'Open the Blinds'

May 30, 2007

The leaders of the Senate Finance Committee have urged the U.S. treasury secretary to change the federal tax form that many tax-exempt entities file each year, with the goal of ramping up scrutiny of the complex financial operations of private nonprofit colleges and hospitals. The letter from Sens. Max Baucus (D-Mont.) and Charles Grassley (R-Iowa) offers some new insights -- worrisome to college tax experts -- into the senators' interest in the possibility of penalizing institutions that are perceived as spending too small a proportion of their endowment assets.

"While we always hear that sunshine is the best disinfectant, sunshine can't do its work unless we open the blinds," the senators wrote in their letter to Treasury Secretary Henry Paulson. "The sooner we open those blinds the better."

Baucus, who succeeded Grassley as chairman of the Senate's tax policy panel when the Democrats took control of Congress in January, seems largely to have embraced the ramped-up scrutiny that his predecessor began of various aspects of nonprofit management and finances, with a particular focus on universities and other big entities. The letter comes, too, as the Finance Committee is contemplating a series of budget proposals that could result in new or expanded taxes imposed on higher education institutions, including the possibility of ending the tax-free nature of tuition benefits for college employees or making nonprofit organizations’ hedge fund investments subject to unrelated business income tax.

The general thrust of the senators' letter to Paulson about Internal Revenue Service Form 990 is that as currently conceived, the federal tax form filed by all private nonprofit colleges and other non-state charities is inadequate to "emcompass vital information regarding major parts of the nonprofit sector -- especially hospitals and universities." The IRS should consider seeking "supplemental" information from "large, complex institutions" like that "if transparency and openness are to have real value."

Many of the topics about which the senators argue more information is needed about major tax-exempt entities like hospitals and universities will sound familiar to college and university finance officers and others who follow tax issues. Chief among them are executive compensation and governance, which have been major focuses of the Senate panel's work in the wake of recent controversies about the payment of chief executives at American University and the American Red Cross.

"Some charities are as creative as for-profit entities in providing compensation -- paying for housing, first class travel, spousal travel, deferred compensation, incentive compensation and bonuses, fringe benefits, loans, dining and often entire life styles," the lawmakers write. "We are concerned that right now it is often easier to understand how much a Fortune 500 CEO is being paid than how much a charity is compensating its executives.... The public needs to easily see the total amount of compensation and not have to piece it all together from different documents."

Right now that picture is complicated, the senators write, because nonprofit leaders often draw compensation not just from their main college, hospital or other organization but from "related organizations" (like fund raising foundations) or joint ventures, about which the senators also suggest more and clearer reporting is necessary on Form 990.

The newest area of scrutiny raised in the senators' letter, however, is about endowments. In recent weeks, aides to the Senate Finance Committee have discussed the prospect of requiring college and university endowments -- like those of private foundations -- to pay out a minimum percentage of their assets each year, possibly as a penalty for institutions that are seen as raising tuition excessively.

The language in the senators' letter Tuesday offers some additional insights into what might be motivating the panel to consider such proposals, with its references to endowments that "claim they have no legal requirement to pay out a dime" and that "have billions in the bank -- or as is more common now, in investments offshore in places such as the Cayman Islands -- and at the same time the entity provides only pennies on the dollar to the charitable goals of the organization."

The letter from Baucus and Grassley suggests that the public needs significant more and better information about institutions' endowments, how much is spent and on what, and where the assets are invested, among other things. "Consideration should be given to having a uniform definition of an endowment," they write.

The senators' letter also raises the prospect that tax-exempt groups should "provide charitable work commensurate with their resources" -- and that the tax form should "allow the IRS and the public to easily identify" whether a college or other charity is "shown to be carrying on through ... contributions and grants a charitable program commensurate with its financial resources. That is another way of suggesting the possibility of requiring minimum payouts for college endowments, says Bruce R. Hopkins, a tax lawyer who specializes in nonprofit organizations.

"This focus on endowments, from a higher ed point of view, should be quite troubling," Hopkins said. "Talking about a uniform definition of endowment logically leads to a uniform definition of what an endowment is supposed to do and be used for. But charities use endowment funds for different reasons -- they could be building funds, or for research, and sometimes they're ready to spend the money and sometimes they aren't. This recurring theme that these things are all alike could lead to a one-size-fits-all approach that could create major problems for colleges."

Baucus and Grassley ask Paulson to respond to their letter within 30 days.

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