TAX ISSUES IN
HIGHER EDUCATION
#Fin 2238
College Business Management Institute
University of Kentucky, Lexington, KY
August 1, 2008
Isabel Smidy, CPA, MST
Assistant Controller for Tax Compliance
Middlebury College, Middlebury, VT 05753
Tel. 802-443-2399 Fax 802-443-2123
WELCOME
2
KEY ELEMENTS
 Preserving
tax exempt status
loss of contributions, federal aid
 Minimizing



tax liability:
Institution
Employees
Donors/donor relationships
Topics for Discussion
 Payroll
and Employment Tax Issues
 Nonresident Aliens
 Employee vs Independent Consultant
 Fringe Benefits
 Accountable Plans
 Unrelated Business Income Tax (UBIT)
 Intermediate Sanctions
4
Topics for Discussion
 Tax
Exempt Bonds
 Charitable Contributions
 Lobbying and Political Activity
 Other Resources
 IRS Priorities for Nonprofit Review & Other
Legislative Agenda
 Risk Management Issues
5
Payroll and Employment Tax Issues
 Employment
Tax Responsibilities
Reference: IRS Pub 15 Circular E
 an employer-employee relationship (not
independent contractor)
 the payment of wages (settlements, N.Dakota case)
 the payment must be made with respect to
employment
6
Payroll and Employment Tax Issues
 Payment
and Reporting Obligations
 Electronically remit payments withheld
“If you accumulate $100,000 or more of taxes on any
day during a deposit period, you must deposit the tax
by the next banking day, whether you are a monthly
or semiweekly schedule depositor”

Report covered wages paid on Form 941
Employers Quarterly Federal Tax Return –
does not include wages of non resident aliens
which are treaty exempt.
7
Payroll and Employment Tax Issues

IRS Penalties





Filing late or incorrect information returns
If no $ is due have an additional 10 days
Filing late or incorrect payee statements
$50 per statement
Depositing tax withholding after the deadline
1-5 days = 2% Greater 15 days 15%
Not filing or depositing at all
Max penalty is 25% of taxes due
ER STILL RESPONSIBLE IF USING PAYROLL SERVICE.
ESTABLISH “REASONABLE CAUSE” INTEREST &
PENALTIES.
8
Payroll and Employment Tax Issues
 Income


Tax Withholding
On wages, salaries, and bonuses, unless a
specific exemption exists – not on treaty
wages of non resident aliens, or foreign
earned income exclusion
Fringe benefits not excluded by the IRC, such
as season tickets and personal use of
automobiles, spousal travel, and club dues
Employers Tax Guide to Fringe Benefits
Pub 15B
9
Payroll and Employment Tax Issues
 Graduate


Student Stipends
As payment for services rendered
As a grant, scholarship or fellowship
Need to allocate between the service
component and the scholarship component.
How much does your institution pay for similar
services to regular staff?
10
Payroll and Employment Tax Issues
Settlement Payments – Prior to Aug 1996 most settlements were tax free

Non-Reportable
 Payment based on tort
or tort-type rights
(injury or wrongful act)
 Personal physical
injuries or physical
sickness - IRC 104 (a) (2)

Reportable

Emotional distress

Attorneys’ fees
Prior to Comm. vs Bonds,
543 U.S. 426 the courts
were divided, the Supreme
Court settled the issue,
attorneys fee payment
represents taxable income
to the plaintiff thereby
imposing the withholding
requirement.
Twist: Newhouse vs McCormick, 157 F 3rd 582 (8th
Cir 1998) Ind. brought an age discrimination case
against a Prospective Employer, “rejected for the
position.” The court held that since the ind. was a job
applicant and not an employee, was not subject to
taxes.
11
Payroll and Employment Tax Issues
 FICA

Exclusions
Certain nonresident aliens
individuals in the US on F-1, J-1, M-1, or Q-1 visas qualify under
section 3121(b)(19) of the IRC
- Services performed for certain churches or
church-controlled organizations
 Student FICA exception
While regularly attending
classes
12
Payroll and Employment Tax Issues

Student FICA Exception

Primary Function of Institution
School, College, or University §31.3132(b)(10)-2 (2005)
formal instruction, regular faculty & curriculum, regularly enrolled student
body

Career Employees/Professional Employees - not eligible
•
•
•
•
•
•
Work >=40 hours per week regularly
Participate in Retirement
Required to be Licensed
Work requires advanced knowledge
Work requires discretion and judgment
Work is intellectual and varied
13
Payroll and Employment Tax Issues

Student FICA Exception
 Medical Residents
14
Payroll and Employment Tax Issues
 Worker

Classification
Originally IRS relied on the twenty common law
factors (Rev. Rul. 87-41)
 Behavioral Control
• Instructions
• Training

Financial Control
• Significant Investment
• Expenses
• Opportunity for Profit or Loss
15
Payroll and Employment Tax Issues (cont.)

Worker Classification (cont.)

Relationship of the Parties
•
•
•
•
Employee Benefits
Written Contracts
Services are a key aspect (Faculty, Coaches)
Permanency of the position
Penalties for misclassification, including payment of taxes that should
have been withheld
Relief under Section 530 of the Revenue Act of 1978.
Reasonableness, Case law.

Audit alert: The IRS is once again investing resources in this area.
The tax gap has been a driving force. Examiners will review for
persons receiving both a W2 and 1099. The good news is that the
IRM will be updated with the details.
16
Nonresident Aliens
Laws date back to the early 1960’s. Tax Reform Act of 1986 made
the most significant changes in terms of redefining the “sourcing”
rules of scholarships.
 Who
are Nonresident Aliens
Students, faculty, performers, lecturers



Tax residency status IRC 7701(b)
Green card test (Permanent Res. Treat Like a US person)
Substantial presence test (determines if you are an
NRA or a RA) current yr at least 31 days, previous 1/3 days,
second preceding 1/6 if sum is equal to or greater than 183=RA
17
Nonresident Aliens
 When

is Tax Withholding Not Required
Foreign-sourced income IRC 861-863
NRA students who are abroad on scholarships, Web and course
design outside of the US, work performed outside the US,
scholarships from outside US.

Internal revenue code exemption
Mostly qualified scholarships under IRC 117.

Exempt under an income tax treaty
Currently there are about 60 tax treaties.
18
Nonresident Aliens
Systems
that Process Payments Taxable to
NRAs
Student Accounts - Scholarships
Accounts Payable – Honorariums, Prizes,
Performers, Lecturers (Never on a Form 1099)
Payroll – Students and faculty

Gathering
data: FNIF
Audit activity: focused exams – open door
program. VCP.
19
Fringe Benefits
§ 132 Enacted 1984 (DEFRA ’84) “Deficit Reduction Act”
included the term “fringe benefit”
Any property or service (or cash under
certain circumstances) that an
employee receives from an employer,
in lieu of or in addition to regular
taxable wages, is a fringe benefit that
may be subject to taxation.
A statutory exclusion must exist in order for the benefit to not
be taxable..
20
Fringe Benefits




Reporting requirements
Penalties
Recordkeeping requirements – no records-taxable income
IRS audit activity
Employee benefits handbook
Union Agreements
Employment contracts (especially those of executives)
Corporate minutes
Chart of accounts
Written policies and procedures regarding fringe benefits
A/P Journal, G/L Accts that include ee benefits
Payroll Journal
Examiners will look at expense categories that are less obvious but may include
fringe benefits such as misc expenses, auto expense, ins & travel
reimbursements.
IRM 4,23, 5,11.5 (02-01-2003)
21
Fringe Benefits
 Examples
of benefits that may be entirely
or partially excluded from the taxable
income of an employee:


qualified undergraduate tuition reduction for
dependents §117
certain insurance, up to a certain level
• health and disability insurance; IRC 105
• group-term or other life insurance ($50,000 limit) IRC 79
• personal liability insurance
22
Fringe Benefits





Dependent care assistance (IRC § 129)
Use of athletic facilities, subject to certain conditions
Automobile allowances or use of an employer’s
automobile for business purposes
Travel benefits, including recruiting, fundraising,
attending conferences
Awards for length of service and safety achievement
The length of service and safety achievement awards must be
awarded as part of a “meaningful presentation”, Regs 1.274-8(3)
Less than $1,600 (cannot be cash) if written plan – no
management or executives
23
Fringe Benefits



Employer-paid transportation($115) or parking($220)
Free or discounted admission to university sponsored
events
Cafeteria plan benefits §125 Flexible spending accts
•
•
•
•
•

medical/dental/vision expenses
group term life insurance §79 greater $50k taxable
dependent care assistance
adoption assistance
http://www.benefitconsultinginc.com/Questions.htm
Moving and relocation expenses §217
IRS Pub 521 Form 3903 (meals, real estate, house hunting & temp
living expenses are taxable)
24
Fringe Benefits



Qualified Employee Discounts §132 ( c )
No Additional Cost Services §132(b)
Working Condition Fringe Benefits §132(d)
May be provided on a discriminatory basis. Employee can deduct on
return. Related to the employee’s work.

Di minimis Fringe Benefits §132(e)
Bookkeeping is a burden. The free turkey. Certificate is taxable, turkey not
taxable.
Qualified Moving Expense Reimbursements §132(g)
 Qualified transportation fringe benefit §132(f)
 Gifts (less than $15), Free Stuff (expensive door prizes),

25
Fringe Benefits

Employer-Provided Cars (listed property)

Employer-Provided Cell Phones (listed property). Current IRS
position, absent detailed substantiation, it will be 100% taxable to
the ee. If legs passes they will be treated like all other fringe
benefits including the desk phone. For latest developments check
H.R.5450 http://thomas.loc.gov.

Lodging & Meals Provided for the Convenience of the Employer
§ 119

Educational Assistance §127 Max $5,250

Employee Business Expense Reimbursements (Accountable Plans)
IRC 274(d)
-must be a business expense
-verify and substantiate
-return any unused portion
26
Accountable Plans

Business Connection IRC 162
The amount must be paid for business
expenses paid or incurred by the ee in
connection with the performance of services
on behalf of the er.
 Substantiation


Amount
Time and place of the travel, entertainment,
amusement, recreation, or use of the facility or
property, or the date and description of the gift,
27
Accountable Plans

Substantiation





Business purpose of the expense or other item
the business relationship to the taxpayer of
persons entertained, using the facility or property,
or receiving the gift
Expense advance must be reasonably calculated
to cover expenses
Employee must substantiate within 60 days
Must return unspent allowance within 120 days
28
Unrelated Business Income Tax
A little history…
Prior to 1950 tax exempt organizations could
engage in unrelated business activities. Then along
came NYU School of Law with it’s subsidiary the
Mueller Macaroni Company. Mueller Co. v.
Commissioner, 190 F.2d 120 (1951).

Income is from a trade or business “production of
income”

The trade or business is regularly carried on by the
organization (frequency, continuity, and how it is carried on)
 The trade or business is not substantially related to the
institution’s tax-exempt functions “mission”
29
Unrelated Business Income Tax
 Exceptions

Convenience businesses (laundry operated for
students)

Research (for the public interest-inc tech transfer to
private sector for testing)

Corporate Sponsorships (no substantial return
benefit other than the use or acknowledgment of the
name or logo – cannot say that coke is better than
pepsi)

Certain types of income (received in a passive
manner)
30
Unrelated Business Income Tax (cont.)
 Income


Exceptions
Investment income IRC § 512(b)(1) (interest,
dividends and annuity income)
Rent IRC § 512 (b) (2) (no not provide cleaning
services)


Royalty income (trademark, copyright)
Capital gains IRC § 512 (b)(5) (excludes all
gains or losses from the sale, exchange, or other
disposition of property)
31
Unrelated Business Income Tax
 Unrelated
Debt Finance Income
property held to produce income to which
there is acquisition indebtedness
32
Unrelated Business Income Tax
 Corporate

Sponsorships
Qualified Sponsorship Payments (money,
transfer of property, performance of service)

Substantial Return Benefit (exclusive provider
arrangement, goods, facilities, services, rights to
intangible assets)

Use or Acknowledgement (value neutral descriptions)
33
Unrelated Business Income Tax
 Corporate
Sponsorships
• Advertising not per se a return benefit
• Messages containing qualitative or
comparative language
• Price information or other indications of
savings or value
• An endorsement or an inducement to
purchase, sell, or use the products or
services
34
Unrelated Business Income Tax
 Corporate
Sponsorships
• Exclusive Arrangements
• Exclusive sponsorship
• Exclusive provider of goods and services

Internet Sponsorships (hyperlink with no other
information)

Periodicals (student run newspapers)
35
Unrelated Business Income Tax
 Travel
Tours – (if structured as an -
educational activity no UBIT (Rev Rul 70-534)
 Rental
of Facilities (if provide meals and
maintenance will be UBIT)
 Fitness
Facilities (who is being served & how much
is being charged)
36
Unrelated Business Income Tax

Reporting



Form 990-T
New public disclosure requirements
IRS Notice 2007-45
Quarterly payments
IRS Publication 598 UBIT
37
Intermediate Sanctions
 An


excess benefit transaction
is any transaction in which an economic
benefit is provided by an applicable taxexempt organization, directly or indirectly, to
or for the use of any “disqualified person,”
if the value of that economic benefit exceeds
the value of the services provided by the
disqualified person.
38
Intermediate Sanctions
 Applicable

tax exempt organization
501(c)(3) or 501(c)(4) tax exempt public
charity

Includes higher education

Does not apply to for profits
39
Intermediate Sanctions
 Disqualified




persons
Substantial influence
Family members
Entities in which any of the above own more
than a 35% interest
Facts and circumstances test
40
Intermediate Sanctions


Organization Managers
trustee, director, or officer, has similar powers to
trustees
Rebuttable Presumption of Reasonableness
IRS notice 2006-109
1. arrangement approved by an independent body - board
2. board obtained & relied on appropriate comparable data
3. Basis for determination was adequately documented


Tax Penalties to insiders and possible loss of tax
exemption
IRS Publication 557 Tax Exempt Status
41
Tax Exempt Bonds
 Arbitrage
– the act of making money w/ money.
Borrow at a
low rate at the taxpayer’s expense. With a few exceptions money
must be rebated to the gov.
 Private



Use Issues
501(c)(3) threshold - §145,
5% of net proceeds for
unrelated use including issuance costs
Governmental entity threshold -10% unrelated use
Issuance costs – capped at 2% counts twds private use
42
Tax Exempt Bonds

Private Use Issues (cont.)
 Research agreements – original investigation for the
enhancement of scientific knowledge – no commercial objective
Rental income
 Naming rights
 Record retention requirements –

for as the long as the
bonds are o/s & three yrs after the final redemption

Audit alert: TEB division of the IRS has increased staff by 20%. Cliff
Gannett the Director states this will increase significantly, the
number of audits. The twenty page FY2008 TEB work plan can be
found at IRS.gov. Some of the areas under scrutiny include: yield
burning, tax and revenue anticipation loans, 501 ( c) 3 charities.
43
Charitable Contributions
 Qualifying

donations
Qualifying donees § 170 ( c )-must be a US entity
state & local, religious, charitable, educatioal, veterans org, non
profit cemetery companies
 Determining
the amount and limitations on
deductions -based on donor A.G.I. & Donee, & type
of property
 Recordkeeping
and substantiation
requirements.
44
Charitable Contributions
 Elements

of a Charitable Donation
Charitable intent detached, disinterested
generosity (Comm vs. Duberstein 363 US 278 (1960))



No substantial benefit to the donor, complete,
voluntary and unconditional
Delivery org must have full control
Acceptance by the donee
 Quid
pro quo gifts part gift and part
consideration for good or service
45
Charitable Contributions
 Types

of Contributions
Cash – check, credit card, prom note, IRA’s, mailed though
not recd on 12/31 is deductible § 1.170A-1b



Stocks and bonds – fmv at date of gift
Real estate – Conservation easements – a lot more scrutiny
Tangible personal property – anything you can touch
other than lands or bldgs.; full fmv if inst does not dispose in yr
given – does not apply to vehicles

Intangible personal property - i.e. life ins contracts,
oil and gas interest (very complex subject to UBIT)
46
Charitable Contributions
 Types

of Contributions (cont.)
Services and out-of-pocket expenses – no
deduction for the value of the service

Prizes and awards as gifts
Recipient does not take into income if certain conditions apply:
r’cd because of charitable purpose or civic engagement (Nobel
prize), no action performed, does not have to perform service
and gives the prize to a charity

IRS Publication 526, Charitable Contributions

IRS Publication 561, Determining the Value of
Donated Property
47
Lobbying and Political Activity

Restrictions on Lobbying Activities

Definitions of lobbying-retained for financial or other
compensation; makes at least two lobbying contacts; 20% of time in a
three month period engaged in lobbying


Lobbying election- pros & cons
Lobbying Disclosure Act- 1995
applies 1.) one ee that is a lobbyist 2.) spends at least
$10k per calendar quarter
 Lobbying expenditures
 Reporting requirements
–electing & non electing must rpt on Form 990 Sch. A as well as to
maintain records that will enable them to calculate and report
expenditures
48
Lobbying and Political Activity
 Definition
of Candidate
§1.501 ( c ) (3)-1( c )(3)(iii) “an individual who offers
himself, or is proposed by others, as a contestant for an
for an elective public office, whether such office be
national, state, or local”
 Public
Office no IRS definition
 Intervention in a Political Campaign

Rev. Rul. 2007- 41 Lists 21 Examples of what
is allowed and not allowed
49
Political Activity
 Permissible

Political Activities
Candidate debates and forums
equal opportunity, no fundraising, explicit statement
indicating that the inst does not endorse a candidate

Student newspaper endorsements
may publish editorials Rev. Rul. 72-513

Use of institutional facilities – no problem
needs to state that inst does not endorse and
no fundraising
50
Permissible Political Activities
 Voter
registration on campus
higher ed amendment 1998 required to make forms
widely available to students
 Other
voter education
voter guides must not be biased in favor of a candidate
 Course
credit for participation in political
campaigns
Rev. Rul. 75-512 cannot indicate for which party must be an elective course
51
Resources
 Tax
Department
 Internal
Audit
 External
 Payroll,
Auditors
Human Resources & Other Dpts.
Resources
 NACUBO’s
Taxlist
mary.bachinger@nacubo.org
 ALIEN’s
listserv
http://listserv.utk.edu/archives/aliens-l.html
53
Resources (cont.)

NRA assistance
http://www.arcticintl.com/
http://www.windstar.com/

NRA tax preparation
http://www.arcticintl.com/cintax.asp

EO Tax Updates
Send a blank e-mail to
EO-Update-Subscribe@lists.qai.irs.gov
54
Resources (cont.)
Mr. Lowell G. Hancock
Internal Revenue Service
LMSB International
Foreign Payments
International Information Reporting
SE:LM:IN:C:FP
lowell.g.hancock@irs.gov
Tel. 330-253-7357 Fax: 330-253-7003
Internal Revenue Service
Federal Bldg / U.S. Courthouse
2 South Main Street., Room 395
Akron, OH 44308-1869
55
Resources (cont.)







Guide to Federal Tax Issues for Colleges and Universities
Loose-Leaf Binder
CD-Rom Updated Quarterly
Federal Tax News for Colleges and Universities
http://www.nacubo.org/x43.xml
Click on Subscription Services in the left hand column
The Tax Law of Colleges and Universities, 2nd Ed.
Bertrand M. Harding, Jr.
Employee Benefit Plans: Audit and Accounting Guide
Publisher: AICPA
NACUBO Guide to IRS Audits Laura Kalick, Peter K.
56
RESOURCES
 Taxation
of Charities and Other Exempt
Organizations (West Publishing Co, 2003
Moran, Brennen, Jones and Willis).
A
Federal Income tax Guide for College
and University Presidents
American Council on Education
http://www.acenet.edu/bookstore/pdf/2002_tax_guide.
pdf (free download)
57
Resources (cont.)

Income Tax Treaties (A-Z)
http://www.irs.gov/businesses/international/article/0,,id=96739,00.html
Publication 901, U.S. Tax Treaties
Publication 515, Withholding of Tax on Nonresident Aliens and
Foreign Entities
Publication 519 , U.S. Tax Guide for Aliens

Revenue Rulings Online
http://www.taxlinks.com\
58
Resources (cont.)

Internal Revenue Code
http://www.fourmilab.ch/ustax/www/sections.html

Revenue Rulings Online
http://www.taxlinks.com

IRS Website for Students
www.irs.gov/app/understandingTaxes/index.jsp
59
Resources (cont.)

Tax Workshops and Presentations
 Tax Institute for Colleges and Universities
(TIFCU)
May 17-19, 2009
Indianapolis, IN
http://www.indiana.edu/~tifcu
 NACUBO
Tax Forum
October 6 -7, 2008
Chicago, IL
60
IRS Priorities for Nonprofit Review &
Other Legislative Agendas

A.

B.

C.

D.

E.
F.
G.
H.



IRS Sets Priorities for Nonprofit Review in 2008
Interview with Lois Lerner – Director IRS Exemptorganization
Division (12/20/07)
United States Senate Committee on Finance
(Baucus, Grassley) Write to 136 Colleges, Seek Details of
Endowment Pay-outs, Student Aid (1/24/08)
Tax-Exempt Bond Financings Compliance Check
Questionnaire Form 13907
(TEB Work plan FY 2008)
Exempt Organization Executive Compensation Compliance
Initiative
CEP and other examinations in higher education
Governance Concerns
Form 990 Redesign
Form 990T Public Disclosure Requirements
61
Risk Management Issues
Risk – Not supporting
institutional goals
 Financial Risk – Penalties, interest & fees
 Compliance Risk  Operations Risk – Not effective & efficient
 Public Relations Risk- Reputation
 Strategic
62
WITH APPRECIATION
Susan Brooks
Associate Vice Chancellor of Finance
UNC Charlotte
414 Reese
Financial Services
Charlotte, NC 28223-0001
Beverly I. Moran
Professor of Law and Sociology
Vanderbilt University Law School
131 21st Avenue South
Nashville, TN 37203
College Business Management Institute & The University of Kentucky
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