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Surprising Shift for Senate Tax Panel

November 17, 2006

For more than a year now, the leaders of the U.S. Senate Finance Committee have investigated the management and compensation practices of charities and, more recently in the wake of a scandal at American University, colleges and universities. So when word leaked out this week that the panel planned another hearing on college issues next month, the widespread assumption was that colleges were about to get more scrutiny along those lines.

Not exactly. Colleges' tax practices are in for more examination in the months and years ahead -- from the Internal Revenue Service (more on that below) -- but the Senate Finance Committee seemingly has a different target in mind for its December 5 hearing: federal tax breaks for college tuition.

A Finance Committee spokeswoman confirmed late Thursday that in one of their last acts while their party still controls Congress, the panel's Republican leaders would hold a hearing "that looks generally at whether tax breaks for tuition and universities’ efforts to help low- and middle-income families are helping in an era of ever-increasing tuition."

That statement was generally consistent, though somewhat vaguer, than what one Washington higher education official was told the subject of the hearing would be: "a look at the relationship between federal tax provisions and tuition increases." In other words, do federal policies that give taxpayers a deduction or credit for money they spend on college tuition -- like, for instance, a proposal by the new Democratic majority in Congress to "make college tuition deductible from taxes, permanently" -- lead colleges in turn to raise their tuition?

College officials seemed genuinely perplexed by the committee's plan, which some saw as laying the groundwork for Republican objections to that and other proposals Democrats have vowed to pursue when they have the ability to set the agenda in the 110th Congress. "Reading the tea leaves, this seems to be a way of developing arguments for when [the Republicans are] in the minority," said one college lobbyist, who asked not to be identified. Another person briefed on the committee's plans noted, though, that the panel's Republican leader, Sen. Charles Grassley of Iowa, is not seen as an especially partisan lawmaker, and that he has worked closely and collaboratively with his Democratic counterpart (and the committee's soon-to-be chairman), Sen. Max Baucus of Montana.

The Finance Committee spokeswoman said little else was known (or could be said) about the hearing at this point, and that no witness list had yet been developed. But some scholars, including Bridget Terry Long, a Harvard University economist, and Richard K. Vedder, the Ohio University economist who sat on the Secretary of Education's Commission on the Future of Higher Education, both have argued that the existing federal tax credits may encourage institutions to push their tuitions higher.

College officials have generally scoffed at arguments that increased federal financial aid fuel rising tuitions, and are likely to be unhappy with the Finance Committee's chosen line of inquiry. It was not clear whether the hearing would touch on other aspects of colleges' operations as well.

Higher education officials will also probably be uncomfortable with the new thrust that the IRS plans to pursue next year. College officials and tax experts said they were taken by surprise by the Internal Revenue Service's announcement this month that one of its focuses for the 2007 fiscal year would be a new project examining how colleges and universities account for "unrelated business income" -- revenue they take in from activities that are not deemed to be connected to their underlying educational mission, and that are therefore taxable. The announcement was included in an annual letter the IRS's Exempt Organizations division releases with its guidelines for the coming year.

"I certainly had not heard it was coming, and it strikes me as a potentially huge development," said Bruce R. Hopkins, a tax lawyer who specializes in nonprofit entities. "Colleges have not been looked at by the service in a long time -- they've just been above the fray. I don't know whether this thing with the NCAA and the Congress is incidental, but ..."

Hopkins said it was unclear from the language of the IRS announcement just how broad the agency's review would be. It might focus narrowly, he said, on whether colleges are appropriately allocating expenses between their nonprofit and profit-making operations. In the past, for instance, the IRS has concluded that in cases where colleges use facilities for both taxable and tax-exempt actvities, some institutions had allocated too large a share of the overhead costs of the facilities to the taxable activities, such that they did not show a profit and paid no unrelated business income tax, or UBIT, as it is known.

More significantly, Hopkins said, would be if the IRS was planning to look into whether there are entire areas of activity that colleges are engaging in that they should be treating as unrelated to their core mission. He mentioned some of the universities' operations in the commercialization of research and conferences; others have cited potential problems in areas such as alternative investments, such as hedge funds, that a growing number of college and university endowments are diving into.

"There's a lot there if they really mean to get into it," Hopkins said. "I don't know whether they have the courage to look into it."

Sheldon E. Steinbach, a Washington higher education lawyer and longtime vice president at the American Council on Education, said he was not convinced that the IRS scrutiny would amount to much. Taking the long view, he said that despite the rumblings out of the Senate committee and the House's review of the National Collegiate Athletic Association's tax status, he did not sense anywhere near the kind of momentum today that occurred nearly 20 years ago, when Congress held hearings on colleges' businesslike activities in the wake of significant objection by small-business groups, who complained about unfair competition.

At the least, though, Steinbach said, "this sends a very clear warning to institutions to explore how they're handling the accounting of unrelated business income."

 

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