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[ Corporate Tax - Intermediate Sanctions Excise Taxes ]

Suggested Answers : Case Study #11 - Asset Purchase
Intermediate Sanctions :|: Case Studies of Potential Excess Benefit Transactions

  1. Identify, if any, disqualified persons and/or organization managers.

    Disqualified person
    Dr. Welby is a disqualified person for purposes of this transaction. He manages a discrete segment of the organization that represents a substantial portion of the activities, assets, income, and expenses of the organization, as compared to the organization as a whole. Brent Letsmakeadeal, Dr. Welby’s brother, is also a disqualified person for purposes of this transaction because, as a brother, he is a family member specifically identified in the Intermediate Sanctions rules.

    Organization managers
    Dr. Welby is an organization manager by virtue of his having powers and responsibilities which appear similar to those of an officer, director, or trustee. The facts show that he has the authority to make important decisions for the organization, such as the final decisions for buying and selling significant assets. These are the type of decisions typically made by an officer or board member. By virtue of his position as head of the cardiology department at Ace, it would be expected that Dr. Welby would regularly exercise general authority to make administrative or policy decisions on behalf of the organization.

  2. Describe any potential excess benefit transaction(s).

    Dr. Welby would certainly be popular and admired within his extended family for his generous efforts in helping his brother, Brent Letsmakeadeal, with his new business. However, based on the facts stated or implied in the case, Dr. Welby’s decision to help his brother may have been at a tremendous cost to Ace Academic Medical Center. Dr. Welby failed to take any of the steps necessary to qualify the sale of the old equipment for the Rebuttable Presumption safe harbor. There does not appear to have been the involvement of the board, which would certainly have been more independent relative to this transaction, in approving the sale of the equipment. Furthermore, Dr. Welby chose not to obtain an independent appraisal of the market value of the equipment. The review done by his brother of the equipment would not appear to qualify as a true appraisal, and regardless, it would not be independent. And since it will take Brent up to a year to pay off the purchase price, the $200,000 amount would have to be discounted to reflect a reasonable implied interest rate on the transaction. If David Smith, the medical equipment salesman, was reasonably accurate in his estimate that the equipment might be worth $500,000 or more, it would appear that Dr. Welby sold the equipment to his brother for $300,000 or more below it true fair market value. $300,000 would certainly had been enough to more than cover the cost for an formal, independent audit as well as justifying the time or hassle that a more formal approach might have taken.

  3. Who would be liable for any potential excise taxes and how much would they be?

    Assuming that the excess benefit is $300,000, the difference between the estimate value of $500,000 and the $200,000 actual purchase price, the potential Intermediate Sanctions excise tax would be $75,000 (25% x $300,000). In addition, Brent would need to either return the equipment to the hospital if he still had it, or pay the hospital the additional $300,000.

    Since Dr. Welby is the organization manager who approved the transaction, he would have exposure to the 10% excise tax (10% x $300,000) which would be limited to the maximum penalty of $10,000.

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