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					    AHLA Tax Issues for Healthcare
    Organizations

    Executive Compensation: View from
    the Trenches


TJ Sullivan, Esq., Partner
Drinker Biddle & Reath LLP
202-230-5157
tj.sullivan@dbr.com
October 3-4, 2011




   Just sit right back


   And you’ll hear a tale, a tale of a
    fateful trip…




                                         2




                                             1
Executive Compensation

 Continued focus of IRS exams
 Agents more likely to challenge EO
  decisions
 Agents may be new to exempt
  orgs
 IRS is skeptical of peer groups,
  especially use of for-profit
  comparables
                                       3




IRS Compensation Examinations

 Far more likely to involve a
 whistleblower
 IRS is more likely to challenge
 rebuttable presumption (RP)
 IRS may try to send EO/exec to
 Fast Track Settlement
 Opportunities for missteps abound

                                       4




                                           2
 EO Guiding Principle


 Private Inurement
   No part of the net earnings inures to the
   benefit of any private shareholder or
   individual
   Applies only to “insiders” (disqualified
   persons)
   No minimum threshold—One dollar is
   enough to cause trouble

                                               5




 Intermediate Sanctions

  Code Section 4958 (1996)
  Applies to 501(c)(3)s and
  (c)(4)s
     “Applicable tax-exempt organizations”
     “Excess benefit transactions”
     “Disqualified persons”
     “Rebuttable presumption”
     “Penalty excise taxes”

                                               6




                                                   3
Avoiding Intermediate Sanctions

 It’s All About Reasonableness
 It’s All About Process
 It’s All About Documentation
 It’s All About Reporting


 But watch out. In some cases it’s about the
                  amount!
                                               7




Excess Benefit Transactions

 Non-Fair Market Value (FMV)
  Transaction
 Unreasonable Compensation
  Transaction
 Automatic Excess Benefit
  Transaction
   Unreported compensation
   PPA transaction



                                               8




                                                   4
   Penalty Excise Taxes

    Disqualified Person
        25% tax and additional 200% if the transaction is
        not timely corrected

    Organization Manager
        Approved transaction, knowingly, willfully and
        without reasonable cause
        10% tax (to a maximum of $20,000)

    No Penalty on the EO
        Wait!—What about disclosure on the 990?

                                                            9




   Rebuttable Presumption of
   Reasonableness

 Applies if:
    The arrangement was approved by board or committee
    composed entirely of individuals who do not have a
    conflict with respect to the arrangement;
    The board or committee obtained and relied on
    appropriate data as to comparability; and
    Adequately documented the basis for its determination
    (by later of next meeting or 60 days).




                                                            10




                                                                 5
Determining Comparability

 Appropriate data as to
 comparability includes:
    Compensation levels paid by similarly situated
    organizations, taxable and tax-exempt
    Independent compensation surveys compiled from
    independent firms
    Actual written offers from similar institutions
    Independent appraisals of the value

 IRS skepticism growing

                                                            11




Determining Comparability

 The approving body is protected in
 relying on a consultant’s written
 reasoned analysis, if the consultant
 certifies that it:
    Holds itself out to public as compensation consultant
    Performs these valuations regularly
    Is qualified to perform these valuations

 These certifications should be in every
 comp opinion

                                                            12




                                                                 6
Case Study

 Non-healthcare EO heavily
  dependent on charitable
  contributions
 Statewide operations, $80 million
  in revenue
 Governed by a board drawn from
  the community
 Top performing CEO, $850k

                                      13




Case Study

 Disgruntled former employee
 wrote to AG and (possibly) IRS
 complaining about CEO pay
 IRS commenced exam of ’03 and
 ’04, then extended to ’05 and ’06




                                      14




                                           7
List of Players

 EO attorney for org
 Tax attorney for CEO
 EO attorney for Board (TJ)
 IRS Lead Agent #1 (retired)
 IRS Lead Agent #2 (retired)
 IRS Lead Agent #3 (brand new to EO)
 IRS Group Manager
 TE/GE Regional Counsel
 Comp consultant #1 and #2 (Marty)
                                        15




Year One

 Agent 1 interviews CEO, Board,
 formulates view:
    RP not achieved
    For-profit data not appropriate
    CEO paid too much

 Agent 1 orally suggests finding
  EBT and DP and OM penalties
 Agent 1 and CEO’s attorney have
  personality clash
                                        16




                                             8
Lesson One

 Never leave personality clashes in
  place
 Always treat IRS agents with
  respect even if you disagree with
  their position or application of law




                                                 17




Year Two

 Agent 1 retires, deputy is promoted to lead
  agent
 TJ is retained to represent Board members,
  files Form 8821 for org and CEO, leads
  negotiations, prepares JDA
 Agent 2 begins to develop comparability data
  from private database (NFP only) supporting
  IRS view
 Agent 2 informs Board no OM penalties
 No Revenue Agent’s Report (RAR)


                                                 18




                                                      9
Year Three

 Agent 2 retires
 Agent 3 transfers from SB/SE, picks up
 trail, promises RAR
 Org retains Comp consultant 2 (Katz),
 prepares new study (NFP only)
 IRS struggles to determine “total
 compensation” for 4958 purposes
 No RAR

                                           19




Lesson Two

 IRS does not understand
 executive compensation design
 very well, nor application of 4958
 EBT calculations to elements of
 compensation beyond base salary




                                           20




                                                10
Year Four

 Agent 3 continues to struggle to
  pinpoint CEO total compensation for
  4958 purposes
 Comp consultant 2 issues report finding
  total comp reasonable
 Org requests Technical Advice as to
  presence of EBT
    Group Manager consults TE/GE Regional Counsel
 IRS TE/GE National Office declines TA
 (4958 too factual)
    Remember mandatory TA??

                                                    21




Year Four (cont’d)

 Regional TE/GE Counsel provides
 assistance but is non-committal
 Org hires tax litigation counsel to
 prepare case for USTC
 No RAR




                                                    22




                                                         11
Lesson Three

 In 4958 cases, IRS will try to
 divide and conquer and will use
 6103 against you
   Keep co-parties together
   Keep all eyes on the goal
   Manage counsel relations carefully
   Where necessary, let IRS know you are prepared to
   litigate




                                                       23




Year Five

 Org receives “no change”
 Draft RAR is provided to CEO
   No EBT in two years
   $200k EBT in two years
   More conciliatory tone

 IRS tries to divide and conquer
   Encourages use of new Fast Track Appeals program
   to resolve the dispute



                                                       24




                                                            12
Year Five (cont’d)

 Org requests final RAR, traditional
  Appeals
 IRS drags feet 8 more months,
  issues narrower RAR
 Parties prepare submission to
  Appeals
 Parties wait for Appeals Officer to
  be assigned
                                        25




Year Six

 Parties wait, extend statutes
 Appeals Officer is assigned,
 hearing is scheduled
 Appeals Officer reviews
 submission, resolves case without
 hearing


                                        26




                                             13
Lesson Four

 Resolve comp cases at the lowest
  level possible, but prepare the
  case for litigation
 TE/GE National Office has
  abandoned ye, and handed ye off
  to Fast Track
 Consider carefully the outcome
  org needs before participating in
  Fast Track
                                      27




             Questions




                                      28




                                           14

				
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