On October 1, 2008, the Internal Revenue Service (IRS) announced that it is sending questionnaires, in the form of a Compliance Checklist, to approximately 400 colleges and universities. The avowed purpose of the Checklist is to help the agency to determine the extent of those institutions’ compliance with tax rules in virtually all aspects of their operations. The materials are referred as Form 14018.
The identity of those institutions that are on the list has not been released, but it appears that all types of institutions of higher learning are eligible, including public universities.
The issuance of the Compliance Checklist is not a surprise. The IRS included it in its Exempt Organizations “to-do” list that it published last December. See Exempt Organizations Implementing Guidelines for fiscal year 2008, as described in our client communication late in 2007.
What Does the Checklist Cover?
Bad news: The compliance check materials cover 33 pages and require detailed information on a vast array of areas, including:
- Disregarded entities, related tax-exempt organizations, and other organizational structure arrangements;
- 47 different types of activities, ranging from food services to golf courses to power generation, in which your organization may participate;
- Financial information regarding most of the above activities;
- Unrelated business income activities;
- Endowment funds, including the management and use thereof; and
- More than 9 pages of compensation information on your organization’s highest paid employees.
Good news: None. Well, the IRS is including a return mailer with the Compliance Check materials.
What Will the IRS Do with the Information?
Good News: The IRS professes that it intends to use the information from the responses only to gain insight into the above activities.
Bad News: The IRS reserves the right to use the information that you provide to open a formal examination of your institution.
Clearly, the IRS will compile the information returned by the institutions solicited and will issue a report in 2009. We also expect that the IRS will be particularly interested in reviewing these responses to determine the processes and procedures by which your institution makes decisions that are important to its tax exempt status. For example, in our brief review of the Checklist, we have seen references to the following activities:
- How your institution classifies activities as taxable or exempt;
- Whether it makes audited financials available to the public;
- Whether it conducts programs and maintains facilities outside of the U.S.;
- How its activities are reflected in its organizational chart;
- What written policies your institution has in a host of areas involving its relationship with outside entities;
- The manner in which fees, rents, royalties, etc. are determined and paid among your institution and its related entities;
- Whether it has relied on the advice of independent accountants or counsel in identifying unrelated business activities and internal pricing models;
- Whether your institution has an investment policy and committee for managing endowment;
- The extent to which outside investment consultants are used;
- How compensation arrangements for investment managers are created and whether they are reviewed by members of your institution’s board;
- The extent to which your institution uses charitable gift annuities and similar vehicles; and
- How endowment funds are distributed and how distributions are monitored to ensure that donor restrictions are met.
What About Our Executives’ Compensation?
The Compliance Checklist saves the best for last – 9 pages of questions on executive compensation! The Checklist requires information on the following:
- 2006 dollar information on amounts paid to, or accrued by, the 6 highest paid employees of your institution in 32 different types of remuneration and 13 different questions regarding loans and other extensions of credit;
- Whether your institution has a formal compensation policy;
- Whether your institution hires outside consultants to provide comparable compensation information for officers, trustees, and key employees – if so, what factors are included in the studies and what sources were used;
- Who sets compensation for specified groups and whether these decisions were documented;
- The use of employment agreements;
- How your institution is set up to deal with the intermediate sanction rules promulgated by the Treasury Department.
Do We Have to Respond to the Solicitation?
Good news: Your institution does not have to respond to the Compliance Checklist.
Bad news: The IRS may then open a formal examination of your institution.
There are several take-aways from even a cursory review of the Compliance Checklist.
- If your institution is on the hit list, you must first decide whether to return a completed form, or not.
- Recognize that the task of correctly completing the Checklist will likely involve many people and many, many hours.
- Your responses will require you to consolidate information, including compensation data, from all of your affiliated entities, including supporting foundations.
- The content of your responses should be carefully reviewed both internally and externally. If one or more of the responses include admissions to conduct that might create tax liability or jeopardize your institution’s tax exempt status, it may be preferable to fail to return the completed Checklist than to voluntarily expose the institution to sanctions.
- In addition to creating a report and reviewing your institution’s statistical data, policies, and procedures, we believe that the IRS is using the Compliance Checklist as a wake-up device for all types of tax exempt organizations. The elements of the Checklist and the resultant report will likely be used by tax exempts as a compendium of best practices for their future governance and as audit measuring rods for the IRS.
McGuireWoods has performed legal services for more than 125 colleges, universities, and related entities. We have had considerable experience working with both public and private institutions of higher learning in connection with a broad range of educational issues including governance; accreditation; alcohol, drug, and academic disciplinary policies; athletics; tenure; employment; executive compensation; 403(b) retirement plans; joint ventures; intellectual property; housing; construction; unrelated business income; charitable contributions; and financial aid. These, of course, are in addition to the services that we also provide for taxable entities and individuals.
We urge you to consult with counsel regarding the Compliance Checklist. Please feel free to contact the authors.