Article by Steve Hoffman
This article originally appeared in the July/August 2015 Net Assets.
With myriad changes every year in federal, state and sometimes even local tax laws, independent schools can find themselves in a precarious position without keeping careful oversight of tax reporting duties. Of notable concern is that the Exempt Organizations Division (EOD) of the IRS is increasing its enforcement efforts involving nonprofits, where noncompliance is believed to be significant. For that reason and others, I suggest that independent schools pay particular attention to several major areas of federal tax law for the school year beginning in August.
In essence, nonprofits are more likely than for-profit organizations to be audited. Schools that do not act now to become compliant are playing a game of ‘audit roulette’ with the IRS — and the house always wins this game.
Stepped-up Scrutiny in 2015–2016
- Form 990: In its work plan for the fiscal year beginning October 1, the EOD has indicated that it will continue to select nonprofits for audits based on potential indicators drawn from their Form 990s. Schools should be as complete and transparent as possible in completing the Form 990. Also bear in mind that during an audit, the IRS will ask to see a school’s written policies. The Tax Toolkit on NBOA’s website includes a list of the 10 policies every school should have, along with sample record retention policies, sample whistle blower polices and more.
- Meals for employees: The IRS is intensifying scrutiny of free meals provided to employees, an emphasis prompted by audits of major software companies and since expanded to all organizations, including nonprofits. In order to be considered a nontaxable fringe benefit, meals provided to employees must meet certain requirements. For instance, they must be for the convenience of the employer, not the employees. Schools that provide free meals without being able to demonstrate this could face large tax liabilities.
- UBIT: The IRS’s continued focus on unrelated business income tax is a result of an EOD compliance project that resulted in large assessments. The concern is whether organizations are accurately reporting their sources of unrelated business income—for instance, facility rentals and school merchandise—and whether they are correctly allocating and deducting expenses associated with them.
- Political activities: Coming into an election year, the IRS will almost certainly refocus on “political activity by nonprofits.” Certain actions can even result in the revocation of an organization’s tax-exempt status. For instance, schools may conduct voter education activities but are prohibited from endorsing candidates for public office or placing signs on their property that show support for a particular candidate.
Ongoing Areas of Focus
- Independent contractors: The IRS believes that vast sources of income are not being reported through payroll withholding. The issue of independent contractor vs. employee is a ‘gray area’ of taxation for independent schools, yet it arises in virtually every audit and often results in assessments, penalties and interest. For instance, a school may treat a counselor who works at its summer camp as an independent contractor when, depending on the facts and circumstances, he or she should be paid through the payroll process. When in doubt, I suggest taking a conservative approach and paying independent contractors through the payroll system to protect the school from financial and reputational harm.
I also recommend that schools review how they decide whether to treat an individual as an independent contractor or employee, and then compare that to published guidance from the IRS. Another tip is to complete the questionnaire in the NBOA Tax Toolkit to determine whether someone should be considered an independent contractor. Finally, schools should have a clearly written policy covering payments to independent contractors.
- Fringe benefits: These can be taxable or nontaxable, depending on the circumstances. In the context of independent schools, the IRS seems particularly interested in housing and meals provided to employees. Prizes and awards can also be taxable unless certain conditions are met.
- State sales tax: Looking to increase revenue, states have become more sophisticated and aggressive in collecting sales tax. Some independent schools hold the mistaken belief that their tax-exempt status means they do not need to collect sales tax on items sold or services performed. But students and parents are not exempt from sales tax, so if a school has annual sales of plants or Christmas trees, for example, it may have to collect sales tax.
Finally, be advised that states might change their rules on sales taxes at any time of the year. Check your state’s tax authority to be sure your school is in full compliance.
Help Is Available
The complexity and changing nature of tax laws make it incumbent on independent schools to take advantage of educational opportunities to stay compliant. Many free webinars are archived on the IRS video portal. At the state and local level, CPA societies and other professional organizations offer training and continuing education. And I invite NBOA members to contact me directly and spend time with NBOA's Tax Toolkit.
