On October 1, 2008, the Internal Revenue Service (the “Service”) announced that approximately 400 public and private U.S. colleges and universities of all sizes will soon receive compliance questionnaires. The Service press release states that the compliance project is intended to give the Service a better understanding of how higher education institutions: (1) report revenues, expenses, income, and losses from taxable trade or business activities on their Form 990-T; (2) classify activities as exempt or taxable activities; (3) allocate revenues and expenses between exempt and taxable activities; (4) invest and use endowment funds; and (5) determine types and amounts of executive compensation. The Service plans to issue a report on its findings in 2009. The full questionnaire is available for review at http://www.irs.gov/charities/article/0,,id=186865,00.html.
The 33-page form is divided into questions relating to: (1) demographic information; (2) activities; (3) endowment funds; and (4) executive compensation. Questions concerning financial information relate to the 2006 fiscal year, while other questions address the institution’s current policies and practices. The form includes a large number of questions that are directed only at private institutions. Responses will be due within 90 days of the date on the form cover letter.
While an institution may refuse to participate in a compliance check without incurring penalties, such refusal is not generally advisable, as it may trigger a formal Service examination. The Service may also choose to initiate a formal examination on the basis of the responses that a particular institution provides on the form.
Institutions that receive a compliance check letter should immediately contact their legal counsel for guidance in preparing their responses. For other institutions, the compliance check provides a helpful road map of some of the areas that the Service is likely to explore in a formal examination of any tax-exempt college or university. Noteworthy areas of inquiry on the form include the following.
- Conflicts of Interest Policies. The Service asks whether private institutions currently have conflict of interest policies applicable to their governing body, top management officials, and full-time faculty members, and requests the date on which such policies were adopted. Public institutions must identify any state statutes that govern conflicts of interest of the governing body, top management officials, and full-time faculty.
- Joint Venture/Transactions with Non-Charities Policies. Private institutions must disclose whether they have a written policy designed to ensure that all transactions with non- 501(c)(3) related organizations are made at arm’s length, and whether the policy addresses: (1) the provision of goods and services; (2) the lending of money; (3) the rental of property; (4) the transfer of assets; (5) cost-sharing and expense-reimbursement arrangements; (6) licensing arrangements; (7) shared employees; and (8) other transfers of assets, liabilities, or funds not addressed above. Public institutions must disclose which of the arrangements listed above are addressed in any applicable state statute designed to ensure that transactions are made at arm’s length.
- Policy for Payments to Controlled Entities. Private institutions must disclose whether they have a written policy that establishes arm’s-length assurances when amounts are paid or accrued to the institution from a controlled entity, and whether the policy specifically addresses: (1) management fees; (2) interest; (3) rents; (4) royalties; and (5) annuities.
Public institutions must identify which (if any) of the items of income listed above are subject to a state statute designed to assure that transactions are made at arm’s length.
- Methods for Determining Pricing in Related Entity Transactions. All institutions must disclose their methods for determining pricing in related entity transactions, including payments or accruals of interest, rents, royalties, or annuities by a controlled entity to the institution.
- Investment Policy and Procedures for Endowment Funds. All institutions must disclose whether they currently have an investment policy for their endowment funds, as well as an investment committee that oversees the investment of endowment fund assets; approves the selection of external investment consultants; and approves the recommendations of such external consultants. Organizations must also disclose whether compensation for internal and external investment managers was approved by the institution’s governing body or by a committee thereof.
- Endowment Distribution Policies and Procedures. Institutions must disclose whether they monitored endowment distributions to ensure that they were used for the donor’s intended purposes, and describe the institution’s policy with respect to endowment fund disbursements that were not used in the fiscal year of disbursement.
- Compensation Practices. The form requires very detailed compensation disclosures on the six highest-paid officers, directors, trustees, and key employees for the 2006 calendar year. The form also asks questions concerning the procedures and policies that governed any institutional loans or extensions of credit to such persons. Private institutions must also disclose whether, for the 2006 calendar year:
- They had a formal written compensation policy that covered at least some of their officers, directors trustees, and key employees and the policy’s effective date
- They retained an external compensation consultant to provide comparable compensation data for any officers, directors, trustees, or key employees, and whether such compensation consultant provided other services to the institution
- They had employment or independent contractor agreements with their six highest-paid persons
- They used the rebuttable presumption process to set compensation for their six highestpaid persons
- Compensation analysis to establish compensation for the six highest-paid persons included: compensation levels paid by similar organizations, the level of the person’s education and experience, the specific responsibilities of the position, previous compensation packages, similar services in the same geographic or metropolitan area, similar number of employees or students, similar budget or gross revenues, annual budget and/or gross revenues/assets, and the nature of curriculum (2 year/4 year, undergraduate/graduate)
- Sources of compensation-data relied upon to establish compensation for the six highestpaid persons included: published surveys of compensation at similar institutions, Internet research on compensation at similar institutions, phone surveys of compensation at similar institutions, outside expert hired specifically to provide comparability data and reports, reports prepared by expert compensation analysts employed internally, written offers of employment from similar institutions, and IRS Form 990 data from other colleges and universities.
All institutions should assess their current ability to answer these questions and determine whether they should adopt new policies or make changes to existing procedures to ensure federal tax compliance.
Circular 230 Notice: To ensure compliance with Treasury Department regulations, we inform you that any U.S. Federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or applicable state and local provisions or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein.