[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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______
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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.
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Note: All Committee advisories and news releases are available on
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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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