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What Higher Education Officials Should Know: Key Tax Risks For Universities

by
Gordon W. McNamee
on
9/22/2022
What Higher Education Officials Should Know: Key Tax Risks For Universities

In recent years, university tax compliance has become an increasingly challenging thing to navigate, particularly for those higher education officials who don’t have a background in accounting or the federal tax code.

Amid students’ return to school for the fall semester, Bloomberg recently broke down some of the hidden tax risks that educational institutions face. The outlet noted that as a result of  “growing tax compliance and reporting requirements, they [universities and colleges] should understand some of the key risks and how to mitigate them through proper planning.”

Here, we delve into several key tax risks for universities, and how officials can plan for them all year long to avoid surprises during tax season.

Unrelated Business Income (UBI)

Unrelated business income (UBI) is defined by the IRS as “an activity [that] is an unrelated business (and subject to unrelated business income tax) if it meets three requirements:

  • It is a trade or business,
  • It is regularly carried on, and
  • It is not substantially related to furthering the exempt purpose of the organization.”

The tax agency does, however, note that a number of exemptions and modifications exist. These include volunteer labor, selling donated merchandise – such as at a thrift store – and “convenience of members.” 

The latter specifically applies to universities and other educational institutions in many cases. The IRS notes that the exclusion applies to any trade or business “that is carried on by an organization described in section 501(c)(3) or by a governmental college or university primarily for the convenience of its members, students, patients, officers, or employees. A typical example of this is a school cafeteria.”

Although universities often qualify for UBI exceptions, Bloomberg pointed out that proper planning and reporting are essential to avoid IRS scrutiny and major problems at tax time.

The outlet stated, “it’s critical that institutions evaluate revenue streams to ensure they’re reporting and properly documenting UBI.”

Scholarships For Unpaid Internships

Whether or not it is required to pay taxes on scholarship dollars is an issue that frequently arises for students who receive financial aid to help pay for higher education. Bloomberg explains, that monies “used for tuition and related expenses, such as books, course fees, and equipment, are nontaxable to the student, while scholarships for room and board, or that exceed the student’s tuition and related expenses, are taxable.”

What about, though, scholarships for unpaid internships? The creation of scholarship funds to assist students who are working to gain experience – but not income – is becoming more and more popular. 

However, it is possible that students may have to pay taxes on the scholarship funds they are given for living expenses while working as unpaid interns. 

From the viewpoint of a university, it is important to make this clear to students before they accept scholarship funds in order to avoid problems later. 

Excise Taxes 

Most universities were not impacted by excise taxes until the Tax Cuts and Jobs Act of 2017 went into effect. 

As a result of that legislation, per Bloomberg’s report, “[there was assessed] a 1.4% tax [on endowments] on institutions enrolling at least 500 students that have endowment assets exceeding $500,000 per student.”

At the time the law went into effect, only about 40 institutions nationwide were expected to meet the requirement. Now, though, declining enrollments have made additional institutions subject to this excise tax. 

In order to avoid tax pitfalls, it is imperative for university officials to closely monitor student enrollment numbers and endowment sums. 

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Gordon W. McNamee

Gordon W. McNamee

Gordon W. McNamee is a Certified Public Accountant (CPA) based in Rancho Cucamonga, CA. Gordon W. McNamee can assist you with your tax return preparation, payroll, accounting and tax planning needs. <br /> <br /> 2021 is Gordon W. McNamee, CPAs 38th year in the profession. As as a former IRS agent (1984 through 1987), Gordon has been in public accounting since 1987. Gordon specializes in individual, corporate, HOA, trust, estate and payroll taxes. He also prepares financial statements and provides accounting & bookkeeping services. He enjoys making his clients feel at ease while providing a personalized professional service.

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