Scrutiny From Many Sides

Discussion of nonprofit tax issues suggests that IRS, Congress and others plan busy season of review of colleges' spending and governance practices.
May 12, 2008

They may not have been a representative sample, but the Congressional aides, Internal Revenue Service officials, and others at an American Bar Association meeting on nonprofit tax issues Friday made abundantly clear that colleges and universities should expect plenty of scrutiny in coming months about their operations and whether they are spending their money effectively.

None of the speakers at the meeting of the ABA's Section on Taxation's Exempt Organizations Committee revealed brand-new regulatory or legislative efforts to examine colleges' activities. But the accumulation of continuing or contemplated initiatives they described left the unmistakable impression that, on multiple fronts and from multiple sources, federal (and state) examination of the effectiveness of colleges and other nonprofit organizations is on the rise.

Not only have other members of Congress joined Sens. Charles Grassley and Max Baucus in questioning whether colleges are spending enough from their endowments, but as the Internal Revenue Service contemplates expanding its examination of whether colleges and other charities are fulfilling their public purposes in line with their wealth, the Federal Trade Commission is also seeking expanded power to regulate nonprofit groups, including educational ones. (And state legislators have sought to get into the act in recent weeks, too.)

The most visible efforts, by far, remain centered in the Senate Finance Committee, where Grassley, the panel's senior Republican, and Baucus, a Democrat who is its chairman, are several years into a review of an inquiry into tax-exempt groups on a wide range of fronts. The senators asked 136 colleges in January seeking data and explanation about their admissions, financial aid and endowment spending policies and practices. A Republican aide to the Finance Committee said at Friday's session that staff members were reviewing the responses and deciding "where we head next" -- to roundtable discussions involving colleges, hearings and/or a report on the committee's findings.

Although some college officials have speculated (hopefully) that Grassley's ardor to examine college and other nonprofit issues might fade with the departure this winter of his bulldog aide, Dean Zerbe, the Republican aide on Friday sought to dash those hopes. The staff member noted that not only has Grassley not lost interest, but other recent developments -- the introduction and quick withdrawal by Rep. Peter Welch of an amendment to the House Higher Education Act bill that would have required colleges to spend at least 5 percent of their endowment assets each year, for instance, and a push by Sen. Byron Dorgan to expand the Federal Trade Commission's authority to regulate abuses by nonprofit entities -- suggest that the interest is spreading.

"It's not just us -- it's not just Senator Grassley that's agitating," the aide said. "There's a whole conversation about what public charities are supposed to be doing these days."

And that conversation is not relegated to federal legislators, as shown by the proposal by a Massachusetts lawmaker last month that would have imposed a 2.5 percent tax on any college endowment valued at over $1 billion. The proposed amendment to the state budget was tabled in favor of further study, but the message was delivered.

Colleges are front and center on the agenda of the Internal Revenue Service's tax-exempt division, too. In describing her agenda for the coming year to the tax lawyers and others in attendance at Friday's meeting, Lois G. Lerner, director of exempt organizations at the IRS, offered few additional details about its previously announced survey of public and private four-year colleges. Governance, endowments and executive compensation will top the areas of review, Lerner, said, suggesting that the agency would seek to dig deeper into how the six highest-paid officials at each college are compensated, including payments and loans they receive from the institution and from all affiliated organizations.

Lerner also said that the survey would also give the IRS information it might use to decide whether to delve more aggressively into the question of whether colleges and other charities are providing benefits to society "commensurate" to their financial wealth. The prospect of the IRS paying more attention to the so-called "commensurate test," which has been in the service's arsenal for decades but used little if at all, was raised in a speech at Georgetown University last month by Steven T. Miller, commissioner of the IRS's Tax Exempt and Government Entities Division.

"We need to look at it in the context of the world as it stands now," Lerner said Friday. That would seem to feed naturally into the discussion Grassley and others have been prompting about whether colleges are using their wealth sufficiently to ensure access to higher education for low- and middle-income students, among other public purposes.

Amid that environment of continued and potentially expanded scrutiny, a cautionary note was sounded at the ABA meeting on Friday. As one panel of law professors and others convened to discuss the practical questions of what a proposal to require colleges to spend a minimum percentage of their endowments might look like (setting aside the philosophical query of whether such a policy is sound), an assessment of one existing policy offered an emphatic No.

Adam Parachin, a professor of law at the University of Western Ontario, described Canada's experiment with a "disbursement quota" that requires charitable organizations to spend a large proportion (about 80 percent) of the gifts they receive each year in the following year and a small percentage (3.5 percent) of their "enduring property," or longer-term assets.

Laying out a large number of practical problems that have unfolded with the law's sometimes conflicting demands, it would be "fair to say, in Canada, that if someone were to write a narrative about the experience, it would most certainly be a tragedy, because the experience has not been positive," Parachin said.

As one fellow panelist, Zerbe, Grassley's former aide, suggested that momentum for a payout requirement is building, and another, Lorraine Sciarra, a lawyer for Princeton University, explained the ways in which colleges were already ensuring that they were spending intelligently from their endowments, Parachin warned that U.S. policy makers should move cautiously in contemplating such an approach.

"You'll be flirting with technical disaster," he said. "And if you want to look for an experience north of the border, you have a place to look."


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