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According to press reports, the House Ways and Means Subcommittee on Oversight has written numerous colleges and universities questioning how highly lucrative compensation packages for current and former athletic coaches further the schools' tax-exempt purposes under IRC Section 501(c)(3). The letters demand answers to an extensive list of questions aimed at discerning how large compensation packages further the schools' educational mission and benefit their students. Some of the schools are private entities and some are state institutions.

Background

To meet the requirements of IRC Section 501(c)(3), an organization must satisfy the organizational and operational tests by (1) being organized and operated exclusively for charitable, educational or other exempt purposes, and (2) allowing no part of its net earnings to inure to the private benefit of any shareholder or individual. The term "charitable" for IRC Section 501(c)(3) purposes includes advancing education and science and lessening the burdens of government. Tax-exempt organizations must maintain books and records showing items of gross income, receipts and disbursements, and provide them to the IRS upon request.

IRC Section 4960 imposes an excise tax on applicable tax-exempt organizations (ATEOs) and related organizations that pay remuneration over $1 million (i.e., excess compensation) or an excess parachute payment to a covered employee. Public charities, described in IRC Section 501(c)(3), are considered ATEOs. But many governmental entities, such as state universities, are normally excluded from the ATEO definition. A governmental entity is an ATEO, however, if it has an IRC Section 501(a) tax exemption letter from the IRS or income excluded from taxation under IRC Section 115(1). Even if it is not an ATEO, a governmental entity may still be subject to the IRC Section 4960 excise tax if it is related to, and employs a covered employee of, an ATEO. Several questions from the House Ways and Means Subcommittee on Oversight to colleges and universities focus on the IRC Section 4960 implications of their compensation to football coaches.

Implications

Colleges, universities and other tax-exempt organizations continue to experience increased scrutiny of certain compensation arrangements with highly compensated individuals. The increased scrutiny that some colleges and universities are facing regarding large compensation packages provided to newly hired athletic coaches should serve as a warning to other similarly situated schools, which could face similar questions from Congress, other regulators, the press and watchdog groups. Such scrutiny could adversely affect a college's or university's reputation, even if the school has not violated federal tax law.

This congressional interest parallels the IRS's increasing interest in executive compensation paid by tax-exempt organizations, particularly as the IRS increases its IRC Section 4960 enforcement efforts. As such, tax-exempt organizations should focus on following and documenting a board-and/or-compensation-committee-approved process to establish that any compensation packages to insiders/disqualified persons are reasonable and further their tax-exempt purposes under IRC Section 501(c)(3). They should also be vigilant in determining their covered employees under IRC Section 4960, any excise tax liability they incur for excess compensation or excess parachute payments to those employees, and their Form 4720 filing obligations to report and pay the tax.

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