Buffalo schools pay $7.5 million tax bill — thanks in part to cosmetic surgeries

Oct. 29--The taxman has caught up with the Buffalo Public Schools.

The school district had to pay $7.5 million to the Internal Revenue Service this month for unpaid payroll taxes from the past three years.

The settlement was less than the roughly $21 million in employment taxes that the IRS assessed for 2014, 2015 and 2016. That figure was the result of a recent audit that zeroed in on four issues, two of which have long been at the center of controversy:

* The cosmetic surgery rider for district employees.

* The antiquated way the school district pays its building engineers.

* The practice of paying "parent facilitators."

* And the district's role as a pass through for payments to non-public school teachers.

In its audit, which began last year and wrapped up in August, the IRS focused on those four areas where the school district should have paid employment taxes but didn't, with the cosmetic rider and the operating engineers accounting for the bulk of the tax payments.

The audit was just one of several that scrutinized the school district last year for one thing or another, raising questions from at least one board member about why these tax issues weren't flagged by the district's independent auditor prior to the IRS coming in.

The cosmetic rider and deal with the operating engineers, in particular, have long been a point of contention in the school system, said Board Member Larry Quinn.

"Why wasn't there any advisement to the district?" Quinn said. "What other practices are out there that might be deemed income or unreported expense by the IRS?"

While $7.5 million is a large, unexpected expense, the school district was able to absorb the cost because it ended the 2016-17 fiscal year with more funds than expected, explained Geoffrey Pritchard, the district's chief financial officer. Several revenue lines exceeded budget, while several expenses came in under projections, Pritchard said.

"That was quite a bit of money," said Superintendent Kriner Cash, "but we think it was responsible to do it this way as opposed to appealing.

"All things considered this was a decent year for us from a financial standpoint. We've been working hard at saving funds," Cash said. "We felt it would probably be better to take care of it now."

The head of an association of school business officials called the IRS audit "very unusual."

"I've never heard of the IRS auditing a school district, because they're not an entity that pays business taxes, typically," said Michael Borges, executive director of the New York State Association of School Business Officials. "This, at least to my knowledge, is not a common audit."

Cash said he doesn't know what triggered the IRS audit, but he is viewing it as an opportunity to turn a negative into a positive by making changes that should have been made long ago.

Independent operators

In the case of the 52 operating engineers, the audit focused on the unusual way the district pays them to maintain boilers and heating and ventilation systems at individual schools.

They are salaried employees of the district earning about $45,000, but in effect also act as independent contractors who get lump sum allowances totaling $15.5 million to buy their own equipment and hire custodians to help them.

They get to keep what they don't spend of the lump sum allowances.

It's an unconventional practice that dates back to the Civil War era and has long been criticized because there's no accountability on how the money is spent.

Still, the arrangement has continued, and in its audit, the IRS said all the money paid to the building engineers should be treated as wages subject to employment taxes.

Operating engineers did demonstrate to the IRS that they deducted taxes from the salaries of their custodians, which helped reduce the district's payments to the IRS, said Nathaniel Kuzma, general counsel for the school district.

But, Kuzma said, the engineers didn't divulge how much income they kept from the lump sum allowance.

The school district's contract with its engineers has been expired since 2010, and Cash said the district will take an aggressive stance at the bargaining table to dump an arrangement from "days gone by."

In the meantime, the engineers will be taxed on their lump sum allowances until the district can negotiate a "fair agreement for both sides," Kuzma said.

"We're not going to be put in the position where we're going to pay their taxes anymore," Kuzma said. "The system is going to have to change -- it must change."

IRS tax assessment: $14.5 million.

Settlement: $2.5 million.

The cost of good looks

The question surrounding cosmetic surgery is this:

Does the amount paid for the surgery, on behalf of employees, constitute wages subject to employment taxes?

The IRS said it is subject to taxes -- unless, for example, the surgery is done to improve a deformity caused by an accident, trauma or a medical condition.

BlueCross BlueShield, the district's health insurance provider, supplied data used to identify those surgeries that were medically necessary, which helped lower the cost of the district's payment to the IRS.

The cosmetic surgery rider was recently negotiated out of the new contracts for both teachers and administrators but is still included for those who retired with the benefit.

Moving forward, the tax liability will be passed along to retirees who use cosmetic surgery, officials said. The audit, they added, also gives the district greater leverage to eliminate the rider for retirees, too.

IRS tax assessment: $6.7 million

Settlement: $5 million.

Paying parents and teachers

Two other issues raised by the IRS are similar, but carried smaller tax liabilities.

The district's 58 parent facilitators were paid $300 a month for 10 months to serve as a "bridge" between parents and building administrators.

The IRS audit found that the facilitators could no longer be considered as paid "consultants" but had to be treated as employees of the district if school officials wanted to continue that relationship.

The district ended the program last month, but the superintendent is talking with parents about developing a different model.

The last issue involved the use of federal anti-poverty dollars to help fund teaching positions in non-public schools in Buffalo, where the district acts as an intermediary to hold the money before passing it on.

Similar to the parent facilitators, those teachers at the non-public schools receiving the money were being treated as "independent contractors" and no taxes were being withheld.

Combined IRS tax assessment: $131,000

Settlement: $19,000.

The fix will be in

Audits are conducted routinely by a school district's independent auditor, while the state comptroller audits a district on a five- to seven-year cycle, said Borges, from the state association. The U.S. Department of Education also does periodic audits if the district receives anti-poverty funding, he said.

In Buffalo, the IRS audit was one of nearly a dozen ongoing last year, Cash said.

"We're a large school district," Cash said, "so every year we have a number of audits that are going to occur -- some of our education programs, some of our grants, some are dealing with the financials."

The school district ended its fiscal year on a positive note, which helped make the payment to the IRS a little easier to handle.

The district was anticipating a $43.0 million deficit for the 2016-17 fiscal year, but even with the $7.5 million expense to the IRS the district ended the year with a $20.7 million shortfall, Pritchard explained.

"Addressing and settling the matter now eliminates much of the risk that a more significant liability may be assessed in the future, if the district was unsuccessful in challenging the liability or if additional years were added into the tax assessment," Pritchard said.

"In addition," he said, "it presents an opportunity to fix the problems that resulted in the tax liability in the first place."

School Board President Barbara A. Seals Nevergold was surprised by the IRS findings and the cost to the district, but said there was no reason to believe there were tax problems.

"I think that the issues that have contributed to the IRS review are ones that are longstanding," Nevergold said. "They didn't just occur in the last two to five years."

But now that the district knows, it can't continue with business as usual, she said.

"We're moving on to make sure we don't encounter the same problems again," Nevergold said.

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