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[ Corporate Tax - Intermediate Sanctions Excise Taxes ]

Suggested Answers : Case Study #6 - Sponsored Research
Intermediate Sanctions :|: Case Studies of Potential Excess Benefit Transactions

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

    Disqualified person
    Professor Sytek, as chair of a major department in the School of Medicine and as head of the department’s clinical practice, may have substantial influence over the affairs of UPHS. It would be reasonable to assume that an individual with these responsibilities would regularly exercise general authority to make administrative or policy decisions on behalf of the organization. As such, he is a disqualified person. Bill Penfriend, as a trustee of UPHS, is by definition, also a disqualified person. Panacea, appears to be 70% owned by the Capital Group which is 60% owned by Bill Penfriend. Bill therefore owns more than 35% of Panacea which makes Panacea a disqualified person as well.

    Organization managers
    Managing Director of CTT approved the licensing of the patent and the Vice Provost for Research reviewed and approved the entire transaction. Both individuals appear to have responsibilities that allow them to regularly exercise general authority to make administrative or policy decisions on behalf of Penn. As such, both appear to meet the definition of an organization manager.

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

    The licensing of the patent by Penn to Panacea may be an excess benefit transaction if the value Penn receives from Panacea (20% ownership in Panacea, reimbursement of patent expenses, etc.) is less than the fair market value of the patent that Penn is licensing to Panacea. Professor Sytek also receives a 10% equity interest in Panacea as part of the deal for his role as a co-founder and his future services on Panacea’s scientific advisory board. Since Professor Sytek is also a disqualified person, the value of his services in the transaction needs to be compared to the 10% equity interest that he receives to determine if it also constitutes an excess benefit transaction. The facts of the case may suggest that the 10% equity interest received by Professor Sytek should be treated as additional taxable compensation from Penn. If it is deemed to be compensation from Penn and not properly reported, it would be a per se excess benefit transaction.

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

    Start-up ventures are difficult to value. How the IRS views this transaction may, however, depend on the University’s ability to demonstrate that it carried out and documented an adequate valuation at the time of the transaction. Based on the price of Panacea shares after the IPO, after five years Panacea is worth $50,000,000. The University’s share of Panacea would be worth $10,000,000, Professor Sytek’s interest would be worth $5,000,000, and the Capital Group’s share would be $30,000,000. This is a tremendous success story, but the University would need to document that its 20% interest at the time of the formation of Panacea was really fair market value. Since valuation is an imperfect process, without the proper documentation, upon audit, the IRS could assert that the University should have received more than a 20% interest in Panacea in return for the patent and/or that Dr. Sytek should have received less than a 10% interest in return for the value he contributed. Any excess benefits to either Dr. Sytek or to Panacea would be subject to the 25% excise tax in addition to the requirement that the excess benefit be returned to the University.

    Both the Managing Director of CTT and the Vice Provost for Research could be jointly liable for the 10% tax on organization managers. It would appear likely, that if any excess benefit transaction were identified, the tax on organization managers under these facts would probably hit the $10,000 maximum because of the dollars involved.

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