IRS Final Report on Tax-Exempt Colleges and Universities Compliance Project

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The Internal Revenue Service has released its final report summarizing the audit results from the IRS’s colleges and universities compliance study, which began in 2008.  The final report focuses on two primary areas within the examinations:  reporting of unrelated business taxable income (UBTI) and compensation, including employment tax and retirement issues.  This article summarizes the UBTI reporting issues identified in the final report.

As part of the Tax-Exempt Colleges and Universities Compliance Project, the IRS examined 34 colleges and universities for unrelated business income.  The examinations resulted in:

  • Increases to UBTI for 90% of the colleges and universities examined, totaling about $90 million;
  • Over 180 changes to the amounts of UBTI reported by colleges and universities on
    Form 990-T; and
  • Disallowance of more than $170 million in losses and net operating losses (NOLs) which could amount to more than $60 million in assessed taxes.

According to the report, the primary reasons for increases in UBTI in the completed exams were:

  • Disallowance of expenses that were not connected to unrelated business activities.  The IRS indicated that the misreporting occurred in two ways:
    • Lack of profit motive – nearly 70% of the examined colleges and universities reported losses from activities for which expenses consistently exceeded UBI for many years.  The IRS cited this pattern of recurring losses as an indication of a lack of profit motive, and disallowed the losses.  As a result, these losses were no longer available to offset profits from other activities, and more than $150 million of NOLs were disallowed by the IRS.
    • Improper expense allocation – the report indicates that nearly 60% of the Form 990-Ts examined by the IRS had misallocated expenses to offset UBI for specific activities.  In many cases, the IRS concluded that claimed expenses were not connected to the unrelated business activity.
  • Errors in computation or substantiation of net operating losses.
  • Reclassification of exempt activities to unrelated.  Upon audit, the IRS determined that nearly 40% of colleges and universities examined had misclassified certain activities as exempt or otherwise not reportable on Form 990-T.  The IRS reclassified nearly $4 million to unrelated business income, thereby subjecting those activities to tax.

The majority of the adjustments described above came from the following activities:

  • Fitness, recreation centers and sports camps
  • Advertising
  • Facility rentals
  • Arenas
  • Golf

Based on these audit results, we recommend the following action items:

  • Review and document the business purpose and profit motives of any unrelated business activities.
  • Maintain records that substantiate the allocation of expenses on a reasonable and consistent basis between related and unrelated activities.
  • Maintain records that substantiate unused NOLs from prior years.
  • Review the activities that the organization engages in which the IRS believes may result in UBI, and document the conclusions as to whether a particular activity is UBI.

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.

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