    [House Hearing, 113 Congress]
    [From the U.S. Government Publishing Office]

                    INTERNAL REVENUE SERVICE'S COLLEGES AND
                        UNIVERSITIES COMPLIANCE PROJECT

    =======================================================================

                                    HEARING

                                   before the

                           SUBCOMMITTEE ON OVERSIGHT

                                     of the

                          COMMITTEE ON WAYS AND MEANS
                         U.S. HOUSE OF REPRESENTATIVES

                        ONE HUNDRED THIRTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                  MAY 8, 2013

                                   __________

                               Serial No. 113-OS4

                                   __________

             Printed for the use of the Committee on Ways and Means

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                          COMMITTEE ON WAYS AND MEANS

                         DAVE CAMP, Michigan, Chairman

    SAM JOHNSON, Texas                   SANDER M. LEVIN, Michigan
    KEVIN BRADY, Texas                   CHARLES B. RANGEL, New York
    PAUL RYAN, Wisconsin                 JIM MCDERMOTT, Washington
    DEVIN NUNES, California              JOHN LEWIS, Georgia
    PATRICK J. TIBERI, Ohio              RICHARD E. NEAL, Massachusetts
    DAVID G. REICHERT, Washington        XAVIER BECERRA, California
    CHARLES W. BOUSTANY, Jr., Louisiana  LLOYD DOGGETT, Texas
    PETER J. ROSKAM, Illinois            MIKE THOMPSON, California
    JIM GERLACH, Pennsylvania            JOHN B. LARSON, Connecticut
    TOM PRICE, Georgia                   EARL BLUMENAUER, Oregon
    VERN BUCHANAN, Florida               RON KIND, Wisconsin
    ADRIAN SMITH, Nebraska               BILL PASCRELL, Jr., New Jersey
    AARON SCHOCK, Illinois               JOSEPH CROWLEY, New York
    LYNN JENKINS, Kansas                 ALLYSON SCHWARTZ, Pennsylvania
    ERIK PAULSEN, Minnesota              DANNY DAVIS, Illinois
    KENNY MARCHANT, Texas                LINDA SANCHEZ, California
    DIANE BLACK, Tennessee
    TOM REED, New York
    TODD YOUNG, Indiana
    MIKE KELLY, Pennsylvania
    TIM GRIFFIN, Arkansas
    JIM RENACCI, Ohio

            Jennifer M. Safavian, Staff Director and General Counsel

                      Janice Mays, Minority Chief Counsel

                                     ______

                           SUBCOMMITTEE ON OVERSIGHT

                 CHARLES W. BOUSTANY, Jr., Louisiana, Chairman

    DIANE BLACK, Tennessee               JOHN LEWIS, Georgia
    LYNN JENKINS, Kansas                 JOSEPH CROWLEY, New York
    KENNY MARCHANT, Texas                DANNY DAVIS, Illinois
    TOM REED, New York                   LINDA SANCHEZ, California
    ERIK PAULSEN, Minnesota
    MIKE KELLY, Pennsylvania

                                C O N T E N T S

                                   __________

                                                                       Page

    Advisory of May 8, 2013 announcing the hearing...................     2

                                    WITNESS

    Ms. Lois Lerner, Director, Exempt Organizations Division,
      Internal Revenue Service, Testimony............................    42

                           SUBMISSION FOR THE RECORD

    The Colleges and Universities Compliance Project Final Report....     6

                       MATERIAL SUBMITTED FOR THE RECORD

    Questions For The Record:

    Rep. Kenny Marchant..............................................    62

    INTERNAL REVENUE SERVICE'S COLLEGES AND UNIVERSITIES COMPLIANCE PROJECT

                                  ----------

                             WEDNESDAY, MAY 8, 2013

                 U.S. House of Representatives,
                           Committee on Ways and Means,
                                     Subcommittee on Oversight,
                                                        Washington, DC.

        The Subcommittee met, pursuant to call, at 2:00 p.m., in
    room 1100, Longworth House Office Building, the Honorable
    Charles Boustany [Chairman of the Subcommittee] presiding.
        [The advisory of the hearing follows:]

    HEARING ADVISORY

     Boustany Announces Hearing on the Internal Revenue Service's Colleges
                      and Universities Compliance Project

    1100 Longworth House Office Building at 2:00 PM
    Washington, May 1, 2013

        Congressman Charles W. Boustany, Jr., M.D., (R-LA), Chairman of the
    Subcommittee on Oversight of the Committee on Ways and Means, today
    announced that the Subcommittee will hold a hearing on the Internal
    Revenue Service's (``IRS'') Colleges and Universities Compliance
    Project Final Report. The hearing will take place on Wednesday, May 8,
    2013, in Room 1100 of the Longworth House Office Building, beginning at
    2:00 P.M.

        In view of the limited time available to hear witnesses, oral
    testimony at this hearing will be from invited witnesses only. However,
    any individual or organization not scheduled for an oral appearance may
    submit a written statement for consideration by the Subcommittee and
    for inclusion in the printed record of the hearing. A list of invited
    witnesses will follow.

    BACKGROUND:

        On April 25, 2013, the IRS released the final report of its
    Colleges and Universities Compliance Project. Based on responses to a
    questionnaire distributed to over 400 tax-exempt colleges and
    universities, the IRS audited a sample of 34 colleges and universities
    identified as at risk for noncompliance. The report focused on
    compliance rates among colleges and universities in the following
    areas: (1) unrelated business income tax (``UBIT''), (2) executive
    compensation, and (3) employment tax issues.

        During its 4-year investigation, the IRS found significant
    noncompliance and underreporting of UBIT by over 90 percent of the
    audited schools, with income adjustments of about $90 million, and loss
    disallowances of over $170 million. The primary increases to UBIT were:
    disallowed expenses that were not connected to unrelated business
    activities, errors in computation or substantiation of losses, and the
    misclassification of unrelated activities as exempt. With the colleges
    and universities compliance project completed, the Subcommittee will
    review these audit findings, with an eye toward reform. In its review
    of executive compensation and employment tax issues, the IRS found
    colleges and universities setting compensation in the upper bounds of
    what is permissible, and all of its employment tax examinations
    resulted in adjustments.

        In announcing the hearing, Chairman Boustany said, ``Given the
    importance of nonprofit colleges and universities, it is critical that
    the Subcommittee continue its review of this segment of the tax-exempt
    sector. The IRS's colleges and universities compliance project suggests
    widespread noncompliance. The Subcommittee has an obligation to explore
    the root of these alarming findings on the audit of our Nation's higher
    education providers. This hearing is an excellent opportunity to
    discuss the results of the compliance project and examine areas for
    improvement in oversight, with an eye toward comprehensive tax
    reform.''

    FOCUS OF THE HEARING:

        The hearing will focus on the findings of the IRS's Colleges and
    Universities Compliance Project final report and will examine the
    causes for the widespread noncompliance found through the audit among
    tax-exempt colleges and universities.

    DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

        Please Note: Any person(s) and/or organization(s) wishing to submit
    written comments for the hearing record must follow the appropriate
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    waysandmeans.house.gov, select ``Hearings.'' Select the hearing for
    which you would like to submit, and click on the link entitled, ``Click
    here to provide a submission for the record.'' Once you have followed
    the online instructions, submit all requested information. ATTACH your
    submission as a Word document, in compliance with the formatting
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    22, 2013. Finally, please note that due to the change in House mail
    policy, the U.S. Capitol Police will refuse sealed-package deliveries
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    technical problems, please call (202) 225-3625 or (202) 225-5522.

    FORMATTING REQUIREMENTS:

        The Committee relies on electronic submissions for printing the
    official hearing record. As always, submissions will be included in the
    record according to the discretion of the Committee. The Committee will
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    written comments must conform to the guidelines listed below. Any
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        1. All submissions and supplementary materials must be provided in
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    record.

        2. Copies of whole documents submitted as exhibit material will not
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        3. All submissions must include a list of all clients, persons and/
    or organizations on whose behalf the witness appears. A supplemental
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        The Committee seeks to make its facilities accessible to persons
    with disabilities. If you are in need of special accommodations, please
    call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
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        Note: All Committee advisories and news releases are available on
    the World Wide Web athttp://www.waysandmeans.house.gov/.

        Chairman BOUSTANY. This Subcommittee will come to order.
    Welcome to this hearing on the IRS' final report on its
    Colleges and Universities Compliance Project. Over the last 2
    decades, tax-exempt organizations have grown increasingly
    complex in their organizational structures and operations. This
    has made it more difficult for the IRS to conduct oversight of
    the sector. Lending to this complexity is the prevalence of
    profit-generating arms and investment activities within the
    tax-exempt organizations that may be subject to unrelated
    business income tax, or UBIT.
        Colleges and universities have been at the forefront of
    this trend toward greater complexity and the expansion of for-
    profit activities. These institutions have evolved to meet
    changing needs of students, but also have engaged in activities
    that are not ordinarily associated with higher education's tax-
    exempt function. Indeed, colleges and universities are a huge
    part of the tax-exempt sector. They generate a disproportionate
    level of tax-exempt revenue and hold a disproportionate
    quantity of tax-exempt assets.
        In number, colleges and universities represent just 0.5
    percent of the tax-exempt sector but generate more than 11
    percent of the revenue of charitable organizations, nearly $160
    billion in annual revenue, and they hold over $150 billion in
    assets, which is more than 21 percent of the entire charitable
    sector's assets.
        Given the significance of colleges and universities to the
    tax-exempt sector and the compliance difficulties that can be
    associated with such a large concentration of assets and
    revenue, the IRS launched the Colleges and Universities
    Compliance Project to review compliance in this area. The
    project began in 2008 with the IRS sending questionnaires to
    400 randomly selected colleges and universities. The IRS then
    selected 34 of the 400 institutions for further examination
    based on questionnaire responses and Form 990 reporting, which
    suggested possible noncompliance.
        The IRS' examinations focused on under-reporting of UBIT,
    executive compensation, and employment taxes. The final report
    was issued on April 25th of this year. The IRS found almost
    universal noncompliance by some of the most sophisticated
    organizations in the tax-exempt sector. Noncompliance included
    widespread calculation errors and misreporting, 90 percent of
    the 34 institutions had their UBIT calculations adjusted upward
    for a total increase of around $90 million. The adjustments
    came from misreporting income from activities likes facility
    rentals, fitness centers, fitness center operation, golf
    courses as well as the improper classification of loss-
    generating activities as trade or businesses to offset for-
    profit income.
        While the UBIT rules like many tax rules may involve
    uncertainties, these findings may suggest deeper problems with
    the classification of for-profit activities by colleges and
    universities. Additionally, the report found that many
    institutions were unreasonably compensating top officials. In
    all, wage adjustments totaled around $36 million, with over $7
    million in corresponding taxes and penalties.
        Today, we will hear testimony from Lois Lerner, Director of
    IRS' Exempt Organizations Division. I look forward to hearing
    her views on this troubling report and look forward to taking a
    deeper look at the issues that have been raised. And so I want
    to thank our witness, Ms. Lerner, for being here with us today.
    And with that I will yield to the distinguished Ranking Member
    from Georgia, Mr. Lewis.
        Mr. LEWIS. Thank you, Mr. Chairman. Mr. Chairman, I want to
    thank you for holding this hearing. Today, we will review the
    results of an Internal Revenue Service project on colleges and
    universities. Colleges and universities play an important role
    in our society. They educate our young people and create our
    work force for the future.
        I am honored to have many colleges and universities in my
    district. We have wonderful institutions in metro Atlanta:
    Spelman, Morehouse, Georgia State University, Clark Atlanta
    University, Georgia Tech, and Emory University, to name just a
    few. They are training the next generation of scientists,
    doctors, and engineers. They also provide many positive
    benefits to their local communities.
        I understand that many colleges are large and complex
    organizations. They have sports program that enrich their
    student body and raise revenue for the university. They may
    engage in activities such as advertising and operating golf
    courses, as the chairman stated, that may generate income
    subject to Federal tax.
        The range of their activities is diverse. I commend the
    Internal Revenue Service for taking a closer look at these
    organizations and groups. Projects like this are positive for
    both the agency and the universities. They are useful tools for
    educating each other.
        As we move toward tax reform, it is important that we all
    understand how colleges and universities operate and comply
    with the Federal tax laws. The agency report helps us begin
    this process. I look forward to hearing from our witness today.
    I am pleased that she is here to discuss what the agency
    learned from this report.
        Thank you. And like the chairman, I welcome you.
        And I yield back, Mr. Chairman.
        Chairman BOUSTANY. I thank the gentleman.
        Chairman BOUSTANY. And now it is my pleasure to introduce
    our witness today, Lois Lerner. Ms. Lerner is Director of the
    Exempt Organizations Division at the Internal Revenue Service
    and has been since 2006. Before her appointment, Ms. Lerner was
    Director of the Exempt Organizations Ruling and Agreements
    Division.
        Ms. Lerner, I want to thank you for joining us today, and
    you will have 5 minutes to give your oral testimony. The
    subcommittee has received your full written statement. That
    will be made part of the formal record.
        At this time I also ask unanimous consent to enter into the
    record the final report of the IRS' Colleges and Universities
    Compliance Project. And without objection, it is so ordered.
        [The Colleges and Universities Compliance Project Final
    Report follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman BOUSTANY. Ms. Lerner, you are now recognized for 5
    minutes. Thank you.

       STATEMENT OF LOIS LERNER, DIRECTOR, EXEMPT ORGANIZATIONS
                   DIVISION, INTERNAL REVENUE SERVICE

        Ms. LERNER. Thank you, Chairman Boustany, Ranking Member
    Lewis, and the Members of the subcommittee. I appreciate the
    opportunity to come and talk to you today. My name is Lois
    Lerner and I am the Director of Exempt Organizations at the
    Internal Revenue Service, and I am here today to discuss with
    you what we have learned in our recent examinations of tax-
    exempt colleges and universities. These examinations were the
    final phase of a multiyear project that began in 2008 with the
    distribution of a wide-ranging questionnaire to 400 public and
    private colleges and universities.
        IRS has a very good relationship with the college and
    university sector, so we asked the National Association of
    College and University Business Officers for input in designing
    the questionnaire so that the recipients would understand the
    questions and we would get the best information. Responding to
    the questionnaire was voluntary and the response rate was about
    97 percent.
        There were no big surprises in these responses. We saw a
    high level of good governance practices and policies, general
    use of the rebuttable presumption and executive compensation
    setting, and a significant amount of unrelated business
    activity.
        After reviewing the responses, along with the
    organizations' 990s and 990-Ts, we selected 34 institutions for
    examination, concentrating on unrelated business income and
    executive compensation. We have completed almost all of these
    exams and released our final report last month. Please keep in
    mind that the schools examined don't represent a statistical
    sample, so the results are not attributable to all colleges and
    universities; and also, because section 6103 of the Internal
    Revenue Code prohibits disclosure of taxpayer information, the
    report and my comments are not taxpayer specific.
        So what did we find in these exams? Significant under-
    reporting of unrelated business taxable income. Taxable income
    from unrelated business activities was under-reported at 90
    percent of the schools we examined and the amount totaled about
    $90 million. Amounts were under-reported for 30 different types
    of activities, but the majority of adjustments were made from
    only five, and those were fitness and recreation centers and
    sports camps, advertising, facility rental, arenas, and golf
    courses.
        In total, the IRS disallowed more than $170 million in
    losses in net operating losses, which could result in more than
    $60 million in tax liability for the impacted organizations.
    The most common reasons for these adjustments were that in
    about 70 percent of the schools they were reporting activities
    on their 990-T that didn't qualify as a trade or business
    primarily because they generated continual losses over a
    protracted time period.
        Second, on 60 percent of the forms 990-T examined, colleges
    and universities offset income from unrelated business
    activities with expenses that were not directly connected to
    the activities.
        The third problem area involved net operating losses, which
    are losses reported in 1 year that can be used to offset income
    in other years. On more than a third of the returns examined,
    the schools had either improperly calculated the net operating
    losses or the losses were not substantiated.
        Fourth, nearly 40 percent of the schools incorrectly
    classified activities as exempt or otherwise not reportable on
    the 990-T, and after the IRS reclassified these, there was
    about $40 million in income coming from unrelated activities
    that was now subject to tax.
        We also looked at compensation. Section 4958 of the
    Internal Revenue Code requires that public charities, including
    private colleges and universities, pay no more than reasonable
    compensation to their officers, directors, trustees, and key
    employees. It also imposes a tax on covered individuals who
    receive unreasonable compensation and on the organizational
    managers who approved the compensation. An organization can
    shift the burden of proving unreasonable compensation to the
    IRS if it follows the rebuttable presumption process, and under
    that it must use an independent body to review and determine
    the amount of compensation, rely on appropriate comparability
    data, and contemporaneously document the process.
        Although we found that most of the colleges and
    universities use the rebuttable presumption process to set
    their compensation, at about 20 percent of the schools the
    comparability data was not appropriate, which means that those
    schools failed to establish a rebuttable presumption.
        Problems with the compensation data included data from
    supposedly comparable schools that were not similarly situated,
    compensation studies that didn't specify the selection criteria
    for the supposedly comparable schools, compensation surveys
    that didn't specify whether the compensation amounts they used
    were limited to salary only or included the total of other
    types of compensation as required by Section 4958. We also
    looked at the amounts of compensation paid to top management
    officials and other college and university employees, and that
    information is included in the report.
        Mr. Chairman, Ranking Member Lewis, let me thank the
    Subcommittee again for this opportunity to discuss the report,
    and I would be happy to answer any questions.
        Chairman BOUSTANY. Thank you, Ms. Lerner.
        [The prepared statement of Ms. Lerner follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Chairman BOUSTANY. The final report notes that very few
    colleges and universities sought outside advice about the
    treatment of potentially unrelated business activities, and
    when they did, they frequently received incorrect advice. So I
    have a few questions regarding that. First, do you have any
    thoughts on why such a small number of these universities and
    colleges failed to seek outside advice? Are there any insights?
        Ms. LERNER. I really don't know other than the fact that
    they are large organizations and oftentimes large organizations
    have inside resources.
        Chairman BOUSTANY. Okay. Are you concerned about the high
    frequency of incorrect advice that colleges and universities
    did indeed receive?
        Ms. LERNER. I think it is very important to keep in mind
    that part of our project was to provide information to folks
    about what the rules are and how they play out. If we are
    seeing that high level of concern with regard to folks who are
    actually seeking information, that means we could probably do a
    better job of explaining the rules to them.
        Chairman BOUSTANY. Okay. Because, thirdly, colleges and
    universities and advisers were frequently wrong about the
    classification of activities, allocation of expenses related to
    activities, and it kind of suggests or indicates that the rules
    are not well understood or that the institutions, maybe they
    are taking advantage of ambiguities in the law or some
    combination of the two. Could you comment further?
        Ms. LERNER. Sure. I think in this area everything is very
    facts and circumstances. You have to look at all of the factors
    in a particular institution that is making that judgment. What
    we did not see was organizations that didn't seem to have a
    thought-out reason for classifying things the way they
    classified them. But it is very factual related and there were
    disagreements between the IRS and the organizations, and I
    think by putting this report out and doing some other work
    around the issue, that we can probably benefit the college and
    university sector as well as the exempt sector in general.
        Chairman BOUSTANY. What are your next steps?
        Ms. LERNER. Well, these are very, very narrow exams. As I
    said, there are only 34, and they were selected because they
    appear to have some potential for noncompliance. So we have
    already started a second unrelated business income project. We
    are looking at organizations that are reporting unrelated
    business activity on their 990s but they are not filing a 990-
    T. We think that is problematic. That is going on this year and
    we are already developing our projects for next year, which
    will include, I think, a more expansive project that goes
    beyond a particular part of the sector to see if these same
    issues are apparent across the sector.
        Chairman BOUSTANY. Thank you. And we will look forward to
    following up with you on that as it evolves.
        It no secret that the Ways and Means Committee this year is
    looking at tax reform and looking to rewrite the Tax Code.
    There is a consensus that the Tax Code is too complicated for
    many taxpayers and what we need are real solutions for a broken
    Tax Code. This report contains some troubling details about
    tax-exempt organizations and how they report unrelated business
    income and determine executive compensation.
        If the Committee were to consider changes in these areas,
    does the report suggest that there are structural problems with
    the tax-exempt sector or perhaps more targeted changes should
    be contemplated in the Code?
        Ms. LERNER. Again, I think that it is really important for
    us to get more information than just these 34 organizations,
    because they were selected because of potential noncompliant
    activity. I would like to gather more information more broadly
    to see where the real issues are that could be addressed before
    changes were made.
        Chairman BOUSTANY. Do you have a timeframe on that?
        Ms. LERNER. The project that I mentioned, it is already
    ongoing, began in this fiscal year. With examinations, it is
    somewhat difficult. You can't really predict when they will be
    completed. But we are trying to look for ways that we can
    provide information during projects rather than waiting until
    the end of the project.
        It is sometimes difficult because in the beginning of the
    project you might see an issue that doesn't carry through and
    you don't want to give a misimpression that, oh, my goodness,
    this is going on across the sector, when in fact it is not. But
    we will try to get information out to the public as quickly as
    we can.
        Chairman BOUSTANY. I thank you.
        Now I am pleased to yield to my friend, Mr. Lewis.
        Mr. LEWIS. Thank you very much, Mr. Chairman.
        Ms. Lerner, I want somehow in some way for you to clarify
    the report's finding regarding unrelated business income tax
    and compensation. Maybe in your response to the chairman you
    covered this. The report notes that 34 colleges and
    universities were selected from a pool of 400 for examination.
    Were these colleges a valid sample of all colleges and
    universities? Are there any assumptions that can be made based
    on these examinations regarding the practice of all colleges
    and universities?
        Ms. LERNER. The questionnaire was a statistically valid
    sample, so that can be looked at as how colleges and
    universities in general act. With regard to the examinations,
    it was not a statistically valid sample, so the results really
    only apply to the 34 organizations that were examined.
        Mr. LEWIS. Do you think from this examination, from this
    study, that you learned something or came across something that
    would be helpful to the IRS in other nonprofit charitable
    groups when you investigate or conduct an examination?
        Ms. LERNER. Yeah, I think we did. The compensation piece is
    not our first crack at compensation. We have been looking at
    this for some time. There have been allegations of
    inappropriate compensation in the tax-exempt arena for quite
    some time.
        Our first study on this was across the board. It looked at
    small, large, medium-size organizations, as well as private
    foundations and public charities. We did not find rampant
    improper compensation, but we did see some areas that created
    issues for us, and so we have continued that view.
        And I think the compensation piece that we saw here with
    regard to the rebuttable presumption and the use of comparables
    is an important one. This is the first time we have actually
    looked beyond the fact that the organizations were using
    comparables to see whether the comparables were really, in
    fact, comparable. And when I speak to groups about this, what I
    caution the board Members and the executive directors about is,
    don't just accept the report from a compensation consultant,
    you need to ask them questions about this, because it can be
    done correctly and obviously the organizations are trying to do
    it correctly. So that is one piece that I think would apply
    across the board.
        Mr. LEWIS. Sometimes you read reports, news reports by way
    of radio or television where a college president, a university
    president has been paid a certain salary and maybe the football
    coach is being paid much more. Do you look at things like that?
        Ms. LERNER. We do, and we did look at it here when we
    gathered information about how people were being paid. But
    there are separate rules for individuals that fall under
    Section 4958 of the code than there are for other individuals.
    So Section 4958, where I talked about the rebuttable
    presumption of reasonableness, in a private charitable college
    under 501(c)(3), the pay for everyone has to be reasonable. The
    law requires that it be reasonable, that charitable dollars go
    for charitable purposes.
        How you get to the reasonable is by looking at other like-
    situated organizations, people who are in the same part of the
    country, who have the same level of responsibility, who did the
    same kinds of jobs with a similar size organization. You look
    at those, and if you can find comparable jobs, then you look at
    what those people are getting paid and that is the way that
    organizations do set the compensation.
        The rebuttable presumption process and the excise tax,
    however, do not apply; only applies for officers, directors,
    trustees, key employees, and their families. It does not apply
    for a sports coach or an investment manager. They would not
    fall under that.
        Mr. LEWIS. Suppose you have a board member of a college or
    university, a private college, a small college or university,
    and this particular board member goes out and raises millions
    of dollars, and they want a certain amount earmarked for a
    certain department, for a certain professor, or for the coach.
    How do you examine something like that?
        Ms. LERNER. I am sorry. Could you say it again? I missed
    part of the question.
        Mr. LEWIS. So, as a member of the board of trustees, okay,
    and this member maybe is head of a foundation and said we are
    going to make a grant to this department or to the sports arm
    of the university to compensate the coach, to compensate a
    particular head of a particular department.
        Ms. LERNER. There are totally separate rules for that. What
    I am looking at here is how do you determine the compensation
    for that trustee for what the trustee is doing as a trustee?
    There are lots of other rules about how organizations and other
    foundations can provide compensation for an employee of the
    university outside of the university context, but that wasn't
    what we were looking at here.
        Mr. LEWIS. Thank you very much.
        Mr. Chairman, I yield back.
        Chairman BOUSTANY. Thank you. Ms. Jenkins.
        Ms. JENKINS. Thank you, Mr. Chairman. Thank you for holding
    this hearing.
        Ms. Lerner, thank you for being here.
        Your final report states that the IRS weighted the data
    contained in the interim report so that the findings could be
    extrapolated to give a sense of the characteristics,
    activities, and tax reporting of colleges and universities,
    both private and public, regardless of their size. Can you
    briefly describe how the information was weighted, like what
    factors you took into consideration? And from the final report
    findings, is it possible to describe any trends in
    noncompliance? Does it depend on the college size, whether it
    is public, private, or some other variable?
        Ms. LERNER. Well, let me start with the last part of your
    question first. In terms of noncompliance, remember the
    questionnaire was not an examination. The questionnaire was
    asking them for information. Based on that information, when we
    went out initially with the questionnaire, we divided the
    colleges and universities into three groups, small, medium and
    large, depending upon their student size, because we thought
    they would probably look different. So we wanted to get
    information along those lines.
        Then when we got all of the information in, we had a
    conversation with the people in our office who do statistical
    analysis and research. I am not expert in that area. And what
    they said to us was: Very nice study and very nice information,
    but because of the way that you asked the questions and divided
    up the groups, you can't say anything across the board, you can
    only talk about those groups. So the weighting was done by
    statisticians, whatever magic mumbo jumbo they do to do that,
    so that we could say overall the college and university sector
    looks like this in this particular area.
        We did not find a great difference when we did the
    weighting than we had seen in the small groups. So we did it
    because we thought it would be important to be able to make
    broad statements, but it really didn't make a difference.
        Ms. JENKINS. Okay. And the final report also notes that
    with regard to the compensation data, weighting the results
    produced meaningful results at the entity level but not broken
    down to individuals. Can you just further explain what that
    means and what impact it should have on our understanding of
    the compensation section?
        Ms. LERNER. Well, first of all, when you look at an
    organization, you have to see what type of job they have. So if
    you are looking at 20 different jobs in the organization, we
    did not break it down to those 20 different jobs, but we looked
    at the organization as a whole and said, is this organization
    using the processes and providing reasonable compensation, what
    kinds of things are they looking at, and how are they going
    about this. That is what we meant by the entity level, the
    organization as a whole, not particular jobs within the
    organization.
        Ms. JENKINS. Okay. Thank you.
        Mr. Chairman, I yield back.
        Chairman BOUSTANY. Thank you.
        Mr. Davis, you are recognized for 5 minutes.
        Mr. DAVIS. Thank you very much, Mr. Chairman.
        And thank you, Ms. Lerner.
        Let me ask you, were there special characteristics of the
    34 institutions that you used as your sample?
        Ms. LERNER. If you mean by that question did we look at
    them because we saw particular aspects in them, the answer is
    yes. When we looked at the responses to the questionnaires and
    we looked at their 990s and their 990-T's, we were looking for
    organizations that were paying high levels of compensation, for
    example. We were also looking for organizations that appeared
    to have high levels of unrelated business activity, because
    those were the two issues we wanted to focus on and we were
    looking for organizations that we thought might have those
    issues and might have some problems. That is why the 34 doesn't
    represent a random sample of what the whole sector looks like.
        Mr. DAVIS. And so you really couldn't project with any high
    degree of certainty that this really becomes a problem across
    the board with colleges and universities throughout the
    country.
        Ms. LERNER. That is correct.
        Mr. DAVIS. I was just thinking, I represent about 30 or so
    colleges and universities, and I am wondering if maybe some of
    them may not really understand that they have got to be in
    compliance with certain kinds of rules and regs--I admit that I
    have sat on the board of a couple and I sometimes wondered how
    we arrived at paying our chief executives. Are there guidelines
    and is there guidance for institutions to use?
        Ms. LERNER. The rebuttable presumption is probably the best
    guideline they can use because it lays out the process they
    need to use to set the compensation, and if they follow the
    process and the IRS comes in to question the compensation, the
    onus is on the IRS to prove that it is unreasonable rather than
    on the organization to prove that it is reasonable.
        There are other ways of showing that you are paying
    reasonable compensation, but I believe that most organizations
    try to use that presumption because it is very clear what they
    have to do, and if they do it correctly, they are pretty safe.
        Mr. DAVIS. When it came to endowments, your report notes
    that 56 percent of total endowment spending was for scholarship
    awards, grants, and loans. Do you know about the rest or the
    other portion of the endowments, how they were spent?
        Ms. LERNER. I don't have that information with me today,
    but I can go back and see if we can get that information to
    your staff.
        Mr. DAVIS. I would appreciate that. And let me ask you,
    when discussing the 56 percent of distributions for
    scholarships, awards, and grants, is there an average endowment
    distribution or an average amount--I guess I am thinking some
    institutions have these great endowments where they get help
    and others have very low endowments or they don't really get
    much in the way of endowments. Is there an average across the
    board?
        Ms. LERNER. I think the other thing that is important to
    remember about the endowment information that is in the report
    is that we sent the questionnaire out in 2006. In 2008, when we
    had the economic downturn, I am guessing most of the
    information that we got in 2006 may have been impacted greatly
    by that. So there are some limitations to looking at that data,
    but we can provide your staff with what we have.
        Mr. DAVIS. All right. Thank you very much.
        Mr. Chairman, I yield back.
        Chairman BOUSTANY. I thank the gentleman. Mr. Marchant.
        Mr. MARCHANT. Thank you, Mr. Chairman.
        The report says that the IRS made over 180 adjustments to
    institutions' unrelated taxable income due to misreporting of
    income and losses. The majority of the adjustments came from
    sources like advertising, facility rentals, golf courses, and
    arenas. What income was being offset by losses from these
    operations is question one, and can you give us some specific
    examples of that?
        Ms. LERNER. Probably I can't answer question one today
    because I don't have it at the top of my head, but we would be
    happy to go back and try and get that information to you. Let
    me make sure I understand exactly what you were asking. Could
    you repeat it, please?
        Mr. MARCHANT. Well, what income was being offset by the
    losses?
        Ms. LERNER. It varied in the institutions. Let me go back.
    There were about 30 different types of unrelated activities
    across the institutions, and the reason that I mentioned the
    five that I did was because most of the issues that we saw were
    in those five. I think, though, that they were in those five
    because if you look at the questionnaire results, you will see
    that those were the five activities that the most organizations
    conducted anyway. So you had a much larger number of
    organizations doing these activities, so it wasn't surprising
    that there would be issues there.
        With regard to what they would be offsetting, the unrelated
    business income rules allow a tax-exempt organization to
    conduct its exempt activity and it doesn't have to pay any
    taxes on that. With regard to activities that are not related
    to its exempt purpose, so you have got a college and its exempt
    purpose is to train folks and to teach folks, so that is all
    related. If you have----
        Mr. MARCHANT. Let's say they have a golf course.
        Ms. LERNER. Right. Let's take the golf course. The golf
    course can be related under the right circumstances, but it
    might be a mixed use. So if your students who are training for
    your golf team are using the golf course, that would be related
    to your educational mandate. If on the other hand you are
    allowing your students to use it and your faculty to use it,
    but you also allow memberships from outside individuals, the
    money that you get from those outside individuals to use it is
    unrelated to your educational responsibilities, and so,
    therefore, it becomes taxable. So in one organization, one type
    of activity, you could have both taxable and nontaxable
    activity and you can allocate your expenses among those.
        But let's take the golf course. Let's say you had a golf
    course that was making lots of money, which is not what we saw
    here, but if you had a golf course that was making lots of
    money and it was unrelated, you would owe taxes on that. But
    you also have a parking lot, which is also not related, but you
    are losing your shirt on that parking lot. You can offset the
    gains in the golf course with the losses from the parking lot.
    That is how you get to what you have to pay tax on.
        Mr. MARCHANT. In a consolidated statement.
        Ms. LERNER. In a consolidated way, yes. It is no different
    than a taxable business. Taxable business may do lots of
    different things and it has all this big pile of gain and it
    has a whole bunch of deductions and it applies the deductions
    against the gain and the bottom line is what you have to pay
    taxes on.
        Mr. MARCHANT. What role do outside auditors play in the
    function of auditing these consolidated statements? I mean,
    they have to have independent auditors that come in and audit
    the books. Do the auditors certify the accuracy of the
    compliance of the tax return?
        Ms. LERNER. I don't know the answer to that question. I
    would imagine that they certify to something, but I am not sure
    the accuracy is what they are certifying to. I am not the right
    person to answer the question.
        Mr. MARCHANT. So you have got big accounting firms, if
    these are big universities they have got undoubtedly a big
    accounting firm that has come in and audited their financial
    statements. And I serve as a trustee of a small university, so
    I rely pretty heavily, when I go to the meetings, on those
    audited statements. But this university has no outside entity,
    so I wouldn't worry about it. But if I were a trustee of a big
    university, I would want the auditor to certify, to also
    certify that the university was compliant in its tax returns,
    and maybe some education at that level might help.
        Ms. LERNER. Thank you.
        Mr. MARCHANT. Thanks.
        Chairman BOUSTANY. I thank the gentleman.
        Mrs. Black, you are recognized.
        Mrs. BLACK. Thank you, Mr. Chairman.
        And thank you, Ms. Lerner. This is a very interesting
    report. I am interested in the chicken or the egg kind of thing
    here. What led you all to do these audits? Was it the
    questionnaire that you got back in conjunction with the 990s or
    did you have the 990s and you saw some things on there and sent
    questionnaires out?
        Ms. LERNER. It was the first. We do questionnaires a lot.
    Colleges and universities or other large organizations, we
    can't do a lot of audits of them in a particular year, and even
    if we do and we learn something, it is difficult for us to
    share that with anyone because it is specifically taxpayer
    related. So we use the questionnaires to go out broadly to ask
    either a particular part of the sector about its activities, or
    if we have got a particular issue like compensation that
    crosses the sector, we will go out and ask questions about the
    issue.
        Then, to use our resources in the most efficient way, we
    use the answers to the questionnaires and the 990s, and in this
    case the 990-T, to narrow down the field so that we can pick a
    much smaller number to audit and get more information on.
        Mrs. BLACK. Tell me, what is a 990-T? I am familiar with a
    990, but I am not familiar with a 990-T.
        Ms. LERNER. Very good question. The 990 is the annual
    return that any tax-exempt organization has to file.
        Mrs. BLACK. Right.
        Ms. LERNER. If one of these organizations has unrelated
    business income over $1,000, then they file a separate form,
    which is the 990-T. It is really an income tax form, which is
    unusual in the tax-exempt world.
        Mrs. BLACK. Right. Right. So given what you have seen here,
    whether it is just a lack of education or maybe someone in the
    department not being aware of how to do this properly, and what
    you have found in the university study, are you now going to
    use this in other sectors of nonprofits that have 990s as well?
        Ms. LERNER. Yes. I think it is very important to broaden
    this out and see what kind of activities are going on in other
    tax-exempt organizations because this was a homogenous group.
    We want to look farther, and we are developing a project for
    our next year's work plan that will do just that.
        Mrs. BLACK. I know these were only 34 universities.
    Obviously there are a whole lot more of those, of universities
    across this country that might be looked at. Are you drilling
    down any deeper now that you have seen certain things that are
    apparent, to go back and look at some of these other
    universities to see if they are--because I know you are saying
    that this is not statistically significant because of the way
    in which it was done. But are you trying to do anything to go
    back and look and say, let's try to do something and really
    figure out whether this is pervasive across the industry,
    whether this is just misunderstandings or non-education or
    whatever?
        Ms. LERNER. I think that some of those organizations, other
    colleges and universities may be included in this larger study
    that I was talking about, which will look broadly across the
    sector. So we may be looking at more of them.
        Mrs. BLACK. Okay.
        Thank you. I yield back.
        Chairman BOUSTANY. Thank you.
        Mr. Crowley.
        Mr. CROWLEY. Thank you, Mr. Chairman. And I appreciate
    particularly Ms. Black's statements in terms of what the focus
    of the investigation was and whether or not it will be
    broadened out beyond colleges and universities. Because I think
    it is laudable in terms of ensuring that folks under the status
    are actually abiding by the requirements of that status and not
    abusing that. So I welcome that.
        I want to thank you as well, Ms. Lerner, for the swift
    approval of the nonprofit status for the Empire State Relief
    Fund, a charitable nonprofit founded by Governor Cuomo in the
    aftermath of Hurricane Sandy. We appreciate the IRS' quick
    action on that.
        I understand that after the tragedy some unscrupulous
    dealers would set up phony charities from time to time with the
    aim of personally enriching themselves, so it takes some time
    for the IRS to vet each charity. I suspect that Governor Cuomo
    passed the test for being expedited. I am pleased that you did
    expedite that request for the Empire State Relief Fund
    nonprofit status.
        Second, with respect to the study--and to somewhat follow
    up on Ms. Black's line of questioning--you have done on
    colleges and universities, how many of these colleges and
    universities have law schools? Do you know?
        Ms. LERNER. I don't know the answer to that question.
        Mr. CROWLEY. So you wouldn't know if they had them, if they
    were accredited? So you don't have that answer?
        Ms. LERNER. I do not know that.
        Mr. CROWLEY. It would be interesting to see if those that
    have law schools would know whether or not they themselves
    would know they are in violation of any of the provisions. But
    seriously, this investigation is notable for what you
    uncovered, and I think we are all disturbed by what you have
    discovered in terms of the abuse within college and university
    systems.
        On that topic, Ms. Lerner, as the Director of the IRS
    Exempt Organizations Office, your office covers a wide range of
    areas outside, as Ms. Black was alluding to, the college and
    university systems, including business leagues and chambers of
    commerce. Is that correct?
        Ms. LERNER. That is correct.
        Mr. CROWLEY. My question is, if there is a large national
    umbrella business league that receives its income from
    collecting dues from its corporate Members, the dues paid by
    those corporate Members to the umbrella business league would
    generally be something the Member corporations could deduct on
    their corporate income taxes. Is that correct?
        Ms. LERNER. That is correct.
        Mr. CROWLEY. Now, if the business league used those
    deductions for political purposes, such as partisan campaign
    ads, those funds would no longer be deductible by the
    Membership corporations. Is that also correct?
        Ms. LERNER. That is right.
        Mr. CROWLEY. When was the last time the IRS looked into the
    actions of these large tax-exempt business chambers to ensure
    that they are not spending their Members' dues on political
    activity?
        Ms. LERNER. Well, they are allowed to spend their Member
    dues on political activity, but they have a responsibility. The
    responsibility is either to notify the Members that they cannot
    deduct the entire amount of the dues, or if they want to take
    the obligation upon themselves, they can pay the tax for this
    nondeductible activity. So the law does provide for covering
    both of those aspects.
        Mr. CROWLEY. I appreciate that, but I am concerned that
    some of these business chambers are skirting Federal tax laws
    and putting their corporate Members and the American job
    creators in legal jeopardy with the IRS to push a certain
    partisan viewpoint that doesn't reflect all the Members of
    their Membership or the American public.
        I would urge the IRS to undertake an investigation
    immediately into this sector to ensure that when corporations
    pay their dues to these chambers of commerce, that there is an
    accounting of the receipts of these business leagues to ensure
    that every dollar that corporate members give and deduct are
    not used for political purposes.
        And finally, in the summer of 2012 it was reported that the
    IRS was going to undertake a similar investigation into the one
    taken here on colleges and universities on political entities
    that fund political campaign ads that were taking donations
    anonymously and are tax exempt. These are the folks that put on
    hundreds of millions of dollars in campaign ads in 2012
    elections, all with no accountability and with taxpayer
    subsidy.
        This hearing highlights certain compliance problems in the
    tax-exempt sphere, and I hope the IRS aggressively looks into
    these political and business leagues to see if they are abusing
    the tax-exempt status. I don't want to speak for the chairman
    or for the Ranking Member, but I know my constituents in Queens
    do not want their tax dollars being used to subsidize political
    campaigns. I suspect neither do any of the Members on this
    panel.
        So, Ms. Lerner, if you could comment briefly on the status
    of the IRS investigation into these political not-for-profits,
    I would appreciate that as well.
        Ms. LERNER. Well, there was a questionnaire that began this
    discussion and there is also a questionnaire out there, you can
    look at it on our Web site right now, that is seeking
    information from section 501(c)(4), (5), and (6) organizations,
    and a big piece of that questionnaire relates to their
    political activities. So that is our beginning.
        Mr. CROWLEY. I appreciate that. Thank you.
        And thank you, Mr. Chairman.
        Chairman BOUSTANY. I appreciate the gentleman's line of
    questioning, and this hearing was focused specifically on the
    report dealing with colleges and universities. But I know there
    is considerable interest on both sides of the aisle on this
    subcommittee to look at other areas of the tax-exempt sector,
    and it is my intent to do so as we go forward. But I certainly
    appreciate the gentleman's line of questioning.
        Mr. Reed, you are recognized.
        Mr. REED. Thank you, Mr. Chairman.
        And thank you, Ms. Lerner, for being here today. I reviewed
    your report, and I am going to veer off a little bit into an
    issue because we have already covered a lot of issues in
    relationship to how that impacts IRS and things like that. But
    just so I can clearly understand the data that you compiled
    here when it comes to compensation of folks at these
    educational institutions, for the key employees and the
    officers, directors and trustees, what was the average salary
    you found for those individuals?
        Ms. LERNER. I am going to have to look in my book.
        Mr. REED. Please do. I have got it in front of me, but I
    want this on the record.
        Ms. LERNER. Are you talking about the questionnaire or in
    the exam?
        Mr. REED. The exam. At the conclusion of your reports, I am
    going to ask you some data questions, because the data is
    amazing to me.
        Ms. LERNER. Uh-huh. The compensation for top managerial--
    oh, I am sorry. I am looking at the wrong thing.
        Mr. REED. I believe it is on page 4, but I will let you.
    You may have it differently.
        Ms. LERNER. No, I am looking at something different. I
    apologize. I am looking at my notes, which are not going to
    match up with what you are talking about.
        So the average base salary for officers, directors,
    trustees, and key employees was $448,981, and the average total
    compensation was $561,135.
        Mr. REED. Okay. And then for the highly compensated non-
    ODTKEs, non-key employees, officers, directors, for investment
    managers what was the average compensation you uncovered there?
        Ms. LERNER. It was $894,214.
        Mr. REED. Sports coaches?
        Ms. LERNER. $884,746.
        Mr. REED. And then when you got into the actual faculties
    of these institutions, heads of the departments, what is the
    average compensation you found there?
        Ms. LERNER. Well, there were two different average
    compensations. It depended on whether the heads of the
    department were also medical doctors.
        Mr. REED. Medical doctors.
        Ms. LERNER. If they were not medical doctors it was
    $229,770, and if they were medical doctors it was $753,738.
        Mr. REED. And then the overall faculty level?
        Ms. LERNER. Again, there was a distinction between the
    medical doctor----
        Mr. REED. I understand the distinction between the two.
        Ms. LERNER. Do you want both numbers?
        Mr. REED. Yeah, both numbers would be great.
        Ms. LERNER. So for the non-medical folks, it was $215,854,
    and for the medical folks it was $575,632.
        Mr. REED. And admin/managerial.
        Ms. LERNER. Non-medical doctors $381,745, and medical
    doctors $462,872.
        Mr. REED. See, the reason why I asked you to do that,
    because it is amazing to me, as a person who is a firm believer
    in education and a degree and empowering people to control
    their own lives to get out of poverty, and when I have lived
    and seen the data where college tuition costs, data I have
    seen, public sector educational institutions have gone up over
    the last 10 years 104 percent; private institutions, 60
    percent. And we are dealing with an accessibility,
    affordability of college. When I see compensation levels like
    that, that jumps out at me as an area that needs to be
    explored.
        When you are talking about essentially $900,000 as the
    average in coaches and investment managers and $500,000 for the
    other folks, how in the world, given the increases of cost of
    college education in America, how do these institutions justify
    paying that level of salary?
        Ms. LERNER. The rules on salary are reasonableness and the
    rules on reasonableness are to compare the like positions to
    your position, and that is how they do it.
        Mr. REED. So if everybody raises the cost of the salary, if
    everybody increases the salary, and that is something that is
    going on in education and college institutions, from the IRS
    perspective that is reasonable. But from my perspective, as a
    person who still pays his law school debt every month, when I
    see salaries like that, that doesn't appear to me to be
    reasonable. It may be reasonable to colleges and universities
    and their club, but from a student's perspective that irritates
    me.
        And I know, Mr. Chairman, that is not the focus and the
    kind of scope of this hearing, but I think it is an issue that
    needs to be put out in the public domain, and students need to
    understand the level of compensation these institutions in
    America, who get positive treatment by the IRS, are paying
    their administrators, faculty, and managerial staff, as well as
    their key employees when it comes to officers, directors,
    trustees, and elsewhere. Thank you, Mr. Chairman.
        Chairman BOUSTANY. I thank the gentleman.
        With that, I would like to thank Ms. Lerner for being here
    today and for offering some insights into the report. And there
    will be plenty more questions, I am sure, going forward as you
    continue to look at this area and other areas of the tax-exempt
    sector, so we look to further meetings down the line. But we
    appreciate your insights today on these important issues.
        With that, the Subcommittee stands adjourned.
        [Whereupon, at 2:55 p.m., the Subcommittee was adjourned.]

        [Material Submitted for the Record]

                            Questions For The Record
                              Rep. Kenny Marchant

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