IRS's Next Target: Retirement Plans

WASHINGTON -- With their actions and their public comments, Internal Revenue Service officials have signaled in the last several years that the increasingly complex financial operations of nonprofit colleges and universities make them prime targets for the federal tax agency.

To the list of subjects that have attracted the agency's interest -- executive compensation, endowments, and other topics at the core of a broad 2007 inquiry and subsequent audits -- it has formally added retirement plans.

The IRS announced late last month that it will survey a random sample of 300 colleges and universities about their compliance with federal laws and 2009 rules regarding tax-deferred retirement incentives known as 403(b) plans. Agency officials said they hope to learn whether colleges that offer the plans make them available to all of their employees, as they are required to do, and whether they are complying with a new 2009 requirement that they have a formal written policy describing their plans.

"Failure to satisfy the [universal availability] rule and written plan requirement could result in the loss of valuable tax benefits to employees and jeopardize retirement savings for an employer’s entire 403(b) plan," the IRS announcement said in a statement about the inquiry. "This project will give higher education organizations the chance to identify problems with their plans and to correct them on their own."

403(b) accounts are tax-sheltered retirement plans that allow employees (and their nonprofit employers, in lieu of salary) to make pre-tax contributions to accounts and not pay taxes on them (or on the earnings) until the funds are withdrawn. The IRS changed the rules governing the plans, which are widely employed in higher education, beginning in 2009.

Bruce Ashton, a partner in the employee benefits and executive compensation practice of the law firm Drinker Biddle Reath, said the IRS has expressed concern (in individual audits of colleges and other tax-exempt groups) about the extent to which employers, in offering 403(b) plans, may discriminate in favor of highly paid employees over lower-paid ones.

On some campuses, this may entail providing access to faculty over staff, or to full-time professors over part-timers. (The Internal Revenue Service Code provides limited exceptions to the "universal availability" requirement -- including exempting employees who work under 20 hours a week, for instance.) Ashton speculated that the IRS's broad 2007 questionnaire about colleges' tax compliance -- which was designed to identify possible areas for further examination by the agency -- might have turned up evidence of noncompliance regarding 403(b) plans.

Ashton said that employers who fall short of the 403(b) requirements often do so not out of a purposeful desire to evade the law, but because of a "lack of understanding" about its requirements. For those institutions, the IRS's review presents an opportunity, he said.

"If I was a CFO or provost, I might think, I may have dodged a bullet and not gotten the questionnaire," he said. "But despite the impression most people have, the IRS really is interested in compliance" more than enforcement. "It uses these kinds of questions to alert people, 'Hey, these are the areas we're concerned about.' So I'd use them as a signal as to what they're looking for, and use the questionnaire to answer about your own plans.

"This really does create an opportunity for a university to look at what it's doing and make sure they're doing it right."