top-of-mind issues for tax-exempt providers

22nd Annual Health Sciences Tax Conference Top-of-mind issues for tax-exempt providers December 3, 2012

Top-of-mind issues for tax-exempt providers

Disclaimer

► Any US tax advice contained herein was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.


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Presenters

► Tricia Johnson Ernst & Young LLP Cincinnati, OH +1 513 612 1850 [email protected]

► Felicia Tucker Ernst & Young LLP Jericho, NY +1 516 336 0362 [email protected]


Topics

► “Follow the money” and political/lobbying activities ► Medical device excise tax ► Advisory Committee on Tax Exempt and Government

Entities (ACT) recommendations on Form 1023 ► Internal Revenue Service (IRS) Master File considerations ► Tangible property regulations

“Follow the money” and political/lobbying activities


Political campaign activity

► Regarding a candidate ► Any activity that favors or opposes candidates for public

office, including: ► Endorsement of candidates ► Contributions

► To candidates ► To political action committees (PACs)

► Public statements for/against a particular candidate or favorable activity toward or against a candidate

► Distributing materials prepared by oneself or others that favor or oppose candidates

► All facts and circumstances will be considered


Lobbying

► Attempting to influence a piece of legislation ► Direct lobbying

► Directly contacting members of a legislative body ► Encouraging the public to contact members of a legislative body ► Advocating a position on a public referendum

► Grassroots lobbying ► The amount spent to influence, or an attempt to affect, the

opinions of the general public or any part of the general public about an issue


General advocacy and educational activities

► Influence non-legislative governing bodies (e.g., the executive branch or regulators)

► Encourage voter participation in a non-partisan manner ► Voter registration ► Get out the vote drives ► Voter guides ► Candidate debates


501(c)(3) organizations

► Political campaign activity ► Prohibited, and may cause a loss of exemption

► Schedule C (Form 990) does allow a reporting of a correction

► Lobbying ► Must be an insubstantial activity of the organization

► Facts and circumstances test, and “insubstantial” is not defined ► Safe harbor — Section 501(h) election

► Up to US$1,000,000 direct expenditures and US$250,000 grassroots; based on total exempt-purpose expenditures

► Applied on an affiliated group basis ► Excise tax for excess lobbying

► General advocacy ► Permitted as an educational activity


501(c)(3) organizations — 501(h) election and reporting requirements

► Safe harbor expenditure test ► Make election by filing Form 5768 ► Affiliated group application ► Excise tax for exceeding non-taxable amount in any one year ► Loss of exemption if excessive over a four-year period

► May also un-elect ► Form 990, Part IV

► 3. Did the organization engage in direct or indirect political campaign activities on behalf of or in opposition to candidates for public office? If “Yes,” complete Schedule C, Part I.

► 4. Section 501(c)(3) organizations. Did the organization engage in lobbying activities, or have a section 501(h) election in effect during the tax year? If “Yes,” complete Schedule C, Part II.


501(c)(4), (c)(5) or (c)(6) organizations

► Political campaign activity ► Permitted so long as it does not constitute the organization’s

primary activity

► Lobbying ► Unlimited amount of lobbying in furtherance of its exempt

purpose permitted

► General advocacy ► Unlimited amount in furtherance of its exempt purpose permitted

Medical device excise tax


Medical device excise tax (MDET) — imposition of tax

► Internal Revenue Code (IRC) Section 4191 imposes a 2.3% excise tax on: ► The “sale” or rental (or other first use) in the US ► Of “taxable medical devices” ► By a “manufacturer” or “importer” ► Effective January 1, 2013

► Proposed regulations were issued February 3, 2012 ► While the comment period ended May 7, 2012, the IRS has asked

for additional comments from interested parties.


Which devices are taxable?

► Taxable medical devices are medical devices sold or used in the United States and intended for use on humans.

► The Food and Drug Administration (FDA) listing includes 5,800+ separate devices. ► Manufacturers are required to list devices with the FDA. ► Hospitals may make some of the same items for internal use, but

are generally exempt from the FDA-listing requirements for those items.

► To be taxable, medical devices must be: ► Listed with the FDA (i.e., have a three-letter FDA product code) ► Finished goods ready for the market ► Not otherwise qualified for an exemption


Which devices are exempt?

► Items not listed with a 3-letter FDA product code under FDA 510(k) requirements

► Exports ► Eyeglasses, hearing aids and contact lenses ► Specific custom-fit items ► Items sold for further manufacturing ► Certain medical devices sold at retail ► Items not required to be listed with the FDA because they are sold

exclusively for use in “research” ► Investigational device exemption (IDE) — a medical device not yet

required to be listed with the FDA because the FDA has not yet approved it for marketing


Determining the taxpayer

► MDET is imposed on the manufacturer, producer or importer of a taxable article. ► For excise tax purposes, the term manufacturer includes a “producer” and

an “importer.” ► A manufacturer is a person who produces a taxable article by processing,

manipulating or changing the form of an article, or by combining or assembling two or more articles.

► Because the MDET applies only to US sales of taxable medical devices, the MDET is also imposed on importers in lieu of the actual manufacturer. ► An “importer” of a taxable article is any person who brings an article into the US

from a source outside the US and is the beneficial owner. ► While the IRS has yet to issue any rulings on the medical device excise tax, they

have issued several rulings holding customers to be importers in situations where taxable articles are imported directly from foreign manufacturers, even if there was an agent or arranger of the sale involved.


Tax compliance and paying the liability

► Due by the manufacturer or importer ► Tax returns will be filed quarterly on the Form 720 ► Estimated tax payments are due biweekly (every two weeks)

► First payment of the medical device excise tax is due January 28, 2013, for activity January 1–14

► Exemption certificates will be available for exports and for further manufacturing

► There are penalties associated with non-payment/under-payment of MDET; estimated biweekly tax payments are required to sum to 95% of quarterly liability ► Both failure-to-pay and failure-to-file penalties apply

► The manufacturer or importer may try to recover the tax paid by: ► Increasing the price of the medical device or ► Adding to the invoice price the amount of the tax as a separate charge


Provider implications — indirect tax liability

► Cost increases ► The vendor may increase the price or put additional charges on

the invoice, though they are not required to notify. ► For purchased convenience kits (aka custom packs), the tax will

apply to the value of the entire kit, even if there are otherwise non-taxable items included.


Provider implications — direct tax liability

► Importing ► Direct sourcing ► Via group purchasing organizations (GPOs) or other similar arrangements

► Kits assembled for internal use are likely not taxable to hospitals, though this is not confirmed until the IRS finalizes regulations: ► Hospitals are generally exempt from registration and listing requirements of the

FDA when making kits for internal usage. The same taxable kit made by a manufacturer (using the MDET definition of a manufacturer) that is sold on a commercial basis may also be made by a hospital; however, because hospitals are exempt from registration and listing requirements of medical devices, they may not be creating taxable kits for purposes of the MDET.

► Some hospitals, however, may create medical devices and sell them to other, unrelated, hospitals or others. It is less clear whether these sales should not result in an excise tax, and this may be dependent on whether the FDA registration and listing requirements apply (such are not addressed here).


Provider opportunities

► Contract review ► Understand where a vendor could change a behavior and cause a

hospital to have a direct liability ► Consider amending existing contracts to prevent the seller from

passing through the cost of this tax

► Kitting ► Restructure kits — focus on high value, high use ► Bring kitting in-house — consider cost/benefit analysis (assuming

the IRS concurs that hospitals will be exempt for internal-use manufacturing)

► Implement exemption management process

► Leases ► Understand how tax applies to the manufacturer and ensure it is

not charged through on all lease payments ► Separate other economic transactions


Provider opportunities (cont.)

► Central procurement — trigger all direct liability in one entity

► Centralize knowledge regarding what items are taxable: ► Understand which items are taxable devices and which are not to

ensure vendors are not arbitrarily trying to charge through, such as an across-the-board price increase

► Be able to identify items that may at first appear to have a direct liability because they are imported, but really may qualify for one of the exemptions

ACT recommendations on Form 1023


ACT recommendations on Form 1023 — updating for the future

► ACT report ► Project ASPIRE

► A — Alleviate backlog ► S — Streamline process ► P — Prioritize review ► I — Improve customer service ► R — Redirect resources ► E — Enhance quality control


ACT recommendations on Form 1023 — updating for the future (cont.)

► Specific recommendations ► Develop fully interactive Form 1023 ► Develop fully e-fileable Form 1023 ► Facilitate Form 1023 database

► Primary objectives of Form 1023 ► To be effective in identifying whether the organization qualifies ► To be consistent with structure and definitions of Form 990 ► To be simplified by using a short-form and supplemental

schedules ► To be educational by organizing questions


ACT recommendations on Form 1023 — updating for the future (cont.)

► IRS suggested next steps: ► Develop educational tools about substantive requirements ► Coordinate with the Treasury Department and Office of

Chief Counsel ► Examine recurring complaints and improve the filing process ► Expand the Review of Operations (ROO) program to follow up on

Section 501(c)(3) organizations whose exemption application indicated potential future compliance issues

IRS Master File considerations


IRS Master File considerations

The Exempt Organization Business Master File (EO BMF) contains all of the applicable information that the IRS has on file for exempt organizations. ► A name/Employer Identification Number (EIN) mismatch can cause a

delay in payment from Centers for Medicare and Medicaid Services (CMS) and other payors. ► May include the group and subordinate designation structure within the

IRS system as well ► An incorrect address of record (AoR) can invalidate a power of

attorney. ► An incorrect year-end can cause late filing notices (this happens often

with large systems where entities have different year-ends).


IRS Master File considerations (cont.)

► Incorrect public charity status on IRS BMF examples are as follows: ► A change in an organization’s public charity status is allowable on Form

990, Schedule A, but the IRS does not update its records from information on the Form 990.

► Following the Pension Protection Act of 2006 (PPA), many organizations updated their public charity status on Schedule A to avoid some of the donor issues associated with the 509(a)(3) status, but did not request an updated determination letter; therefore, the IRS still has the 509(a)(3) status in the public record.

► There may be a public charity issue if the organization does not qualify for the status claimed on Form 990.

► Form 8940 — an organization may submit, along with the applicable user fee, a request for a letter confirming it qualifies for a new public charity status.


BMF vs Select Check

There are two ways to check the deductibility of an organization with the IRS: ► EO Business Master File

► A state-by-state downloadable spreadsheet including organizations’ names, address, private foundation status, year-end, group exemption number, most recent 990 statistics and more.

► Select Check ► This option can check if an organization is eligible for tax-deductible

contributions, was automatically revoked or if it filed a 990-N. ► Entities exempt under a Group Exemption Number (GEN) are not

currently found with Select Check, but should be in the BMF. We have also found instances where organizations were not found in the state download, but were found in the applicable region download.

Tangible property regulations


Five things you need to know

Who is affected? The regulations affect all taxpayers with tangible property:

► Taxable subsidiaries ► Form 990-T activity ► Partnerships/joint ventures

What do they cover? ► The regulations contain many broad-reaching rules — not just repairs.

When do they go into effect? ► The regulations apply to the 2014 tax year (were just extended

from 2012).

How are the regulations going to affect your company? ► The regulations present new implementation issues.

Why is there so much interest in these regulations? ► The regulations depart from previous law and the

proposed regulations.


Key aspects

► What do the regulations cover? 1. Unit of property 2. Improvements 3. Materials and supplies 4. Acquisitions 5. Depreciation groupings and dispositions

► General changes for most taxpayers include: ► Method changes ► Compliance with Section 263A

► The regulations have broad applicability, with many questions remaining.

► How to implement the regulations — do you have a plan?


What do they cover?

Materials and supplies

Leased property

Acquisition of tangible property

Improvements to tangible property

Depreciation and

dispositions

► Definition ► Rotable spare

parts ► Election to

capitalize and apply de minimis rule

► Lessee/lessor expenditures

► Leasehold improvements

► Acquisition costs

► De minimis rule

► Transaction and investigatory costs

► Unit of property

► Betterments ► Restorations ► New or

different use ► Safe harbor

for routine maintenance

► General asset elections

► Multiple asset groupings

► Dispositions

Treas. Reg. § 1.162-3T

Treas. Reg. § 1.167(a)-4T



Treas. Regs. § 1.168(i)-1T and

§ 1.168(i)-8T

Other regulation sections amended for consistency.


Heating, ventilation and air conditioning (HVAC) system – includes motors, compressors, boilers, chillers, pipes, ducts, etc.

Plumbing system – includes pipes, drains, sinks, bathtubs, toilets, water/sewer equipment, etc.

Electrical system – includes wiring, outlets, junction boxes, lighting fixtures, etc.

Gas distribution system – includes pipes and equipment used to distribute gas, etc.

Fire protection and alarm system – includes sprinklers, computer controls, fire doors/escapes, etc.

Security system – includes window and door locks, security cameras, security lighting, alarm system, etc.

Elevator system – includes all elevators in the building

Escalator system – includes all escalators in the building

Building structure – all other Section 1250 components, including roof, walls, foundation, finishes, windows, doors, etc.

Unit of property: buildings and building systems


Materials and supplies

► Definition: tangible property (not inventory) that is: ► A component acquired to maintain, repair or improve a unit of tangible property

or

► Fuel, lubricants, water and similar items that are reasonably expected to be consumed in 12 months or less

or

► A unit of property with an economic useful life of 12 months or less

or

► A unit of property costing US$100 or less

or

► Identified as such in guidance

► The new definition may mean that some assets are depreciable property rather than materials and supplies.


Tangible property De minimis rule — book conformity election

► De minimis rule to conform to book expense ► Must have applicable financial statements (AFS) ► Must expense amounts in its AFS consistent with written

capitalization procedures ► By taxable entity, aggregate amount less than ceiling of:

► 0.1% of the taxpayer’s tax gross receipts or

► 2.0% of the taxpayer’s total book depreciation and amortization ► If an entity exceeds the ceiling, excess amount must be capitalized

► May choose which items to capitalize ► Exclusions

► Land ► Inventory


The procedural guidance

► Roadmap for implementing the regulations, including: ► Two-year waiver of the scope limitations: provides taxpayers under

examination the ability to file method changes outside of window periods without obtaining examination consent and waives the five-year limitation

► Specific guidance related to the applicability of statistical sampling for computing Section 481(a) adjustments and tax-return positions ► Provisions indicating which method changes will have a full 481(a) adjustment

versus those made on a modified cut-off (based on the effective date of the regulations)

► 19 new automatic changes ► Many of the new changes can be filed on a single Form 3115, although

multiple 3115s are likely ► Compliance with § 263A is generally required

► Self–constructed assets and inventory ► File in Ogden, UT, office in lieu of IRS National Office


Notice 2012-73

Notice 2012-73 (issued 12/20/2012) announced: ► Temporary regulations (currently effective for tax years beginning on

or after 1/1/2012): ► Will be modified to be effective for tax years beginning on or after

1/1/2014 ► May be optionally applied for tax years beginning on or after 1/1/2012 ► Optional early application may be done piecemeal

► Final regulations: ► Are anticipated to be published in 2013 ► Will be effective for tax years beginning on or after 1/1/2014 ► May be optionally applied for tax years beginning on or after 1/1/2012 ► Will include modifications to de minimis rule, dispositions rules, and the

routine maintenance safe harbor


Thank you for your participation and feedback!

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