Tax Takes a Front Seat
Ongoing scrutiny of higher education institutions is driving stronger tax compliance efforts. Fostering interaction between tax directors and the business office can move effective tax management to the head of the class.
By Apryl Motley
Irvine is referring to one of several elements of the Internal Revenue Service’s “compliance project” focusing on colleges and universities and launching this year. Part of the effort is a detailed questionnaire that the IRS will send to 400–500 four-year public and private institutions. The questionnaire will ask recipients to respond within 90 days with information about unrelated—and potentially unrelated—business income activities, executive compensation, and endowments. The IRS also plans to conduct a number of large-scale audits of institutions.
In addition, by year’s end, the IRS will have wrapped up a major overhaul of the annual information returns filed by 501(c)(3) organizations. The Form 990, which has been redesigned and vastly expanded, will require institutions to report more data than ever on everything from conflict of interest policies to how endowments are invested.
And, in terms of the way endowments are spent, former Senate Finance Committee chair and ranking committee member Senator Charles Grassley (R-IA) along with other members of Congress have for more than a year explored a possible mandatory payout from endowments of greater than $500 million.
All this activity is a continuation of the past several years’ surge of interest in greater transparency and disclosure by nonprofits in general. Congressional inquiry into well-publicized abuses in the nonprofit world spurred closer scrutiny of the governance and self-regulation of exempt organizations. The early 1990s saw the IRS expanding its enforcement activities and rolling out comprehensive audits of colleges and universities. Since that time, higher education institutions have gradually taken a more strategic approach to tax compliance and administration.
While many institutions still do not have a campus administrator dedicated solely to tax, the role of tax manager has become progressively more relevant. As the IRS and lawmakers continue to scrutinize tax-exempt organizations—including higher education institutions—colleges and universities are putting more resources into in-house tax teams or hiring the services of external counsel and tax accounting firms.
In an environment of public, congressional, and press attention on the cost of college, federal officials are continuing to take a close look at how institutions fulfill and live up to their exempt purposes and missions. Chief business officers, tax managers, and other institution leaders should expect for the foreseeable future that they will need to boost their internal compliance efforts and think long term about their strategic approach to tax management.
Preparing for What’s Next
True to Irvine’s prediction, some institutions have been placed in the spotlight. “The University of Minnesota has already been audited by the Internal Revenue Service,” says Kelly D. Farmer, who has served as university tax director for the past seven years. “As a result, most units affected by the audit are very sensitive to tax issues, and those units look to the tax manager to receive guidance on how to address issues with tax consequences. We have found that the environment within the community is generally compliance-conscious.”
If you’re still thinking your institution’s chances of getting audited are slim, think again, says David Carson, vice president for business and finance, Armstrong Atlantic State University, Savannah, Georgia. “No one is exempt from being audited,” he says. Even small schools get audited, such as Washington & Jefferson College, Washington, Pennsylvania, where Carson recently served as vice president for business and finance and chief financial officer. “Your time will come,” he says. Like many smaller institutions, Washington & Jefferson does not have a separate tax department. “The accountants in the finance department also were responsible for tax compliance,” Carson notes. After the college was audited, “we increased our staff education and maintained better documentation.”
When audit time does come, there is no such thing as being too prepared. “Schools are doing a lot better job [with tax compliance] than 10 years ago,” says Mike O’Neill, manager of payroll and tax services for the University of California (UC) System, “but even if you think you’re prepared, there will be some surprises. Think of everything, and then some.”
Yet, there are institutions that take a less-focused approach to tax compliance. “Some organizations wait for a crisis before they do anything,” says Barbara Morris, director of tax and payroll at Johns Hopkins University in Baltimore. “That wait-and-see attitude,” says Morris, “is getting riskier when it comes to dealing with tax issues, especially as the IRS and Congress focus more attention on tax-exempt organizations.” To increase tax awareness at Johns Hopkins, business officers from its divisions attend regular meetings to discuss any new initiatives they may be considering that may have tax implications. By creating an awareness of tax rules, especially unrelated business income (UBI), the university reduces its tax risk.
Setting the Tone for Tax
The approach and level of commitment of a chief business officer to keeping up with tax issues ultimately influence how others at an institution will respond to their roles in managing this area. According to Edward Jennings, tax manager at the University of Michigan, one of the first steps to managing tax compliance effectively is for business officers to determine how much risk their institutions are comfortable with.
“You’ve got to check your tax tolerance,” says Jennings. “What’s the appropriate standard for your institution? What are your expectations, and what levels of expertise do you need on staff to meet them? Managing tax can run the spectrum from completing tax returns to identifying risks and liabilities.” Once a business officer has determined where his or her institution fits in the spectrum, the next step is to develop a plan for ensuring that tax gets the attention it requires based on the identified objectives. “Fortunately,” says Jennings, “my bosses understand the importance of tax. When you’re working at an exempt organization, people have to understand that doesn’t mean you’re exempt from tax.”
Timothy P. Slottow, the university’s executive vice president and CFO, has been supportive of Jennings’s efforts to raise awareness about tax compliance. “One of the ways that we’ve been most successful is in making sure that questions about tax get asked,” says Slottow. “I always ask my peers about tax because it likely impacts almost every decision that we make. Then the question usually is, who can help me with these issues? The answer is Ed [Jennings], who listens, understands their departments’ business, and is consultative in his approach.”
The university hired Jennings 10 years ago as its first tax manager. According to Slottow, comprehensive IRS audits in the early 1990s likely contributed to the decision to hire a dedicated tax manager. “Once your institution has been audited,” he says, “a long period of follow-up is likely. It’s important to retain institutional knowledge, so it made sense economically for us to have an in-house expert.” While Slottow acknowledges that every institution may not need a dedicated tax manager, he emphasizes that “CFOs must have a working knowledge of tax risks that affect almost every area of their business, from human resources to sponsorships. Risks are so prevalent that exposures should be assessed in terms of lowest to highest probability.”
On his side of the equation, Jennings has spent much of his time building rapport with senior management. “I consult directly with Tim [Slottow] on tax issues throughout the year, and we meet at least once a year for an overall update or checkup,” says Jennings. “Typically, for our update, I develop a four-page agenda for the meeting, trying to connect the dots so that [Tim] understands the issues and can communicate them to others. As a result, he encourages staff to seek me out and ask questions.”
Many of the inquiries Jennings receives pertain to departments seeking possible ventures or affiliations with private parties or units to broaden their academic programs through international activities. Other issues that arise include review of purchase agreements for the application of taxes (state sales taxes or foreign taxes, such as value-added taxes) or questions regarding the income tax implications of conducting a certain activity, such as selling T-shirts on the quad.
The University of Minnesota, Twin Cities, has taken a similar approach to tax compliance. Kelly Farmer reports directly to Richard Pfutzenreuter, vice president, chief financial officer and treasurer. “We have regular meetings to address significant tax matters,” says Farmer. “I also engage him whenever there is an issue that has wide institutional impact or risk.” After hearing about Jennings’s success with setting up a similar group at the University of Michigan, Farmer established a tax committee to address significant tax issues. “The members of this committee become de facto compliance partners in tax matters,” says Farmer, “which further enhances and fortifies the role of tax compliance within the university.” According to Farmer, his reporting structure puts the tax agenda on a visible plane with other issues that Pfutzenreuter manages.
“Of course, other university constituents—particularly the general counsel’s office—are key components of tax compliance as well,” says Farmer. Morris at Johns Hopkins has developed a good relationship with her institution’s legal counsel as a way to stay on top of new developments that relate to taxation. “The office often calls to gauge our concerns about contracts from a tax perspective,” says Morris. “Our rule of thumb is, ‘Let’s talk before the papers are signed.’ You can’t undo what’s already been done.”
Morris notes that while reviewing documents or initiatives with her department is still sometimes an afterthought for other staff, the situation has improved as awareness of tax issues has increased. “The biggest obstacle that we have to overcome is people simply not thinking about this,” says Morris. “We’re often in the background, and the position responsible for tax needs to be in the mainstream of the university’s operations.”
UC’s O’Neill, who works in the system’s president’s office, advises that the tax office “needs to report to higher-level staff so that departments understand that it’s important to listen to tax professionals.” In doing so, fellow staff receive guidance on accomplishing compliance in a timely manner. “Tax is a very important issue that should have a high profile on campus because of the potential financial exposure of colleges and universities,” says O’Neill. If tax managers report directly to the CFO or CBO, that gives them access to the institution’s senior management team to address high-risk areas and activities.
As was true at his former institution, Carson’s current staff working on tax issues report directly to him, preparing him to regularly brief the board of trustees’ audit committee on significant developments. According to Carson, as higher education institutions review their overall enterprise risk management strategies, “more attention will be placed [on] tax compliance and staff reporting at the institutional level, to the president and the board.”
In sum, interaction between senior administrators and tax directors—and commitment to providing interoffice access—can equal effective tax compliance. “You’ve got to create awareness,” says Irvine, “so that people know where to go to report or raise concerns about potential risks. Institutions need to invest in the tax function and be more proactive than reactive.”
Perhaps Dominic Daher, director of internal audit and tax compliance at the University of San Francisco, summarizes it best: “For an institution of our size, the single most important factor in effective tax compliance is having the tax director report directly to either the CFO or the president. Without such a reporting structure, sound tax compliance initiatives are frequently not given high-enough priority.”
Managing Compliance Effectively
Once you’ve created awareness of and commitment to tax compliance, the next steps include establishing the ongoing communications and processes needed to keep up with changes in regulations and related compliance requirements and deadlines.
Be in the know. It’s not easy to keep up with regulations and their potential impact on existing or new projects. “Because Hopkins is decentralized,” says Morris, “we have a hard time knowing all that is really going on. As institutions come up with new ways of generating revenue, tax risk has the potential to grow; our analysis of the issues must increase as well.” Whether you create a tax department or not, she says, “you need to have someone focused on tax. It’s essential with all the rules that are in play.” To keep up with new and revised regulations, Hopkins subscribes to an Internet-based tax research service that provides daily updates via e-mail.
“[UC] gets audited enough that I don’t have a problem convincing folks that tax is important,” says O’Neill. “But you have to make sure that regular updates keep the staff current with tax issues.” To this end, O’Neill distributes throughout the UC system a monthly tax e-newsletter that includes articles and clippings from a variety of tax sources.
In addition, Anne C. Broome, vice president of financial management, meets once a month with the various UC campus controllers. “At those meetings, Mike [O’Neill] provides us with regular updates on the status of the IRS audits and other tax issues confronting the university,” notes Broome. “He also coordinates this information as part of the regular meetings of campus payroll and accounts payable managers, which he chairs.”
As the IRS has raised the bar on disclosure and the compliance process in general, the UC System has invested more resources in managing tax. “We’ve hired a tax professional who supervises a separate tax group under Mike’s supervision,” says Broome. “In the past, Mike’s staff was assigned both payroll and tax functions. Now, a separate group will be dedicated to tax.”
Involve others. O’Neill also makes it a point to “get on the agenda at key staff meetings” so he can address managers. While he does not meet with a formal tax committee, O’Neill regularly updates his direct supervisor and the vice president of finance. He also interacts frequently with the university’s general counsel, who often consults with him about tax-related issues. In addition, semiannual institutes, says O’Neill, “bring UC business officers together to increase their awareness of a host of financial and compliance issues, including tax.” While some complain and ask why they need to know about tax, “we try to convince them of its importance in a 60-minute presentation focused on the main issues.”
At the University of San Francisco, Daher hosts training sessions for various groups on campus to brief them on current issues. For example, in California, nonprofits are generally subject to sales tax. However, certain regulations exempt from taxation electronically downloaded software, as long as no tangible property (such as a compact disk) is included with the purchase. “Accordingly,” says Daher, “I’ve worked with our information technology and purchasing departments to help ensure that we are downloading all of our significant software purchases.” This initiative alone has saved several thousand dollars annually for the university.
Hire the best. “The most important tools in managing tax compliance,” says Daher, “are competent professionals on staff with a strong understanding of tax issues.” Along with skill, adds Daher, “make sure that the tax office has sufficient staffing and adequate funding. It is also extremely helpful for the tax office to be brought in as a partner when discussing new initiatives that have tax implications.”
Value internal knowledge. Increased awareness brings the realization that higher education institutions remit a huge amount of taxes to different agencies. “We’re responsible for a lot of dollars,” says O’Neill, which is the primary reason he doesn’t believe in outsourcing the tax function. “An outside accounting firm will not catch everything,” says O’Neill, “and you will overlook problems. Tax administration, from preparing tax forms to checking the latest compliance requirements, is something you must be actively engaged in. You learn more about your institution by doing it yourself.”
Ohio State University’s Irvine concurs that, while institutions may rely on outside accounting firms for some functions, it’s important not to lose institutional knowledge. “CFOs may think they’re covered as long as they have someone come in once a year to complete audits and returns,” he says, “but a firm can’t know what’s happening on campus on a day-to-day basis. You need someone on your staff who knows your institution and raises the issues that you need to address.”
When he first arrived at the University of Michigan, Jennings took on just such an internal role. He developed a tax committee, which meets twice a year to gain knowledge and create awareness. Its core members are representatives from the university’s legal, internal audit, compliance, and human resources departments. “It’s important to leverage other people’s knowledge, skills, and materials,” says Jennings. “You have to make others at your institution ambassadors for tax. You can be as centralized as you want to be, but one person cannot do it alone.”
Be an advocate. Jennings acknowledges that while committee meetings open the door, “you can’t rely on just that.” To raise the profile of tax issues, Jennings attends departmental meetings to make presentations that help colleagues learn more about spotting and addressing tax matters. “You can invite me to dinner or not, but I’m coming one way or another,” says Jennings of his outreach efforts. He believes that the more visible the tax function, the more likely people will make the presumption that they should always consult with him before launching a new project. “It’s a never-ending battle. You have to put yourself out there and be visible as a resource.”
Relationships clearly count. “The most effective compliance components I have are my relationships with key people at the university,” says Farmer. “They help me do my job, and I strive to give them the respect and appreciation they rightly deserve. I believe everyone wants to do things right, but sometimes people need help in knowing what the right thing is.”
Seek institutional support. One of the most critical factors in managing tax compliance effectively is getting a stamp of approval from senior administrators. “The CFO must support and encourage our efforts,” underscores Jennings. “The whole beauty of tax management is that it serves as another control measure and, for that reason, has great value.”
Forecasting the Future
Moving forward, you can count on more of everything, says David Carson—“more audits, more complications, and more scrutiny of higher ed. Managing tax compliance will become increasingly complex,”he predicts. “Nonprofits are being scrutinized more by government leaders, and the public is asking for more accountability from the tax-exempt organizations. You have to continue to educate people and invest in staff. Now, more than ever, you’ve got to communicate about taxes and policies throughout your institution.”
As more colleges and universities consider international activities, global tax issues are also rising in importance. The University of Minnesota, notes Farmer, has been involved in setting up a foreign subsidiary in the European Union as well as operations in Hong Kong, India, Africa, South America, and China. “Staying on top of international tax compliance has been a challenge,” he says. “The tax director has been aggressive in holding the general counsel’s office and the study abroad office accountable for noncompliance.” Similarly, at Johns Hopkins, Morris says, “We’re just beginning to scratch the surface of the global issues as they relate to business registrations and in-country employment regulations for study abroad programs and research programs conducted in other countries.” Additional key areas include compensation for faculty and staff traveling and living abroad, foreign bank accounts, satellite campuses, and international business rules.
Colleges and universities will be challenged to provide a consistent message about tax compliance that not only meets regulatory requirements but satisfies public opinion. Between the public and Congress, the desire for ever-increasing disclosure is strong. “Audits will increase because everyone wants more transparency,” says O’Neill. “Making tax returns public goes with the trend toward open disclosure.”
“The next five years are going to be a challenge,” observes Jennings. “We’re going to see much more reporting and, most likely, more examination. We’re now going to be under the microscope. Our time has arrived.”
APYRL MOTLEY, Columbia, Maryland, covers higher education business issues for Business Officer.
|Tips for More Effective Tax Management|
Here are some important areas and issues to consider as you review the state of tax compliance at your institution.
Consider how best to support the overall tax compliance effort. “Our goal is to be 100 percent in compliance with all tax policies and to be transparent to our constituents,” says David Carson, vice president for business and finance, Armstrong Atlantic State University, Savannah, Georgia. “The senior-level administrators are all responsible for ensuring compliance, and the vice president for finance is responsible for disseminating laws and regulations to those responsible for following them.”
Think about how you will involve the board. “We regularly report to the audit committee of the board on tax issues,” says Carson. “We also keep the committee and board informed of tax news that is important to higher education and the related work that NACUBO is doing.”
Don’t tell people what they can’t do. That’s rarely an effective approach. “Initially, nobody likes the tax manager,” says Edward Jennings, tax manager at the University of Michigan. To change this, he recommends, “Instead of starting off with a negative response to an idea that has tax implications, be open-minded and try to seek common ground. As with any business relationship, nobody is going to come to you when they think that you’re going to say no.” Timothy P. Slottow, the university’s executive vice president and CFO, adds: “Ed is really good at positioning himself as a strategic enabler. Deans actually do talk to each other, and word of mouth builds confidence in the process over time.”
Add appropriate processes to meet the increased standards driven by heightened scrutiny and new regulations. “We attend training sessions on tax issues,” says Carson, “and discuss them with our external auditors. We also have our 990 return reviewed by several accountants at the college, the external auditor, and the audit committee.”
Actively search for potential problems. Exempt organizations often have to work to find their issues. “You have to get out of the fishbowl,” says Jennings, “and seek people who can tell you what you don’t know.” For instance, to determine independent contractor classifications, Jennings needed to understand the operational process to know which party—purchasing, payroll, the school, or a combination thereof—decides whether an individual is an employee or an independent contractor.
“That part of the process was a point of risk,” says Jennings, “but I was able to educate the appropriate people and provide them with a toolkit to help make the best tax decision.” Understanding the institution and its operational processes comes from everyday activities, including attending meetings, lectures, and forums; reading the school’s newspaper; or surfing its Web site.
Join a peer group of tax professionals. You don’t want to be too far ahead of or behind the curve. To answer the perennial question, “How are other institutions addressing a particular tax issue?” the staff from the University of Minnesota belong to a tax peer group, which consists of tax professionals from 12 other large research universities. “We meet every year,” says Kelly D. Farmer, the university’s tax director, “to see how other institutions are addressing their tax issues. This provides great resources to take back to our home institution.”
Leave no stone unturned in reporting unrelated business income. “Higher education is unique from for-profit enterprises,” says Farmer, “in that items for inclusion on the UBI tax return need to be identified before they are reported. There is always a risk that items may go unnoticed,” he says. “For this reason, we make a point of visiting outlying areas of the university and attending functions to identify activities that may need to be reported on the Form 990-T.”
Be prepared for a very detailed audit. IRS examiners are moving to greater use of technology tools and asking for detailed documentation. Be prepared to do electronic data mining to gather information and generate reports for the auditors. In addition, consider the following:
|Select Tax Resources From NACUBO|
To learn more about the following resources, visit www.nacubo.org, select “business topics,” and then click on “tax.”
Peer Networking and Training
NACUBO’s Tax Listserv. To join an online discussion group of more than 550 campus tax professionals, send an e-mail to the list administrator, email@example.com, requesting instructions on how to join the NACUBO tax list. Only employees of higher education institutions may participate.
Annual Tax Forum, Nov. 16–18, 2008; Westin Michigan Avenue Chicago. Hear briefings on a host of tax issues, including the redesigned 2008 Form 990 and the Internal Revenue Service’s compliance initiative focusing on college and university unrelated business income tax, executive compensation, and endowments.
Unrelated Business Income Tax Workshop, Feb. 18–20, 2009; Las Vegas. Discuss the current issues related to UBIT facing institutions.
Tax webcasts. Available on demand, these presentations are given by and designed for chief business officers, controllers, tax directors, and general counsel. The average webcast length is 100 minutes. Visit www.nacubo.org/x1573.xml to register.
A Guide to Federal Tax Issues for Colleges and Universities (a NACUBO publication available at www.nacubo.org/x1675.xml). The reliable place to turn for current information on IRS compliance, this annual subscription service includes quarterly updates and monthly newsletters. As an extra benefit, you’ll receive Federal Tax News for Colleges and Universities, an informative monthly newsletter, written by Bertrand M. Harding, a tax attorney who advises higher education institutions.
The Tax Law of Colleges and Universities, Third Edition (available at www.nacubo.org/x3512.xml). This book is a comprehensive tax resource for higher education and its highly complex structures, including research labs, cafeterias, bookstores, travel tours, and more. The text examines the IRS audit guidelines, discusses strategies for successful handling of an audit, and provides updates on unrelated business income, fringe benefits, and employment tax obligations.
Process Guide to 1098-T Reporting, Third Edition (a NACUBO publication available at www.nacubo.org/x1657.xml). This is the only reference you’ll need to ensure your institution is in compliance with the Hope and Lifetime Learning tax credits under the Taxpayer Relief Act of 1997. This bestselling guidebook provides a detailed explanation of the reporting requirements as well as a process for complying with them, answers to frequently asked questions, and sample documents you can modify for your institution’s use.
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