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[ Corporate Tax - Intermediate Sanctions Excise Taxes ]

Suggested Answers : Case Study #4 - Joint Venture
Intermediate Sanctions :|: Case Studies of Potential Excess Benefit Transactions

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

    Disqualified person
    Dr. Rob Hart, as Chief of Cardiology at PAH, is potentially a disqualified person. Given his position, it might be assumed from the reference to “his very busy practice” that he is an important source of admission to PAH. If so, he might be deemed under the facts and circumstances test to have substantial influence over the affairs of Penn. He might also be found to manage a discrete segment of PAH that represents a substantial portion of its activities, assets, income or expenses. If Dr. Hart is found to be a disqualified person, by definition his wealthy brother-in-law would also be a disqualified person under the family attribution rules. In such a case, UFCT would also be a disqualified person by definition because wealthy brother-in-law owns or controls 40% of UFCT which is more than 35% threshold under the attribution rules.

    Organization managers
    The PAH Executive Director, VP for Professional Services, and the Director of Radiology Services all appear to be organization managers. Since all three “reviewed and approved the contract,” they all appear able to exercise general authority to make administrative or policy decisions on behalf of PAH. In order to fully meet this definition, it would need to be shown that they are exercising these types of powers on a regular basis.

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

    PAH enters into a long-term contractual agreement with UFCT, who appears to meet the definition of a disqualified person, and agrees to pay a premium of 25% above current market rates. PAH is never really able to clearly identify or document a market justification for the 25% premium. Without justification for the 25% price premium, it appears that this meets the definition of an excess benefit transaction subject to the Intermediate Sanctions excise taxes.

    The case also points out that Dr. Hart would receive the use of his brother-in-law’s Maui condo for one week, a value of $5,000, if UFCT successfully obtained a contract with PAH. The case states that Dr. Hart was careful not to actively promote UFCT. It is unclear if Dr. Hart used his influence in a non-active fashion to impact PAH’s decision on the contract. It might be argued that UFCT would receive a 25% fee in excess of market (an excess benefit), that wealthy brother-in-law would receive part of that 25% through an increase in the value of his stock, and that Dr. Hart would ultimately receive a part of the 25% premium through the use of the condo. All of these parties appear to be disqualified persons. However, as a practical matter, the IRS would likely focus on UFCT as the recipient of the excess benefit and the party liable for the excise tax. If Dr. Hart used any of his influence over PAH to affect the outcome of the transaction, he likely would have violated PAH’s conflict-of-interest policy. The $5,000 value of the condo usage would also probably be taxable compensation to Dr. Hart for his services to UFCT.

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

    UFCT, as the recipient of the 25% fee premium and a disqualified person, would have exposure to the Intermediate Sanctions excise tax. If the tax were imposed, UFCT would have to return the 25% premium to PAH and, in addition, pay a 25% excise tax on the excess benefit. If UCFT obtains the 2,500 scans annually that it projects, at $600 per scan the excess benefit could be $375,000 per year and the excise tax would be $93,750 for one year. These amounts would increase if the transactions had gone on for more than one year before being challenged by the IRS. In addition, the PAH Executive Director, the V.P. for Professional Services, and the Director of Radiology Services would, as organization managers who approved the transaction, be jointly liable for the 10% penalty tax. The 10% tax in this case would be $9,375 per year with the maximum liability for this transaction being $10,000.

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