The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
By Carla Neeley Freitag
TaxResearchAndWriting.com, Merritt Island, FL
The IRS commenced a major compliance project involving colleges and universities in 2008. The project has three phases. The first phase was to send compliance questionnaires to 400 institutions that represent a cross-section of small, medium, and large public and private four-year colleges and universities. Examinations were initiated on some of the recipients who returned the questionnaires and all of the recipients who did not return the questionnaires. The second phase was to compile the data from the questionnaires and issue an Interim Report on the findings. The Interim Report was released on May 7, 2010. The third phase is to compile data based on the examinations and issue a final report analyzing the need for future guidance or changes in reporting by educational institutions.
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On May 7, 2010, the IRS released the Interim Report on Nonprofit Colleges and Universities Compliance Project. The 75-page Report addresses the same major subjects as the questionnaire. The data from the questionnaires is generally described separately for small, medium, and large colleges and universities.
Organization. The educational organizations receiving the questionnaire answered specific questions about their full-time and part-time students, faculty, and staff. The questionnaire also addressed financial statements, tuition and discounts, related organizations, and international activities.
Faculty and Students. Large institutions reported an average of 22,700 full-time equivalent students, 6,600 part-time students, 1,350 full-time faculty members, and 600 part-time adjunct faculty members. Small institutions reported and average of 1,400 full-time equivalent students, 500 part-time students, 100 full-time faculty members, and 100 part-time adjunct faculty members. The numbers of employees, including faculty, staff, and students, at large, medium, and small institutions were 10,600, 2,800, and 650, respectively.
The student-faculty ratio was 18:1 for large institutions, 17:1 for medium institutions, and 13:1 at small institutions. While not particularly relevant for tax purposes, the numbers show that the student-faculty ratios at large and medium institutions are about the same. Anyone interested in smaller classes should consider a small institution. Note, however, that large institutions averaged less than half as many adjunct faculty members as full-time faculty members, whereas small institutions averaged about the same number of full-time and part-time adjunct faculty members.
The questionnaire asked whether conflict of interest policies were in place for a private institution's governing body, top management officials, and full-time faculty. For public institutions, the questions pertained to applicable statutes governing conflicts of interest for the governing body, top management officials, and full-time faculty. Most private and public institutions had conflict of interest policies or statutes pertaining to governing bodies and top management officials. Many institutions also had policies or statutes pertaining to full-time faculty members.
Financial Data. The institutions receiving the questionnaire reported excess revenue from $11 million for small institutions to $87 million for large institutions for 2006. Based on the barrage of publicity about diminishing revenues and dwindling endowment funds of educational institutions, these figures are not representative of excess revenues in 2008 through 2010.
International Activities. With regard to international activities, 83% of the large institutions and 54% of the medium institutions conducted educational programs outside the U.S. Only 30% of small institutions conducted foreign educational programs. Most of the institutions did not maintain offices, campuses, or employees in at least five foreign countries.
Related Organizations. The percentages of institutions with related entities were 96% for large organizations, 82% for medium organizations, and 45% for small organizations. Thus, a significant number of colleges and universities have related entities. Most of the related entities were tax-exempt supporting organizations, such as separate fundraising organizations or organizations holding an endowment. Other related organizations were taxable corporations and trusts, disregarded entities, and partnerships. Relatively few institutions own related taxable organizations. The percentages of institutions having related organizations taxable as partnerships were only 3% for small institutions, 5% for medium institutions, and 7% for large institutions. For related organizations taxable as corporations or trusts, the percentages were 11%, 13%, and 21%, respectively. The propriety of transactions between a specific institution and its related entities is important; however, the relative paucity of institutions with related taxable organizations may indicate that the potential for abuse from transactions between institutions and related taxable entities is not as great as the IRS may have suspected.1
With regard to written policies regarding arm's-length transactions with related entities or, in the case of public institutions, specific state statutes that address arm's-length transactions with related entities, about one half of the large institutions were governed by such policies or statutes. In contrast, fewer than 30% of the medium institutions and fewer than about 12% of the small institutions were governed by such policies or statutes. Currently, colleges and universities are not required to have policies or applicable statutes concerning arm's-length transactions with related parties. Based on the survey, it is possible that the IRS may wish to take some action on this issue. One possibility is that a policy or statute may raise a presumption that related party transactions are made at arm's length, requiring the IRS to prove that a particular transaction was not at arm's length.
Controlled Organizations. Colleges and universities were required to indicate on the questionnaire the number, if any, of organizations that were controlled by the institution within the meaning of §512(b)(13). The IRS compared the number of controlled organizations stated on the questionnaire with the number of institutions reporting income from a controlled entity. Whereas 38 large institutions reported having at least one controlled entity, only 10 reported income from a controlled entity. Similarly, 29 medium institutions reported having at least one controlled entity, but only 13 reported income from a controlled entity. For small institutions, 31 reported having at least one controlled organization, but only nine reported income from a controlled entity.
Note: For large, medium, and small organizations, 86, 57, and 47, respectively, reported having no controlled organizations. Three large and three medium institutions reported 10 to 25 controlled organizations. Four large institutions reported more than 25 controlled organizations.
According to the Report, the IRS recognizes that not all controlled organizations generate reportable income for the controlling organization. Nevertheless, the across-the-board differences in the numbers of institutions with controlled organizations and the numbers reporting income from a controlled organization suggests "a possible reporting inconsistency that will be reviewed further." It is likely that whether an institution has a controlled entity and whether an institution reports income from a controlled entity will be red flag issues going forward. Because colleges and universities may not even be aware of the issues concerning controlled entities, practitioners may want to delve deeper into the organizations with which an institution has transactions to determine whether any are controlled organizations of the institution. In addition, the practitioner may determine whether income from such controlled organizations is being reported as unrelated business income as required by §512(b)(3).
As to written policies or applicable statutes regarding arm's-length transactions between educational institutions and controlled organizations, a little less than one half of large institutions reported having them in place. Around 20% of medium institutions and less than 10% of small institutions had policies or statutes in place. Roughly the same percentages of large institutions reported having at least one controlled organization and reported having policies or statutes on place. For medium and small institutions, the percentages indicating at least one controlled organization were greater than the percentages indicating policies or statutes in force. As noted above in reference to policies of and statutes governing related organizations, such policies or statutes are not currently required. It is likely that the IRS will focus more attention on policies and statutes regarding arm's-length transactions in the future. The prudent approach is for all institutions to adopt such written policies, whether or not they have any controlled organizations.
Press Release IR-2010-58 (5/7/10).
Sample Compliance Questionnaire – Colleges and Universities.
Interim Report on Colleges and Universities Compliance Project.
Executive Summary of Interim Report (May 2010).
For more information, in the Tax Management Portfolios, see Stophel and Gorsline, 482 T.M., Tax Issues of Educational Organizations, and in Tax Practice Series, see ¶6510, Charitable Organizations and ¶6520, Other Tax-exempt Organizations.
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