IRS May Tax Colleges' Income From Exclusive Deals With Beverage and Clothing Companies
By PATRICK HEALY
WashingtonThe Internal Revenue Service put colleges on notice Wednesday that it may soon go after a growing and largely untaxed source of revenue: payments that soft-drink companies, athletic-gear manufacturers, and other corporations make to colleges in exchange for exclusive deals to provide goods and services on their campuses.
In proposed regulations published in the March 1 Federal Register, the I.R.S. outlined the tax status of income that many colleges and other tax-exempt organizations earn from agreements with corporate sponsors. Consistent with longstanding tax law, the income may be taxable in cases where the income is not related to an institution's core mission, or where the company receives a "substantial return benefit."
The proposals -- which would carry out changes that Congress made in the tax code in 1997 -- offer several examples of when colleges and other nonprofit institutions may be taxed on such "unrelated business" income.
While many of the ideas reflect current I.R.S. practice, four experts on taxation and higher education said Wednesday that the most significant proposal for colleges by far was the proposed tax status of exclusivity agreements between institutions and companies.
Under the proposed rules, a college that makes a company the exclusive provider of a product or service would probably have to pay tax on part of the money that the company pays for those rights.
For example, soft-drink companies often pay a lump sum to colleges in exchange for their beverages' being the only brands available in dining halls. Right now, tax experts say, those deals are often structured so that no tax is owed by the colleges. Under the I.R.S. guideline, the visibility and other benefits of the deal would provide a "substantial return benefit" to the company, making its payment to the college taxable. (Only the portion of the company's payment that is in excess of the fair market value of the service would be taxable.)
The experts who spoke Wednesday after reviewing the regulations said that the I.R.S. proposal opens the door to taxation of these multimillion-dollar arrangements. (See an article from The Chronicle, October 15, 1999.)
"Based on its recent audits of large universities, the I.R.S. is well aware that the exclusive-provider rule in the proposed regulations could subject many of the nation's colleges and universities to significant taxation on athletic-gear and beverage contracts that have been negotiated over the past several years," said James J. McGovern, an accountant at KPMG Peat Marwick and a former top I.R.S. official. "This is big news for the nation's colleges."
Mr. McGovern said KPMG planned to organize a coalition of institutions to work on the exclusivity proposal.
I.R.S. officials did not explain in the proposed guidelines why they were preparing a policy on exclusive arrangements, only noting that they decided to touch on "additional areas" as part of the overall regulation of corporate sponsorship.
The agency has asked for comments on the proposed regulations by May 30. The I.R.S. also plans to hold a public hearing, scheduled for June 21 here, on the proposals.
Written comments may be sent to Room 5226, I.R.S., POB 7604, Ben Franklin Station, Washington, D.C., 20044. E-mail comments may be submitted on the agency's World Wide Web site, at http://www.irs.gov/tax_regs/regslist.html.