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The Academic Graveyard Shift: IRS Provides Guidance on Identifying Institutional Peers

Published:  May 7, 2013
Monopoly game photo


Image credit: flickr.com

“Do not pass go, do not collect $200,” the harsh cliché made ubiquitous by Monopoly, is essentially what the Internal Revenue Service told a group of universities recently. A special report from the IRS found several institutions had inflated their Baltic Avenue social statuses to Boardwalk for the purpose of setting executive compensation. Roughly 20 percent of the private, nonprofit subset of colleges and universities that were selected for inclusion in the report have been told they are not in compliance with statutes governing executive pay in charitable organizations. One result is that “the IRS plans to […] ensure, through education and examinations, that tax-exempt organizations are aware of the importance of using appropriate comparability data when setting compensation.” This statement constitutes a clear shot across the bow of universities locked into the never-ending game of reputational enhancement—often sacrificing important work for visible work and attempting to become cool-by-association (e.g., rank, “tier,” membership in exclusive groups). The implications for proliferation of the IRS-approved measures of comparability extend well beyond executive pay, and the potential for new precedent in reducing competitive perversities among universities is enormous.

The report posed the executive pay problem as follows: “The compensation for most positions analyzed was set in the range of the 75th percentile [of similar positions in comparable institutions]. Moreover, compensation set at or above the 90th percentile was much more common than compensation set in the range of the 50th percentile among the examined colleges and universities.” Ergo, the universities the IRS dinged had paid their executives as though they inhabited a wealthier class of university than they did. The report briefly describes the measures by which the IRS gauges comparability among universities, which include: “type (e.g., private or public; liberal arts, research university, etc.), size of undergraduate enrollment, faculty size, location (urban, rural, suburban; region of the US), endowment size, tuition and cost to attend, selectivity (SAT ranges, etc.) and age of the institution (year founded).” University leaders interested in ensuring institutional compliance with federal tax law should take that as a prescription.

This action by the IRS almost certainly comes in response to the aspirational nature of the comparisons employed by many universities toward fundraising, marketing, and reputation enhancement goals. The IRS has implied that it takes issue with the proposition that colleges should be allowed to pay their executives the going rate of a highly regarded “peer” simply because the institution has a goal of becoming similarly regarded.

Those who draw connections between striving for reputation enhancement and other questionable behaviors of higher education institutions (e.g., overinvestment in non-academic profit centers, the explosion of part-time instruction in the name of prestigious research, administrative bloat, the proliferation of revenue-centered budgeting models that can destabilize other important activities) will view the IRS’s intercession hopefully in other ways too. In fact, the IRS report leads off with the related criticism that in many cases universities dramatically underreported “unrelated business income” (UBI) and even more dramatically over-reported nonprofit operating losses. This tactic of shifting rising university costs to profit centers (e.g., fitness centers, summer camps, facility rentals, sports arenas, and golf courses) resulted in tax adjustments to 90 percent of institutions under examination, potentially totaling $60 million in additional taxes. The report is careful to note these data cannot be interpreted as representative of the broader field of American colleges and universities. Yet, the underlying issue of reputational climbing at virtually all costs is widespread, and the warning to the thousands of colleges and universities that were not audited is clear.

Few people saw an intervention from the IRS coming, and the full extent and weight of this report’s effects is yet to be seen. While it’s unlikely that the IRS’s actions alone will prove a major disruption to the expensive, corporate trajectory of American higher education, the contribution is welcome. It establishes precedent for federal tax law to keep the work of charitable organizations just a bit more charitable.

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