Colleges and Universities UBIT Compliance Project: IRS Final Report (Part 1)

In 2008, the IRS commenced a multi-year project to assess UBIT compliance by colleges and universities. The IRS sent out questionnaires to 400 randomly selected institutions and, based on the responses, selected 34 institutions for audit. Released in 2013, the Final Report analyzes the results of the questionnaires and examinations conducted as part of the Compliance Project. In general, the IRS found significant underreporting of UBIT. While the Compliance Project discussed in the Final Report deals exclusively with colleges and universities, the compliance issues uncovered by the audits may be instructive to other exempt organizations as well.

This article summarizes the highlights of the Final Report concerning the UBIT. Succeeding posts will examine in greater detail the most common compliance errors made by colleges and universities in determining UBTI.

Of the 34 institutions selected for audit, a whopping 90% had increases to UBTI, including more than 180 adjustments representing about $90 million in unpaid taxes. More than one half of the adjustments involved the following activities:

  • Fitness and recreation centers and sports camps
  • Advertising
  • Facility rentals
  • Arenas
  • Golf courses

The adjustments related not only to the underreporting of income from unrelated trades or businesses but also to excessive losses and net operating losses. Over $600 million losses and NOLs were disallowed on 75% of the examined returns.

 Note: The colleges and universities were selected for examination because responses to their questionnaires indicated potential noncompliance on UBIT issues. Thus, the institutions audited are not a representative sample of all colleges and universities. The Final Report cautions that the results apply only to the institutions examined and should not be generalized as representative of other colleges and universities.

 The most common adjustments made in the examinations involved the following issues:

  • Misclassification as a trade or business due to lack of profit motive
  • Misallocation of expenses between exempt and nonexempt activities
  • Errors in computation or substantiation of NOLs
  • Misclassification of unrelated activities as related activities
  • Failure to seek professional advice about the treatment of potentially unrelated activities

In Part 2 of this article, we will discuss how an exempt organization might underreport UBTI as a result of misclassifying an activity lacking a profit motive as a business activity subject to the UBIT.

 

IRS Releases Revised Publication 598

The IRS has released revised Publication 598, Tax on Unrelated Business Income of Exempt Organizations, effective as of March 2012. The publication covers four main topics:

  • Organizations subject to the tax
  • Tax and filing requirements
  • Unrelated trade or business
  • Unrelated business taxable income

 The section entitled “Unrelated Trade or Business” goes over the basic principles from the Code and Regulations concerning the basic requirements for taxatiion under the UBIT.  More importantly, it focuses on the sometimes tricky issue of whether a business is related or unrelated to an organization’s exempt purposes by using examples. The discussion contains numerous common examples of specific businesses and explains why these activities are related or unrelated for purposes of the UBIT. The “Unrelated Trade or Business” section also briefly discusses businesses that are expressly excluded from treatment as unrelated trades or businesses, such as businesses conducted by volunteers, sale of donated items, and the distribution of low cost articles incident to the solicitation of charitable contributions.

 The longest and most detailed section of Publication 598 is entitled “Unrelated Business Taxable Income.” It first discusses the categories of income that are excluded from UBTI. This part covers numerous modifications and special rules, including the treatment of advertising in periodicals, the deductions allowed in computing UBTI, rules for social clubs, VEBAs, and SUBs, income from partnerships and S corporations, and income from controlled organizations. The section concludes with a detailed discussion of the debt-financed property rules with several helpful examples.

 The IRS also maintains a web page on Publication 598. In a Recent Developments section, the IRS will post any changes that occur after the publication date of one revised edition and before the publication date of the following revision. For example, the Publication 598 prior to the current version was revised as of March 2010, applicable beginning with the 2009 tax year. In April of 2011, the IRS alerted taxpayers to the changes for the 2010 tax year. If the next revision of Publication 598 does not come out until March of 2014, an alert on this web page will likely be issued containing the changes for 2012.

 The IRS website has Publication 598 for the following revision dates: 2012, 2010, 2009, 2007, 2005, 2000, 1998, and 1995. If you need to know a UBIT provision applicable for a prior tax year, checking Publication 598 for the appropriate time period may be a good place to start.