Here are some best practices – old and new – that educational institutions may want to consider implementing regarding governance and tax matters.
This first one is new – regarding the new tax law on unrelated business income (UBI) silos. The Internal Revenue Service (IRS) has issued favorable interim guidance that allows exempt organizations to aggregate their investment partnerships in certain circumstances for UBI purposes. Otherwise, what an administrative nightmare it would be to account for silos of different types of investment partnership UBI! Educational institutions may aggregate their investment partnership interests that meet either the de minimis ownership test (up to 2%) or the control test (up to 20% with no control or influence over the partnership), when combined with ownership by any disqualified persons, such as board members, officers and others with substantial influence over the school. Board members, particularly investment committee members, and substantial donors are more likely the ones, if any, who would have the same investments as the institution. As part of the conflict of interest questionnaire, institutions may want to consider providing a list of investment partnerships and request board members represent if they have any common ownership.
The second one is an old item – but sometimes forgotten. If financial aid or a scholarship is provided to a director’s or trustee’s family member, that results in the director or trustee not being an independent board member. If a family member of a director or trustee receives financial aid or a scholarship from the institution, no names need be disclosed, but the institution needs to report the amount and type of grant (i.e. need-based, merit, discounted tuition) on its annual IRS filing, Form 990. Best practice is that this information would already be self-identified by the board member through the annual conflict of interest policy questionnaire.
The new tax law did not change the taxation of on-campus housing, but employer-provided housing remains an IRS hot button. This is an examination item in the IRS’s Audit Technique Guide for schools. Therefore, it’s important for educational institutions to understand the rules and not take the tax-free treatment for granted. There are three requirements: 1) the housing must be furnished on the business premises of the employer; 2) the housing must be furnished for the convenience of the employer; and 3) the employee is required to accept such housing as a condition of his/her employment. This is a facts and circumstances test. Institutions provide tax-free housing to various types of employees. Usually it’s obvious that an employee needs to live on campus to perform his or her job responsibilities – but not always. Schools should continually ensure that the facts and circumstances support the tax-free position taken. Best practice for institutions is to document the tax position for all employees with on-campus tax-free housing.
Likewise, documentation for any entertainment done by Presidents, Advancement Officers and other educational institution executives should be rock solid. Institutions should make sure they follow the accountable plan rules, which is doubly important for executives of tax-exempt organizations. This means the documentation of all meals, entertainment, social club use, travel expenses, etc. should include the amount, place, date/time, business purpose and business relationship of the guest(s) entertained. Best practice is to have expense reports reviewed periodically by someone at a higher level than the employee, which in some cases could be a board member. If the documentation is not adequate, the IRS can treat reimbursements as taxable income to the employee (even if they are truly for business purposes). Even more risky, the entire accountable plan can be disregarded. Other possible negative effects of inadequate documentation, in addition to taxation to the executives, include sanctions to the exempt organization – which should be deterrents. Best practice may be to document using logs or diaries.
This old best practice is a refresh of the recommendation for exempt organizations to keep a list of their former disqualified persons – to capture and disclose any reportable transactions with “formers.” This is a longstanding requirement – a former disqualified person is considered a disqualified person for 5 years. Therefore, educational institutions should keep a running 5-year list of disqualified persons in their records to review for any transactions with these formers. Then drop off the 6th year and add in disqualified persons from the latest former year annually.
The new best practice is regarding a “covered employees” list – that’s a new term relating to the new 21% excess executive compensation tax on remuneration over $1 million and on certain excess parachute payments. This new 21% excise tax is imposed on the exempt organization. Covered employees are the five highest-compensated employees – including officers and key employees (which is a different definition than five highest for IRS Form 990 purposes, who are in addition to the officers and key employees). This term “covered employees” is an evergreen determination. So once someone is a covered employee, he or she is always a covered employee and stays on the watch list.
It’s best practice to capture scholarships paid out of the endowment, and report on Schedule D, Part V of the annual Form 990. Some institutions have not been reporting scholarships paid out of their endowments and have been aggregating with other program or administrative expenditures. Since endowment spending is a focus of Congress it’s best to accurately report the amount spent on scholarships from the endowments.
Tuition remission or scholarships provided to employees for Form 990 purposes should be reported as part of their compensation and benefits rather than as scholarship expense on the functional expense statement on the Form 990.
Best practice is for educational institutions to ensure and disclose on Schedule I of Form 990 that financial aid and scholarships are awarded in a nondiscriminatory and objective manner – this is even more important now in light of the recent national scandal regarding inappropriate scholarships.
Governance is not one-size-fits-all. But here are some best practices, old and new, for educational institutions to consider to stay in compliance, out of the headlines and ahead of the ever changing curve.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.