IRS Starts University Audits

January 29, 2010

The IRS is now examining 40 colleges and universities. Approximately 400 colleges and universities received compliance questionnaires in October 2008 focusing on such issues as unrelated trade or business income, endowments, and executive compensation issues. A comprehensive list of questions and the check sheet can be found on the IRS website.

Compliance Questionnaire

The IRS said that the 33-page questionnaire would gather information from the colleges and universities about how they report revenues and expenses from trade or business activities, and how they classify these activities as either exempt or taxable in reporting income and losses. The questionnaire also gathered information on how these schools invest and use their endowment funds. Significantly, at the urging of congressional leaders, information was requested on how these institutions determine the compensation of highly paid individuals.

Current Audits

The two universities identified as under audit are Harvard University and Suffolk University. While it is unknown what responses triggered these examinations, Harvard disclosed last week in a bond offering document that it is being audited. Harvard is selling $480 million of tax-exempt securities to pay for an expansion of its law school and other capital projects, as well as a refinancing of existing debt. Compensation may be at issue in Suffolk’s audit. Its president, David Sargent, was paid $1.5 million in 2008 – the second highest paid private university president.

The IRS has not commented on the reasons for the audits. But it previously indicated that using comparables from third-party organizations that set their executive salaries using the initial contract exception may result in improper skewing of the comparables. It has also questioned the propriety of using comparables from for profit entities. The IRS initially raised these concerns in the context of hospitals when it released its tax-exempt hospital study in February 2009. The IRS will also have additional information about compensation levels and their reasonableness based upon filings on the redesigned Form 990 that includes questions related to the initial contract exception.

The selection of 40 colleges and universities identified for further examination indicates that the IRS is serious about pursuing compliance issues arising from the information it gathered in the compliance questionnaires. As more information is released about additional examinations and issues, we will keep you informed.

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