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Coming Attractions of IRS Scrutiny

December 18, 2009

WASHINGTON -- As college officials await the results of a broad Internal Revenue Service review of institutions' governance and financial practices, two higher education groups have offered their own preview of what the federal agency may find -- and offer a generally upbeat picture. But just how accurate a forecast it offers is open to debate.

The IRS announced in late 2007 that it would send wide-ranging questionnaires to a cross section of 400 public and private colleges, focusing on such issues as how much they pay their leaders, their endowment spending practices, conflicts of interest, and the extent of their taxable activities. The IRS distributed the 33-page questionnaire last fall, and is reportedly analyzing the data now. The agency's officials are expected to use the findings to identify areas of possible abuse, initiate audits of individual colleges, and possibly as the basis for new regulation or even legislation.

In response, two college groups, the Association of Governing Boards of Universities and Colleges and the National Association of College and University Business Officers, decided last fall by try to mirror the IRS project by collecting the completed questionnaires from as many of the 400 IRS-targeted colleges as possible.

As they released a third-party examination Thursday of the questionnaires they received, officials of the two groups said they had undertaken their own review not as a counterpoint to the IRS's eventual analysis, but because, like the IRS, "we too wanted to be sure that our colleges and universities are applying appropriate standards in governance and transparency and accountability,... and we felt we owed it to our respective constituencies to do our own analysis" to complement the federal agency's, said Richard D. Legon, president of the governing boards' association.

Just how accurate a predictor the groups' analysis may be of the IRS's own findings is unclear. Of the 400 institutions surveyed by the IRS, barely a third -- 146 -- opted to send them to Ernst and Young, the accounting firm that compiled the results for AGB and NACUBO. The groups' officials said they were satisfied by the number of respondents, which Legon described as a "valid sample size."

But they acknowledged that about 60 percent of the participating institutions were public, while the universe surveyed by the IRS -- which has not revealed information about its sample, but reportedly took great pains to ensure that it was scientifically representative of the higher education landscape -- almost certainly included many more private than public institutions, since independent colleges outnumber public ones by a 70-30 margin. Public colleges are more accustomed to sharing information than private ones are, and while the two groups committed to not identifying the respondents to their survey, most state institutions probably suspected that their responses might eventually be susceptible to open-records requests.

The other reason to question the reliability of the sample collected by AGB and NACUBO is because of the self-selection sample, said Sheldon E. Steinbach, a lawyer for the Washington firm Dow Lohnes and a higher education tax expert. Those voluntarily submitting their information to the two groups are likeliest to be those confident that they were engaging in good practices, he said.

"Who sends in news to the alumni bulletin? It's the people who think they're doing well," Steinbach said.

The Results

The report from AGB and NACUBO offers a decidedly upbeat assessment of how colleges are faring in most of the areas the IRS is examining, especially those related to governance. Among the strong and sound practices reported by the survey:

  • 98 percent of public institutions and 97 percent of private institutions have clear, written policies governing conflicts of interest for trustees and top managers.
  • 91 percent make their audited financial statement available to the public.
  • 99 percent indicate that they have an investment policy for their endowment fund.
  • 97 percent of respondents said they had a target endowment spending rate of 4 percent or higher, and 70 percent said it was 5 percent or higher. The respondents said that 45 percent of all distributions went to scholarships or other financial aid.
  • More public institutions reported that their presidents were paid between $200,000 and $300,000 (38 percent) than any other salary band, while the largest group of private institutions (27 percent) reported paying their presidents between $300,000 and $400,000. Compensation of more than $400,000 was reported by 21 percent of public institutions and 20 percent of private institutions, the report found.

"On balance, we saw a high level of performance, transparency and accountability" from the respondents, said John Walda, president of NACUBO.

Walda and Legon said the survey identified some potential problem areas.

Both said they suspected that data from the compliance survey showing comparatively high compensation for sports coaches would pour additional gasoline on an issue that is always contentious -- and more so at a time of economic distress in higher education, as evidenced by recent fights over sports debt at the University of California at Berkeley and a football coach's pay at the University of Texas at Austin. The numbers "are likely to cause a resurgence of conversation about intercollegiate athletics," Walda said.

Just over half of private colleges responding to the survey (53 percent) said they had used a process for setting the compensation of their chief executives that would ensure they would be exempt from IRS rules designed to guard against excessive compensation. In other words, nearly half of them were failing to take advantage of the process, known as "rebuttable presumption" (which focuses on making comparisons to the pay of leaders elsewhere), that is essentially a safe harbor for their institutions against government penalties.

"That's probably an area where I hope some boards will decide they need additional attention," Legon said.

One area that got relatively short shrift in the Ernst and Young report, but has been front and center in IRS discussions of the project, is unrelated business income -- money that colleges take in (and are supposed to pay taxes on) from commercial activities that are deemed not to be "substantially related" to their educational purpose.

Tax experts have speculated that the IRS compliance project is designed, in part, to identify areas in which colleges report that they engage in profit-seeking activities but for which they do not pay taxes, in the hope of "catching" colleges that fail to pay the appropriate tax.

The IRS asked survey recipients about the extent to which they engage in 47 different activities or arrangements that might generate unrelated business income, and the respondents to the higher ed groups' survey reported listing $146 million in gross receipts or sales from those activities, and a net operating loss of $5 million.

Several tax experts who reviewed the NACUBO/AGB report said they were surprised both by the relatively small amount of unrelated business income the institutions reported, and by the disconnect between the proportions of institutions that reported engaging in various activities and the much smaller numbers that said they generated unrelated income from them.

For instance, while 61 percent of respondents said they managed bookstores, but only 26 percent said they generated unrelated business income from them. Similarly, 51 percent said they had corporate sponsorship for events, but only 4 percent said they had reported unrelated business income from that activity.

Other areas that the associations' survey did not examine, but that could prompt scrutiny from the IRS, relate to how colleges treat losses from activities that are sometimes profit producing, and to the deductibility of benefits paid to presidents and other managers.

One interested observer who has been paying close attention to colleges' tax status was unimpressed by the college groups' survey. Sen. Charles Grassley, the Iowa Republican who has been regularly raising issues about colleges' endowment spending and other financial practices, said in a statement late Thursday: “This study is limited. It reflects data from about one-third of the 400 respondents. It was commissioned by two higher education groups. The names of the colleges weren’t released and the data itself wasn’t released, so there’s no chance of independent organizations being able to review the data and make their own conclusions. I appreciate the interest in voluntary transparency, but there’s a lot more that could be done. For example, the colleges that provided their responses for this study could make them public for independent, objective analysis.”

 

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