Tax Issues in Higher Education Duke University May 24, 2007 Donald “Dee” E. Rich, Jr. Partner

1. Tax Issues in Higher Education Duke University May 24, 2007 Donald “Dee” E. Rich, Jr. Partner KPMG LLP

2. NOTICE ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (I) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (II) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

3. Overview • Pension Protection Act of 2006 • Tax Increase Prevention and Reconciliation Act of 2005 • Form 990 Changes • Congressional Oversight • NCAA hearings • Community Benefit • Higher Education • Executive Compensation and Fringe Benefits • Unrelated Business Income

4. Pension Protection Act of 2006

5. Pension Protection Act of 2006 • First significant charitable reform legislation in years • Senate passed House bill without changes to Senate bill • Therefore, scarce interpretation since no conference committee report • Signed into law on August 17, 2006 • Effective implementation dates of July 25, 2006 and August 17, 2006 for specific provisions • A number of charitable giving provisions sunset and are only effective for two years until 2007

6. Pension Protection Act of 2006 Components of Act • Supporting Organization Provisions • Reform Provisions Addressing • Disclosure • Enforcement • Overstatements of donor deductions • Charitable Giving Incentives • Other Provisions • Income from Controlled Subsidiaries • Donor Advised Fund reforms • Private Foundation Net Investment Income Tax base broadened

7. Pension Protection Act of 2006 Supporting Organization (“SO”) Provisions • Type 1, Type 2, Type 3 distinctions on Schedule A • Type 1 – Operated, supervised or controlled by, typically parent/subsidiary relationship • Type 2 – Supervised or controlled in connection with, least common brother-sister relationship • Type 3 – Operated in connection with, loosest level of connection • Private Foundations – Grants not qualified distributions if made to Type 3 that is not “functionally integrated” Theme of SO reforms – SOs cannot be controlled or should not be influenced by related parties (disqualified persons) with respect to grants and/or investments.

8. Pension Protection Act of 2006 Charitable Giving Incentives • Generally provisions sunset at the end of 2007 • Incentives to encourage contributions of these items: • Tax-free distributions from Individual Retirement Accounts (“IRA”) for charitable purposes • Food and book inventory • Real property for conservation purposes • Basis adjustment to stock of S Corporations

9. Pension Protection Act of 2006 General Reforms Mechanisms to correct overstatement of donor deductions for contributions • Historic properties • Recapture of tax benefit on property not used in tax-exempt use • Limitations of deductions for contributions of clothing and household items • Taxidermy • Appraisal reform Enforcement Initiatives • Intermediate Sanctions and other penalty excise taxes doubled

10. Pension Protection Act of 2006 Disclosure Reforms - Transparency • Form 990-T Unrelated Business Income Tax Return now open for public inspection, effective for returns filed after 8/17/06 • Coordination with State officials • Organizations with < $25,000 in assets not previously required to file Form 990, must now make annual notification to the Treasury • Failure of < $25,000 organizations to make annual notification for 3 consecutive years will result in revocation of tax-exempt status

11. Pension Protection Act of 2006 Unrelated Business Income Tax • Income from Controlled Subsidiaries (IRC section 512(b)(13) Provisions • Excess over fair market value (“FMV”) now taxable • FMV defined by transfer pricing rules under IRC section 482, arm’s length pricing • “Qualified specified payment” also subject to an additional 20% tax • Payments received or accrued after December 31, 2005 and before January 1, 2008 • Provision sunsets after 2007 • Form 990-T open for public inspection

12. Tax Increase Prevention and Reconciliation Act of 2005

13. Tax Increase Prevention and Reconciliation Act of 2005 Excise Tax on Prohibited Tax Shelter Transactions • What constitutes a “prohibited tax shelter?” • Notice 2006-65, dated July 11, 2006, provided some IRS clarification. • LILO and SILO transactions • Tax on entity at greater of net income or 75% of proceeds from transaction • Tax on entity manager of $20,000 • Disclosure of all parties involved • Consider alternative investments • Effective for taxable years ending after May 17, 2006

14. Tax Increase Prevention and Reconciliation Act of 2005 Transactions • §516 of TIPRA: “Tax Involvement of Accommodation Parties in Tax Shelter Transactions” • Prohibited tax shelter transaction • “Listed transaction” under §6707A(c)(2). • “Prohibited reportable transaction”: reportable transaction under §6707A(c)(1) that is: • Confidential transaction. • Transaction with contractual protection. • Subsequently listed transaction • Transaction that is listed after tax-exempt entity becomes party to transaction. • Does not include transaction that was prohibited reportable transaction at time tax-exempt entity became party to transaction.

15. Tax Increase Prevention and Reconciliation Act of 2005 General Application • Tax-exempt organizations described in §501(c) or §501(d). • Entities described in §170(c) (other than the U.S.) • Indian tribal governments (within meaning of §7701(a)(40)). • Entities described in §4979(e)(1)-(3) (generally includes §401(a) qualified pension trusts and §403(a) & (b) plans. • §529 qualified tuition programs. • §457(b) deferred compensation plans maintained by employers described in §457(e)(1)(A) (state, political subdivision, or agency or instrumentality thereof). • Arrangements described in §4973 (generally includes §408 IRAs, §220 Archer medical savings accounts, §530 Coverdell education savings accounts, and §223 health savings accounts).

16. Tax Increase Prevention and Reconciliation Act of 2005 Effective Dates • §4965 generally effective for taxable years ending after May 17, 2006 with respect to transactions before, on, or after this date. • No excise tax applied with respect to income or proceeds properly allocable to any period ending on or before August 15, 2006. • Tax on entities that “knowingly” entered into prohibited tax shelter transaction does not apply to any prohibited tax shelter transaction to which the tax-exempt entity became a party on or before May 17, 2006. • New disclosure and penalty provisions generally apply to disclosures due after May 17, 2006.

17. 2005 Form 990 Changes

18. 2005 Form 990 Changes Focus • Board composition and independence • Compensation paid to current and former officers, key employees and directors/trustees • Foreign activities

19. 2005 Form 990 Changes IRC section 6033(a)(1): Every organization exempt from taxation under §501(a) shall file an annual return, stating specifically the items of gross income, receipts, and disbursements, and such other information for the purpose of carrying out the internal revenue laws as the Secretary by forms or regulations prescribe IRC section 6033(b): Every organization described in §501(c)(3) shall furnish annually information, at such time and in such manner as the Secretary by forms or regulations may prescribe, setting forth [among others]: • The names and addresses of its foundation managers and highly compensated employees. • The compensation and other payments made during the year to each such individual.

20. 2005 Form 990 Changes Treasury Regulation section 1.6033-2(a)(1): Every organization exempt from taxation under §501(a) shall file an annual information return specifically setting forth its items of gross income, gross receipts and disbursements, and such other information as may be prescribed in the instructions issued with respect to the return.

21. 2005 Form 990 Changes Treasury Regulation section 1.6033-2(a)(2)(ii) Information required to be furnished includes: • Names and addresses of: • Officers, directors, or trustees (or persons having similar responsibilities or powers). • For private foundations: names and addresses of foundation managers. • For §501(c)(3) organizations: • Five most highly compensated employees. • Five independent contractors providing professional services. • Compensation and other payments made during the annual accounting period (or during the calendar year ending within such period) includible in the gross income of each such individual.

22. 2005 Form 990 Part II

23. 2005 Form 990 Part V-A

24. 2005 Form 990 Part V-A

25. Ann. 2001-33, 2001-17 IRB 1137 Until the IRS notifies otherwise, by an Announcement published in the Internal Revenue Bulletin, organizations that pay other persons, such as management services companies, for the services of officers, directors, trustees, or key employees/foundation managers, will be deemed to have reasonable cause for purposes of the penalty under section 6652(c)(1)(a)(ii) of the Internal Revenue Code for the failure to provide the information required by the relevant portions of Parts IV, V or VIII of the forms, if: 1. Where the form asks for the name of officers, directors, trustees, or key employees/foundation managers, the reporting organization enters the name of the person (e.g., management services company) that performs those services under contracts and services that it performs; 2. Where the form asks for the address of officers, directors, trustees or key employees/foundation managers, the reporting organization enters the address where the IRS can contact such person (management services company); 3. Where the form asks for compensation paid to officers, directors, trustees or key employees/foundation managers, the reporting organization enters the amount paid to the person (management services company) for the services listed in response to inquiry 1, above.

26. IRS Website FAQs - 2005 Form 990 • How much effort must the filing organization undertake to obtain the information requested in Lines 75b and 75c? The filing organization must make a reasonable effort to obtain the information and provide accurate information on its return.  E.g., distribute questionnaire annually to each officer, director, trustee, and key employee listed in Part V; and each highest compensated employee, professional and other independent contractor listed in Schedule A.  Questionnaire should require name, title, date, and signature.  For purposes of line 75b, the questionnaire should contain the family and business definitions set out in the Line 51 instructions. • Does Part V-A require names of all board members or only board officers?  Also, does it require home addresses of board members/officers? Names of all board members must be listed.  In addition, corporate officers, trustees (if any), and key employees must be named.  Address provided for each person should be address at which person prefers to be contacted.  Organization's address may be used if the organization will promptly send any communications to the person contacted.

27. Relationships - Definitions • Family relationships: includes an individual’s spouse, ancestors, children, grandchildren, great-grandchildren, siblings (by whole or half blood), and the spouses of children, grandchildren, great-grandchildren, and siblings. • Business relationships: employment and contractual relationships, and common ownership of a business where any officers, directors, or trustees, individually or together possess more than a 35% ownership interest in common. Ownership means voting power in a corporation, profit interest in a partnership, or beneficial interest in a trust.

28. Compensation from Related Organizations

29. Compensation from Related Organizations

30. 2005 Form 990 Part V-B (Former Officers et al)

31. 2005 Form 990 Part V-B Instructions (Former Officers et al)

32. 2005 Form 990 Schedule A Part I

33. 2005 Schedule A Instructions

34. CPE Text for FY 2002 • The instructions to Part V of Form 990 construe compensation more broadly than other parts of the Code. • In the case of deferred compensation, the focus is on the time that the EO pays or becomes obligated (or potentially obligated) to pay it as well as the time that the employee or independent contractor receives a disbursement. • In the event that the Form 990 instructions require overreporting of actual compensation (e.g., the reporting of deferred compensation in both the year earned and the year paid), an EO can attach a statement to its Form 990 explaining how the compensation as reported is overstated. EOs are welcome to explain the entire compensation package for an individual. • The Service recognizes that precise actuarial cost figures may not be readily available for defined benefit plans and other plans, and allows reasonable estimates. Although many EOs hire an actuary to determine the estimate, it is not required that an EO do so in order for its estimate to be reasonable. Reasonable estimates based on available facts are acceptable, but the refusal to estimate merely because of difficulty is not. Where the Code or regulations allow or require a specific valuation procedure for a fringe benefit (e.g., for vehicles, planes, employer-provided meals, employer parking), that valuation procedure is also allowed or required for Form 990 purposes.

35. 2006 Form 990 Changes

36. 2006 Form 990 Part II Officers’ Compensation

37. 2006 Form 990 New Part XI

38. 2006 Form 990 Schedule A Part IV

39. Congressional Hearings

40. Congressional Activities House Ways and Means Committee Chairman Thomas sent a letter on October 2, 2005 to the NCAA requesting information about the organization’s exempt purpose and tax-exempt status. Chairman Thomas requested detailed information about the following topics: • The organization’s educational mission • The organization’s revenues and expenditures

41. Congressional Activities Senate Finance Committee Chairman Grassley sent a letter on December 29, 2005 to the Red Cross requesting information about the following topics: • The organization’s board governance • Its response to tsunami/Katrina disaster relief • Compensation of its president and other officers • The organization’s IRS filings

42. Congressional Activities The Subcommittee on Oversight of the Committee on Ways and Means held a hearing on May 25, 2006 on charities and employment tax compliance. Issues considered by the Subcommittee included: • What is the IRS doing to determine that charities comply with their payroll tax obligations? • Is the IRS effectively using its regulatory authority over charities to determine that they pay their taxes? • Is it appropriate for charities with substantial tax debt to maintain their tax-exempt status? • Are there tax-exempt organizations with significant tax debt that receive other benefits from the federal government, such as grants? TE/GE Commissioner Miller testified that the IRS plans to launch a pilot program to select taxpayers for examination in the near future.

43. Congressional Activities Senate Finance Committee holds hearing on September 13, 2006 on nonprofit hospitals, charitable care, and community benefit standards. Testimony was heard from the following individuals: • The Honorable Phill Kline, Attorney General, State of Kansas, Topeka, KS • Sister Carol Keehan, DC, President and CEO of Catholic Health Association, Washington, DC • Kevin E. Lofton, Chairman-elect of the American Hospital Association, President and CEO of Catholic Health Initiatives, Denver, Colorado • Scott A. Duke, CEO of the Glendive Medical Center, Glendive, Montana • Dr. Nancy M. Kane, Professor of Management, Department of Health Policy and Management, Harvard School of Public Health, Boston, MA • Raymond A. Hartz, Executive Director of the Legal Aid Society of Eastern Virginia, Norfolk, Virginia Chairman Grassley commended CHA for providing “real leadership in establishing best practices for measurements and reporting for community benefits.”

44. Congressional Activities Senate Finance Committee Chairman Grassley sent a letter on March 8, 2006 to American Hospital Association requesting additional information on three legislative proposals relating to potential nonprofit hospital reform. In particular, the letter requests information about the AHA’s position concerning: • Discounts to uninsured individuals • The definition of community benefit • Recommendations to strengthen the transparency, governance, and accountability of nonprofit hospitals

45. Congressional Activities Senate Finance Committee Chairman Grassley sent a letter on March 8, 2006 to Catholic Healthcare Association requesting the following information: • The organization’s nonprofit hospital members • The “best practices” being used by CHA members with respect to community benefit and charity care • Other topics of interest included investments in joint ventures, taxable subsidiaries, venture-capital funds and financial arrangements, contracts for health care, management and administrative services, executive compensation, travel and expense reimbursement, billing and debt collection practices—particularly for the uninsured, use of tax-exempt bond proceeds, conflicts of interest and other governance issues, and accounting, reporting, public disclosure, and general transparency issues

46. Congressional Activities Changing of the Guard on Capital Hill • Impact on Congressional Oversight • Technical Corrections relative to recent legislation • Change in Tone?

47. Executive Compensation and Fringe Benefits

48. Executive Compensation and Fringe Benefits GAO Study of Non-Profit Hospital Executive Compensation released in September 2006 • What corporate governance structure do selected hospital systems report as having in place over executive compensation? • What is the basis for the compensation and benefits earned by, awarded to, or paid to the executives as reported by selected hospital systems? • What internal controls do selected hospital systems report as having in place over the approval, payment, and monitoring of executive travel and entertainment expenses, gifts, and other perquisites?

49. Executive Compensation and Fringe Benefits GAO Study of Non-Profit Hospital Executive Compensation released in September 2006 • Grassley’s comment on report that Non-profit executive compensation not that different from the taxable community

50. Fringe Benefits, In General • Qualified Employee Discounts • No-Additional Cost Services • De Minimis Fringe Benefits • Working Condition Fringe Benefits • Other IRC section 132 Fringe Benefits • Qualified Transportation (transit pass, commuter vehicle, parking) • Moving Expense Reimbursement