The Internal Revenue Service is conducting a major audit of the University of North Carolina at Chapel Hill and other higher education institutions. While neither university nor IRS officials will confirm any details, federal auditors most likely are scrutinizing executive compensation practices; determining whether the university is fully paying on all sources of taxable income at facilities such as the Carolina Inn, Finley Golf Course, and Rizzo Conference Center; and examining the university’s investment funds and procedures.
The audits may highlight a concern that entrepreneurs have aired about universities for decades: the advantage public and private universities can gain from owning commercial operations that compete with nearby private merchants and service providers.
UNC-Chapel Hill is one of more than 30 colleges and universities culled by the IRS from a pool of 400 public and private colleges and universities offering four-year degrees or higher that were requested to complete questionnaires for the tax year ending in 2006.
These compliance checks could result in more regulation of colleges and universities, tax experts say; they also could clarify existing reporting guidelines. The professionals say whatever policy actions ensue are likely to filter down to other tax-exempt organizations and associations outside of higher education.
The IRS is not divulging the names of the colleges and universities under audit. Lois Lerner, the IRS director of tax-exempt organizations overseeing the initiative, did not return numerous voicemail messages. Mark Hanson, an IRS spokesman for North and South Carolina, declined several requests to discuss the UNC situation.
However, UNC officials acknowledged that North Carolina’s flagship university is one of the more than 30 institutions the IRS acknowledges are being audited. As with the still-unresolved NCAA probe of the UNC football team, UNC officials won’t say much about the IRS compliance check and are releasing few records.
“I can confirm the university’s response to the audit notice is still in process. University officials decline further comment while the response to the audit is pending,” Mike McFarland, director of university communications, told Carolina Journal.
McFarland provided IRS 990-T tax return forms for the tax years ending in June 2007 and June 2010, and the official audit notice that UNC received from Michael A. Bieloski, IRS revenue agent and team coordinator.
“That’s all the information I have to provide,” McFarland said.
The tax return forms show UNC claimed $13,667,445 in gross unrelated business income profit for the year ending June 2007, with expense deductions of $12,594,668, rendering $1,314,545 taxable. Taxes on that amount were determined to be $446,945.
The 2010 form listed $12,196,276 in gross unrelated business income, $12,211,234 in total deductions, and minus-$14,958 in taxable unrelated business income.
In a letter dated Oct. 7, 2009, to Richard L. Mann, UNC vice chancellor for finance and administration, Bieloski said the examination of UNC records “will include the primary return” for the year ended June 30, 2008, “as well as related returns” that may include employee plans returns, excise tax returns, and employment tax returns. Discussions also were to focus on “controlled taxable subsidiaries and related exempt organizations and their relationship to the university.”
In an interim report based on the questionnaires submitted by colleges and universities, the IRS said, “The audits are designed to focus principally on unrelated business taxable income” — revenue generated from sources outside the tax-exempt core purpose of an entity.
“We see oftentimes organizations filing who say, ‘Yes, we have unrelated-business income.’ But when they file an unrelated business tax form with us, lo and behold, they never have to pay any tax,” the Chronicle of Philanthropy quoted the IRS’ Lerner as saying.
“If UNC is being audited right now, you’re talking a couple of years before there’s a finding,” said Marc Azar, a partner in the Atlanta-based Smith and Howard tax group. He is an expert in the nonprofit arena and on IRS Form 990.
UNC will be cautious and thorough in the process because “whatever they agree to will be precedent for future years,” Azar said.
Unrelated business income from corporate banquets, concerts and other events, advertising, endowments, foreign investments, stadiums, hedge funds, and how employees are categorized all could be under the microscope, he said.
“You keep pushing this stuff a little farther,” Azar said of how universities view new ways of generating income through their tax-exempt status. “We’re always thinking about raising revenue but not thinking about tax issues,” he said.
That paradigm is “like speeding at 85 when you know it’s 55. No one’s been getting tickets so no one’s going 55,” Azar said. Those practices will continue “until the IRS says, ‘No, you can’t do that’ or Congress says, ‘No, you can’t do that.’”
Azar said, “When they’re all done with this they are going to give us statistics” in a final report lumping together findings of all the individual audits. Specific findings at individual campuses may be impossible to determine.
He believes whatever policy changes are wrought for colleges and universities are “eventually going to permeate down to other entities.”
“Generally, what we’re anticipating is getting a little clearer guidance” from the final IRS report, said James P. Sweeney, national technical leader for the exempt organization tax practice of McGladrey and Pullen in Washington, D.C. “
Sweeney said his firm already is using markers from an IRS interim report based on completed questionnaires from colleges and universities to assist its clients, including other tax-exempt organizations.
From the interim report, the firm learned some entities were not seeking advice of outside counsel and some were recording no unrelated business activity at all, “which generally is looked upon as being unusual by the IRS,” he said.
Lisa Snell, director of education at the free-market Reason Foundation, has concerns about the IRS initiative.
“Generally, I think that anything that raises taxes on a select group is bad,” Snell said. “But on the other hand, if universities are wanting to compete in the commercial sector and they have a government-sanctioned, unfair advantage over other businesses” in the form of tax exemptions, tax policy reforms may be necessary.
“Regular taxpayers are contributing to the largess of those universities through all kinds of things,” she said, while the universities are “competing with the people who are funding them, and that seems problematic to me.”
Dan Way is a contributor to Carolina Journal.