IRS proposes new audit guidelines for colleges and universities.

In Ann. 93-2, the IRS released very lengthy and comprehensive proposed examination guidelines that open the door to exhaustive university and college audits. Under the proposed guidelines, agents would review documentation of all university activities. Specifically, agents are directed to review Office of Management and Budget (OMB) Circular A-21, Indirect Cost Proposal and Audits; financial statements; compensation packages of faculty, coaches and athletic directors; Sec. 501(c)(3) bond proposals and documents; research grants and contracts; bookstores; sharecrop leases; and the use of campus buildings and facilities.

Agents are instructed to review various publications and documents for an overview of a university's operations and consistency in its policies. Included are board and committee meetings minutes; school bulletins; course catalogues; publication lists; faculty and student handbooks; requisition and purchase order files; disclosure reports to Federal agencies sponsoring research; chart of accounts; audited financial statements; state and local real property tax exemptions; as well as reports prepared for accreditation audits.

Agents are instructed to break down income source by types, e.g., educational services, grant and athletic income. In addition, they will review an institution's investment portfolio and identify all joint ventures and ancillary activities, such as rental of facilities. All contracts for corporate sponsorship will be analyzed for terms or conditions that could result in unrelated trade or business income. Expenses also will be sorted by type, with expenses for each school, department or program reviewed for irregularities. In particular, the Service will focus on "unrestricted" accounts designated for a particular official's use, such as a "President's Reserve," "Official Entertainment Account" or "Athletic Director's Account." Other statements to be reviewed include the balance sheet and statement of cash flow.

The IRS will continue its current focus on employee versus independent contractor classification. It will also focus on payments from booster clubs to members of the athletic staff, and such employee fringe benefits as automobiles; air flights; awards and prizes; tickets to athletic, entertainment or cultural events; subsidized faculty dining rooms; meals; insurance; scholarships; and housing and tuition assistance. Agents will also examine the school's qualified pension plans, Sec. 403(b) annuities and Sec. 457 deferred compensation plans.

The guidelines also direct examiners to look at the issue of reasonable compensation from a multientity standpoint. For instance, salaries received from related exempt and for-profit entities will be aggregated for the purpose of this issue.

Gifts to a college or university that have restrictions attached will be reviewed for any private benefit that may flow from the restriction to the donor. Charitable remainder trusts will be evaluated to determine whether a donor has properly reported the value of the charitable deduction. The guidelines instruct the agents to refer the issue to an examiner who may conduct an audit of the individual's income tax return.

Agents will review both short-term and long term debt contracts, interest rates for both unsecured and secured credit lines, as well as the relationship between the lender and the institution. A prudent-man fiduciary standard for incurring the debt will be applied, and the size and frequency of commissions paid win be considered.

If Sec. 501(c)(3) bonds have been issued, past and future use of the facility and consideration of any third-party benefit flowing from the project, whether direct or indirect, will be weighed. items to be reviewed include feasibility studies; opinions of bond counsel; offering statements; development and management agreements; underwriters' agreements; issuing authority documents; how the bonds were marketed; reasonableness of fees paid; relationship of bond trustees; and the bond closing book.

Agents are instructed to review the bonds for compliance with all related Code provisions, including arbitrage rebate; improper rebates can cause the bonds to lose their tax-exempt status.

Agents are instructed to conduct a complete review of all scholarships and fellowships for compliance with the rules under Sec. 117: taking a sample and determining the source, whether recipients are degree candidates or recent MDs, and if any services are required.

The guidelines specifically instruct agents to scrutinize research grants and contracts for unrelated trade or business income issues and private benefit. The methodology under which research is conducted and how the results are published for distribution to the general public will be analyzed. Important factors are: who is entitled to technology derived from the research; the rights of scientists; institutional safeguards on managing and reporting conflicts of interest; and whether the university competes with taxable entities for contracts.

Agents are instructed to secure and review the university's written policy, if any, on political activities - both "on campus" and on behalf of the institution. The Service will also analyze any activities the institution conducts concerning its own interests, including whether any expenditures for lobbying are substantial or exceed the allowable amount provided for in Sec. 501 (h).

Agents will survey the items sold in a bookstore that may be related to the institution's exempt purpose or for the convenience of the faculty and students. The guidelines clearly advise that the sole fact that the sale of items at a campus bookstore is "more" convenient for students is not sufficient to satisfy the convenience exception.

The IRS has not cited any authority for its-new interpretation of the convenience exception. The test will be one of facts and circumstances, leaving a gray area for the agent to determine what degree of convenience is permissible.

The Service also will identify and examine where appropriate the sale of electricity; use of institutional facilities in unrelated activities; operation of hotels, motels and parking lots; travel tours; services provided to affiliates; other affiliated entity issues; and share-crop leasing.