April 25, 2013; Accounting Today

The IRS’s final report on its inquiry into nonprofit colleges and universities documents two troubling areas: 1) underreporting of unrelated business income and underpayment of unrelated business income taxes (UBIT), and 2) problems in the reporting of compensation on institutions’ employment tax returns.

The IRS began by sending inquiry letters to about 400 nonprofit college and universities in 2008. It issued an interim report in 2010 and selected 34 of the 400 respondents for a deeper inquiry, which was documented in the final report.

“The IRS is curious about why there seems to be so much unrelated business activity, yet so few taxes owed,” said Lois Lerner, IRS exempt organizations director. The answers, it turns out, are that the colleges in the study were writing off expenses that were not part of the unrelated business, and that they were claiming unrelated business activities that hadn’t made a profit in several years. (Once a business activity loses money for several years in a row, it ceases to be considered a business by the IRS.) The IRS increased estimates of unrelated business income for 90 percent of the institutions, totaling an additional $90 million in income, while disallowing over $170 million in claimed unrelated business losses. The changes could mean the colleges having to pay an additional $60 million in taxes.

When the IRS turned to examining some colleges’ employment tax returns, it found that all the examined returns required adjustments in wages, resulting in additional taxes owed. In addition, about half of examined returns showed incorrect retirement plan reporting.

While the inquiry results are based on a subset of a small sample of nonprofit colleges and universities in the US, the results are still troubling for the rest of the institutions and for nonprofits generally. How many nonprofits scrupulously—and correctly—document their unrelated business activities and pay the appropriate taxes? How many nonprofits have compensation practices that are sufficiently well-documented and compliant with current IRS regulations on income reporting and tax payments? The final report of the IRS’s “Colleges and Universities Compliance Project” leaves significant cause for challenging comfortable assumptions.—Michael Wyland