when for profit & not for profit worlds collide

22nd Annual Health Sciences Tax Conference When for-profit and not-for-profit worlds collide December 4, 2012

When for-profit and not-for-profit worlds collide

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.


Disclaimer

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Presenters

► Donna Borgese UPMC Health System Pittsburgh, PA

► Mark Rountree Ernst & Young LLP Dallas, TX +1 214 969 8607 [email protected]

► Chris Monte LifePoint Hospitals Nashville, TN

► Jim Steen Ernst & Young LLP Pittsburgh, PA

+1 412 644 7850 [email protected]

► David Miller Ernst & Young LLP Dallas, TX +1 214 969 0636 [email protected]


Agenda

► Current IRS perspective regarding for-profit/tax-exempt joint ventures

► Practical considerations from the for-profit perspective ► Practical considerations from the tax-exempt perspective ► Partnership technical considerations and pitfalls

► Q&A

Current IRS perspective regarding for-profit/tax-exempt joint ventures

Mark Rountree, Ernst & Young LLP, Dallas, TX


Current IRS perspective regarding for-profit/ tax-exempt joint ventures ► Relevant authority

► In general ► Accountable care organizations

► Pending cases and rulings

► Current IRS perspective

► Ruling posture ► Audit activity

► Proceed with caution ... but proceed

PRACTICAL CONSIDERATIONS FROM THE FOR-PROFIT PERSPECTIVE

Chris Monte, LifePoint Hospitals, Nashville, TN


Practical considerations from the for-profit perspective ► Indirect tax implications for joint venture entity

► Sales tax ► Property tax ► Valuation of asset considerations ► Controversy activity

► Information reporting considerations for exempt partner

► For 990 reporting (e.g., Part VI, Schedules H and R) ► For UBI purposes ► For exempt bond/private use purposes ► Information gathering and tracking considerations


Practical considerations from the for-profit perspective (cont.)

► “Managing the tension” ► Protect tax-exempt status of exempt partner ► Preserve consolidated financial reporting and other preferred

methods ► Process considerations for resolving “tension” matters

► Issues for ventures with health plans

► Section 162(m)(6)

PRACTICAL CONSIDERATIONS FROM THE TAX-EXEMPT PERSPECTIVE

Donna Borgese, UPMC Health System, Pittsburgh, PA Jim Steen, Ernst & Young LLP, Pittsburgh, PA


Practical considerations from the tax-exempt perspective ► Allocation and valuation of costs and charges

► Issues unique to internal allocations ► Issues unique to external allocations ► Educating internal and external parties regarding valuation issues

and requirements of tax-exempt partner

► Transfer pricing

► Regulatory criteria and methodology ► When to apply transfer pricing valuations ► Documentation and process considerations ► Pitfalls ► IRS audit experience


Practical considerations from the tax-exempt perspective (cont.)

► Choice of entity and structuring considerations ► Dynamic environment results in numerous forms and structures ► No “one size fits all” structure in light of market pressures,

competing priorities of partners and need for creativity and innovation

► Key non-tax considerations: ► Respective contributions of venture partners ► Optimizing economies of scale ► Optimizing leverage of partner resources and expertise ► Ongoing flexibility and adaptability of structure ► Exit strategy considerations

► Ongoing 990 reporting implications for exempt partner

Partnership technical considerations and pitfalls

David Miller, Ernst & Young LLP, Dallas, TX


Partnership technical considerations and pitfalls

► Disguised sale implications upon formation of venture

► Section 704(c) considerations

► At formation ► Ongoing

► Section 168(h)(6)


Disguised sales – basic rules

► General rules ► The transfer of property to a partnership in exchange for an interest

therein is not taxable to the contributing partner or the partnership. ► The distribution of money from a partnership to a partner is not taxable

to the extent of the partner’s basis in its partnership interest.

► Exception – disguised sale rule ► Transfer of property from a partner to a partnership is presumed to be

a sale of the property to the extent partnership makes a distribution (whether actual or “deemed”) to partner within two years.

► A reduction in a contributing partner’s share of a “nonqualified” liability is treated as a distribution of money and, as a result, part of a disguised sale.


Disguised sale 1. Target transfers Target

assets to JV for cash and units.

2. Transaction is treated as if Target sold 80% of the Target assets (and Target will recognize 80% of its gain in the property).

Disguised sale of property

Target

JV

$200m units $800m cash

FMV $1B AB $0

Third party


Impact of liabilities

► A reduction in a partner’s share of a nonqualified liability is treated as a distribution of money.

► Nonqualified liabilities ► All liabilities other than qualified liabilities

► Qualified liabilities ► A liability is a qualified liability if, and only if:

► It was incurred more than two years prior to the contribution or was not incurred in anticipation of the transfer and has been secured by the property during those two years.

► It was incurred to acquire the property being contributed. ► It was incurred in the ordinary course of the trade or business and all assets

associated with the business are being transferred. ► If the transferor receives any consideration in the transfer other than

equity and the assumption of qualified liabilities, a portion of the qualified liability will be reclassified as a nonqualified liability.


Disguised sale planning — basic strategies

► Goal: front load basis recovery

► Deferral only

► Strategies ► Assumption of qualified liabilities ► Reimbursement of capital expenditures ► Mixing and matching disguised sale exceptions ► Debt financed distribution rule ► Avoiding distributions through borrowings


Disguised sale reporting obligations

► Taxpayers must disclose: ► Any distribution within two years of a property contribution that the

parties do not treat as part of a disguised sale ► Exceptions for certain preferred returns, guaranteed payments and

operating cash flow distributions ► Any liability treated as a qualified liability under the “not in

anticipation” rule


Section 704(c) — contributions of built-in gain or built-in loss property

► General rules ► Built-in gain (BIG) and built-in loss (BIL)

► Difference between Section 704(b) book basis (FMV) and tax basis of property at contribution date

► Partnership must allocate tax items of income, gain, loss or deduction related to built-in gain or loss to the contributing partner

► Affects only tax basis, not book basis ► Applied on a property-by-property basis ► De minimis rule applies for small disparities between FMV

and basis


Section 704(c) — impact of the method chosen

► Method more important if property’s depreciable tax basis is less than noncontributing partner’s aggregate share of book value (i.e., ceiling rule)

► Method affects taxable income — negotiate method up front

► If parties are in different tax positions, choice of method may result in aggregate tax savings to parties (that may be shared subject to anti-abuse rule)


Section 704(c) allocation methods

► Treas. Reg. §1.704-3 — specified methods ► Traditional allocation method ► Traditional method with curative allocations ► Remedial allocation method

► Different methods may be used for each property, but the method or combination of methods must be reasonable.


Traditional allocation method — example with ceiling rule limitation

► Assume A and B form a partnership with each owning a 50% interest ► A contributes depreciable property with a tax basis of $3,000 and

FMV of $10,000, and B contributes $10,000 of cash ► The property has a remaining depreciation period of 10 years and

the property is depreciated on a straight-line basis

► Step 1 – calculate and allocate annual book depreciation – $500 ($10,000/10 years = $1,000 shared 50%/50%)

► Step 2 – calculate annual tax depreciation – $300 ($3,000/10 years) and allocate all available tax depreciation from the Section 704(c) property to the non-contributor (B) to the extent of its book depreciation – $300


Traditional allocation method — example with ceiling rule limitation (cont.)

► Step 3 – allocate the remaining tax depreciation to the contributor – $0

► Note: In this example, B is allocated $500 of book depreciation and only receives $300 of tax depreciation. This problem is known as the “ceiling rule” and causes B to bear the burden of the built-in gain in the section 704(c) property.


Section 704(c) alternative methods

► Traditional method with curatives ► Attempts to correct distortions created by the ceiling rule by allocating other

partnership tax items of income, gain, deduction or loss to the noncontributing partner

► Must be of the same character (i.e., same tax attributes) ► Remedial method

► Corrects distortions created by the ceiling rule by allocating notional items of expense to the non-contributing partner and income to the contributing partner

► Book basis of asset is split into two components ► Amount of book basis equal to tax basis is recovered over remaining tax

recovery period ► Excess of book basis over tax basis is treated as new asset and depreciated

over applicable tax recovery period ► Has the effect of lengthening the recovery period as compared to curative or

traditional method


Section 704(c) — other items to consider

► Anti-abuse rule if partners have different tax profiles – impact on joint ventures with tax-exempt partners

► “Reverse” Section 704(c) items ► “Opposite sign” layers (arises in the case of multiple

revaluations where the property has fluctuated in value) ► Netting approach ► Layering approach

► Applying Section 704(c) when the contributed property is an interest in a lower-tier partnership

► Section 704(c)(1)(C) trap


Section 168(h)(6)

► General rule

► Implications for depreciation method

► Implications for recovery period

► Implications for joint ventures, including tax-exempt partners

► Qualified allocations

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