examinations, that tax-exempt organizations set compensation appropriately."

We will continue to analyze the impact of the report. If you have any questions, please contact John Yarbrough, at 203-575-2628, or Ann Zucker, at 203-784-3108.