PUBLIC & EDUCATION | 05/22/2024
Independent schools face significant risks if they make tax-related errors, from reputational damage to potential financial sanctions. Even small mistakes on tax filings or missteps in operational activities can force schools to spend months—or even years—on costly damage control.
What steps can tax-exempt schools take to mitigate these risks? By adopting leading practices, implementing sound governance, and staying informed of tax requirements, schools can reduce exposure and maintain compliance.
Best Practices for Tax-Exempt Schools
1. Adopt and Enforce Written Policies
Strong governance starts with clear, well-documented policies that guide decision-making and compliance. Tax-exempt schools should:
- Establish policies addressing conflicts of interest, acceptance of nontraditional contributions, and compensation arrangements.
- Regularly review and communicate these policies to board members, leadership, and staff.
The IRS views robust policies and procedures as a sign of strong organizational controls, reducing the likelihood of tax law violations.
2. Understand and Comply with Tax Rules
Tax-exempt schools must stay informed about the wide range of tax requirements that impact them. Common areas of concern include:
- Unrelated Business Income Tax (UBIT)
Income from activities unrelated to the school’s exempt purpose, such as renting facilities, may be taxable. Determining whether this income qualifies as unrelated depends on the school’s specific circumstances, requiring nuanced analysis. - Worker Classification
Misclassifying employees as independent contractors can result in costly penalties. - Nonqualified Deferred Compensation Agreements
Schools should ensure severance, sabbatical, and retirement incentives comply with excise tax rules on excess compensation. - Executive Fringe Benefits
The federal rules on fringe benefits, including housing, are complex and nonintuitive. Incorrect treatment could lead to tax exposure. - Endowments with Alternative Investments
Schools must adhere to federal and state filing requirements for alternative investments, including:- Quarterly estimated tax payments.
- Disclosure filings for direct and indirect foreign investments to avoid penalties.
3. Document Key Decisions and Activities
Proper documentation is essential for managing tax risks and maintaining consistency, especially during leadership transitions or changes in tax law.
For example, schools providing housing for presidents or heads of school must ensure they meet tax-free treatment requirements under the law. Without proper documentation, schools may struggle to justify past decisions. Thorough records not only reduce exposure but also build confidence in the institution’s governance.
4. Leverage IRS Audit Technique Guides
The IRS provides “Audit Technique Guides” that offer insights into potential red flag areas for tax-exempt organizations. These guides cover issues such as:
- Unrelated business activities with recurring losses.
- Employer-provided housing.
- Anonymous donations that are “otherwise identifiable.”
By reviewing these guides, schools can proactively address areas of risk and ensure compliance with IRS expectations.
How We Can Help
Tax compliance for nonprofit schools requires vigilance, planning, and strong governance. Our tax consulting team specializes in helping tax-exempt organizations:
- Develop robust policies to guide compliance and mitigate risk.
- Review and document tax-related decisions to reduce exposure.
- Analyze and plan for complex tax situations, including unrelated business activities, compensation matters, and alternative investment disclosures.
With our expertise, your school can focus on its mission while minimizing the risks associated with tax compliance.
Contact us today to ensure your organization’s tax practices align with best-in-class standards.