Uncovering UBIT at Your Institution -Mock Audits and Other Tools 4:15 to 5:30 p.m. Thursday, February 21, 2013

Transcription

1 2013 Unrelated Business Income Tax Uncovering UBIT at Your Institution -Mock Audits and Other Tools 4:15 to 5:30 p.m. Thursday, February 21, 2013 Speaker(s): Rick Klee, University of Notre Dame Joel Levenson, University of Central Florida Ed Jennings, University of Michigan

2 AGENDA Reasons to Conduct a Mock Audit Benefits Lessons Learned from Past Audits 5 Steps to Conduct a Mock Audit : Form a Compliance Team, Establish a Risk Management Program, Prepare and Perform a Tax Audit Review, Develop Deliverables, and Report out to Executive Management.

3 Reasons Douglas Adams said: "I'm spending a year dead for tax reasons."

4 Congressional Scrutiny Hearings - On May 16 th and July 25th, 2012, the House Ways and Means Oversight Subcommittee held hearings to explore unrelated business taxable income (UBIT) and IRS compliance efforts. It will allow the Subcommittee to better understand what is driving organizational complexity, and to learn about the new compliance efforts by the IRS and the UBIT rules. Testimony - Professor John Colombo of the University of Illinois College of Law He indicated that the final UBIT regulations adopted by the IRS in 1959 are confusing. The best solution would be to jettison the relatedness test for the UBIT entirely and impose tax on all commercial activities by charities, whether related to their exempt function or not.

5 IRS Scrutiny Recent Initiatives Compliance Checks In 2008, The IRS issued 400 compliance checks to colleges and universities. Of a 33-page questionnaire, 13 pages (or 40%) focused on UBIT. Audits In 2009, the IRS conducted follow-up audits. Interim Report In 2010, the IRS released its interim report. Apparent gaps between information included with the compliance checks and the tax information reported on the Forms 990-T for the year in question have resulted in the IRS continued efforts to further review items. Final Report Awaiting release of the Final Report. IRS EO 2011 Annual Report & 2012 Work Plan - The IRS will analyze data from the Form 990-T to develop risk models that will identify organizations that consistently report significant gross receipts but pay no taxes.

6 Benefits Abraham Lincoln said: If we could first know where we are and wither we are tending, we could then better judge what to do, and how to do it.

7 Win-Win-Win Executive Management - Provides executive management with assurances that the Form 990-T is filed. Schools, Units and other Clients - Educates those folks with the schools, units and departments that work with UBIT activities. Effective Tax Planning - Allows tax professionals to identify tax planning opportunities, manage tax risks, and minimize tax liabilities. Preparation for Examination - Serves as preparation for inquiries, reviews and examinations from the IRS and possibly state taxing agencies.

8 Lessons Learned from Past Audits

9 Lessons Learned From Past Audits Know Your Tax Risks Knowing your risks prior to an examination helps you guide the audit process and resolve and settle proposed liabilities. Review websites for taxable activities, e.g. ads on the Athletics department webpage. Review UBIT losses - Monitor losses from each activity. Review work papers that list the taxable income for each and every activity, i.e. gross revenues and expenses, including an allocation of the accrued state income tax expense. After two years of losses, start asking questions. After 5 years of losses, lean towards removing the activity from the return unless there s compelling facts & circumstances to warrant and justify the losses still being on your return. Review UBIT Expense Allocations e.g. Review depreciation records.

10 Lessons Learned Build Your Tax File - Keep good records and documentation. Work papers should tell the story of every number on the return. Why it s there, why it s different from the financial statements, etc. Make sure those are kept and understandable. Ensure that your departments are aware of your record retention policy on maintaining documentation. Engage a tax accounting firm to review the Form 990-T and supporting documentation. Build Relationships - Work with impacted schools and departments. Send them copies of their stand-alone draft returns and liabilities. Schedule reviews and meetings with them. Centralize tax functions and responsibilities.

11 Lessons Learned Manage Expectations of Executives Report out findings, prioritize liabilities and describe positions taken. Avoid unnecessary surprises. Develop Benchmarks Work with similar institutions. Understand their reporting of UBIT, e.g. what was reported and what was not. Learn their positions taken based on their facts and circumstances. UBIT turns on the specific facts of each activity. Discuss their management of UBIT activities, e.g. allocated of resources. Keep Current To manage risks effectively, the tax professional must keep current with the developments in UBIT.

12 Conducting A Mock Audit

13 5 Steps to Conduct a Mock Audit Form a compliance team, Establish a risk management program, Prepare and perform a tax audit review, Develop deliverables, and Report out to executive management.

14 Form a Compliance Team Align Regulatory Measures - This team should ensure that tax initiatives are aligned with the institution s other compliance programs. Representation - Include internal audit, office of general counsel, finance and other departments responsible for compliance. Responsibilities Review the internal auditor s annual audit plan and recent reports, Discuss opportunities to exchange information with legal counsel, i.e. contracts, leases, royalty agreements. Work closely with the controller and/or finance and other officers who are given fiscal and stewardship responsibilities. Discuss prioritization of UBIT activities and associated risks.

15 Establish A Risk Management Program Define Risks from UBIT Identify Taxable Activities Determine At-Risk Schools and Departments

16 Define Risks Risks from Poor Documentation - The educational institution assumes tax risks when filing its Form 990-T, Exempt Organization Income Tax Return, if it fails to maintain adequate documentation of the activities that are reported on the tax return and those that are excepted from taxation. IRC Section 6001 and Treasury Regulation expressly require exempt organizations subject to tax under Section 511 regarding taxable income to keep permanent records as are sufficient to establish the amount of gross income, deductions, credits or other matters required to be shown by such person. Risks from Different Interpretations - An IRS agent is given broad assessment authority to make determinations of tax liabilities during an examination. IRC Section 6201 allows the revenue agent to weigh conflicting factual information, data or opinions and apply the positions put forth by the IRS on issues of law to determine the correct tax liability.

17 Attributes of UBIT Various Interpretations - UBIT is mired in a minefield of gray with various interpretations for a myriad of issues, for examples: UBIT is based on a facts and circumstances determination, Certain concepts are complex, such as, unrelated debt-financed income, the relationship with taxable subsidiaries, Certain legal terms are vague and ambivalent, such as, profit motive, regularly carried on, reasonable allocation of indirect costs, and substantial services, The treatment of certain activities, such as, alumni members and summer camps are based on authorities that conflict or are unclear.

18 Identify UBIT Activities Road Map - Since schools tend to operate in a decentralized manner, the tax professionals are challenged to discover UBIT. A suggested fundamental roadmap includes the following: Review board minutes.* Peruse school newspapers/bulletin boards.* Review campus directory.* Review records of payment or accrual of real property taxes.* Review contracts to lease or sell property to lessees or purchasers. Review financial revenue accounts with external parties. Research websites of those departments that raise possible tax concerns. Coordinate the review of the institution s sales and use tax return with that of the form 990-T. * Represents items suggested in the IRS Final Examination Guidelines for Colleges and Universities, Announcement , I.R.B , (August 25, 1994).

19 IRS Compliance Check - Sample

20 Determine At-Risk Schools and Departments Perform Revenue Reviews Background - With a decentralized accounting function, the tax professional should review regularly all revenue sources coming into the university from third parties, including new or create accounts. The tax professional may work in conjunction with the Controller/Finance person. Procedure- Run on an annual basis journal entry reports for a department and pick entries to request detail for. The number of entries to choose depends on the size of the department, overall knowledge of the department s activity & accounting department, etc. Results - Identify potential tax risks with affected units. Helps to establish relationships with department representatives and assists with your questions for future tax inquiries.

21 Prepare and Perform a Tax Review Develop Toolkits Use toolkits to gather information and educate folks from impacted schools and departments. Use questionnaires, including checklists and flowcharts, and Information Document Requests (IDRs). Focus on profit motive for activities with consistent losses. Review expense allocations for consistency and reasonableness. Visit At-Risk Units - Meet with these folks to develop a working relationship. Conduct Interviews - Follow IRS interview techniques, e.g. be honest, pause before responding, answer the question and only the question, etc. Assess and Evaluate - Weigh the facts against the risks to determine each unit s compliance level.

22 Other Options For a Tax Review Use Your Outside Tax Advisor for the Audit Advantages: Knows your business and knows what IRS would be looking for, As an outsider, may provide a more objective look at the business and provide benchmarks, Can tailor the engagement to be as detailed or high level as you would like, and Doesn't deplete your operating manpower needs. Disadvantages: Cost, May not know as many rocks to turn over as you would.

23 Other Options (cont d.) Use Your Tax Strategy Committee on a Piecemeal Basis- Use a combination of officers, outside counsel, business managers and finance staff and prioritize the review by risk. Follow-Up with Tax Questionnaires and Other Identified Risks - Probe all the Yes answers and document thoroughly. Risk Management Committee- Document the resolution of identified tax risks.

24 Measure and Prioritize Risks Issues Department Scrutiny Liability (a) Liability (b) Product Rental Income Sponsorship Contracts Housing H M H 3 Athletics H L H 3 Advertising Websites, school newspapers H L M 2 Travel Tours Alumni Association M L H 1 Scrutiny represents the level of review or importance placed by the IRS on this particular issue. Liability (a) represents the taxes quantified by the institution based on its interpretation of the UBIT rules. Liability (b) represents the taxes quantified by the institution based on the IRS interpretation of UBIT rules. Product represents deliverables and level of documentation attributed to that issue. 3 represents the highest level, 1 represents the lowest.

25 Develop Deliverables Manage Expectations of Executives Developing deliverables helps to manage expectations of executives regarding risks from UBIT. Examples of deliverables include the following: Benchmark taxable activities, including profits and losses, that are reported by similar institutions. Report on risks from those activities not reported on the Form 990-T. Identify those activities that derive perennial losses and recompute the tax liability without the loser activities. Ensure that the methodology to allocate indirect expenses is based on reasonable grounds and is treated consistently. Provide a cost/benefit analysis of the tax savings due to the implemented processes.

26 Report Out to Executive Management Executive Committee Management learns the risks associated with UBIT which helps to improve the governance of the institution. This committee may include Regents, Trustees, Vice president of Finance, Vice President of General Counsel and/or outside counsel, Director of Internal Audit. Awareness Management receives assurances that the Form 990- T is filed accurately and completely, in addition to tax planning, i.e. minimized tax liabilities and maximized tax savings. Alignment Management takes comfort that UBIT is reviewed and reported consistent with other campus-wide compliance initiatives. Appreciation Management may provide additional resources to ensure that UBIT and other tax matters are handled appropriately.