TAX UPDATE

Affiliated Entities Summit April 17, 2012

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• IRS Scrutiny • Governance • Intermediate Sanctions • Unrelated Business Income • Charitable Contributions • Other Taxes

IRS Scrutiny

• From the desk of the IRS Commissioner, Douglas H. Shulman; • The IRS Strategic Plan for FYs 2009-2013 lists as one of its six objectives “the continued oversight of the tax exempt sector”. • This objective provides three strategies, the third of which is to “maintain focus on universities, hospitals and other major segments of the tax exempt community”.

IRS Scrutiny

• Comment from Lois Lerner, IRS Director of Exempt Organizations (EO); “[T]his Form will serve as a basis for further compliance projects.”

Form 990

 Form 990 is an information return filed by exempt organizations annually.

◦ It reports information, not taxable income.

 The Form 990-T reports taxable income or unrelated business taxable income – UBTI.

 Both forms are subject to public disclosure rules.

Form 990

 The IRS recently redesigned this Form with the support and encouragement of the Senate Finance Committee.  The 990 requires the disclosure and transparency of more information and focuses on certain risk areas.

 Included is a section on governance and schedules on compensation, and related parties.

Governance

• Comment from Sarah Hall Ingram, the IRS commissioner of tax-exempt and government entities (TE/GE); “[H]ow you go about building good governance… is incredibly important to us and to your donors…It will be part of all the audits that we do and all the studies that we do.”

Governance

• The IRS released a governance check sheet (Form 14114) that is to be used by EO Exam agents in gathering data for use in a long-term study. • Information on training materials can be found on the IRS website.

Governance

• Questions focus on whether the organization has written policies for: Conflicts of interests Whistleblowers Record retentions Compensation • Practices to disclose conflicts and to monitor and enforce compliance must also be described.

Governance

• The IRS reports that about 30% of the organizations that filed the Form 990 for FY 2008 did not file anything on their Schedule O which requires explanations of various questions that must be answered.

• Sample Question Part VI, Section B,11 – has the organization provided a copy of this return to all members of its governing body before filing the form?

Intermediate Sanctions

• Applies to excess benefit transactions.

• Any transaction in which the economic benefit received by a disqualified person is in excess of the value provided to the organization.

• Applies to: Compensation Rental arrangements Loans Sale of assets Other transactions with disqualified persons

Intermediate Sanctions

• Disqualified person.

• Persons having substantial influence over the organization.

• Generally, officers, directors/trustees.

• Also includes family members of the above.

• Also includes entities owned by the above.

Rebuttable Presumption

• Relates to determination of compensation of a disqualified person.

• Shifts the burden to prove that compensation is unreasonable to the IRS if certain procedures are followed.

Independent Committee

• Members unrelated to and not subject to the control of the disqualified person.

• Members have no material financial interest in the compensation.

• Member’s compensation not approved by the disqualified person.

Comparable Data

• Compensation survey of other organizations.

• Should use organizations of similar size and type.

• Using independent compensation consultant not required.

Contemporaneous Documentation

• The results of the survey and the decision-making process should be clearly documented at the time of the decision.

Compensation

• All forms of compensation must be considered.

• Base compensation.

• Bonuses.

• Fringe benefits.

• Deferred compensation.

• Retirement benefits.

Deferred Compensation

• Unlike for-profit employers, nonprofit organizations are limited in the types of nonqualified deferred compensation, they may provide.

• Generally, any compensation deferred beyond the taxable year must be subject to a substantial risk of forfeiture unless contributed to: Qualified plan (401(a)) 403(b) plan 401(k) plan 457(b) plan

Unrelated Business Income

• Income related to your exempt purpose is nontaxable.

• Unrelated business income(UBI) is taxable.

• To be considered UBI, income must be from an activity that is: A trade or business Regularly carried on Unrelated to your exempt purpose

Unrelated Business Income

• There are numerous types of income that are excluded from UBI: Interest and dividends Capital gains Royalties Real property rental Research Qualified sponsorship payments Volunteer exception Convenience exception Donated goods exception

Qualified Sponsorship Payments

A fine line between advertising and sponsorship.

Advertising = taxable income QSP = exempt income

Advertising

• Message or material (broadcast, transmitted, published, displayed, or distributed) that promotes or markets, including: Qualitative or comparative language; Pricing information or other indications of savings or value; An endorsement; or Inducements to purchase, sell, or use any service, product or facility

Acknowledgement

Does not include advertising but may include: Sponsor logo and slogan (as long as no qualitative or comparative descriptions of product, services, facilities, or company); Sponsor’s locations, telephone/fax number or internet address; Brand or trade names and product or service listings; Value-neutral descriptions of product or services; and Exclusive sponsor relationship.

Charitable Contributions

• When a donor receives a privilege or benefit in return for a contribution, the presumption is that the payment is not a gift. • However, a charitable contribution can contain an element of return benefit.

• For contributions $75 or more the benefit must be disclosed.

• Low-cost articles ($9.90 or less for 2012 ) can be disregarded.

Charitable Contributions

• All contributions of cash, check, or other monetary gift must be substantiated by either a bank record or written communication from the charity.

• A bank record must include the name of the charity.

• A communication from the charity must include the name of the charity, the date of the contribution and the amount of the contribution.

Sales and Use Tax

• Charitable organizations are exempt from use tax.

• Sales tax must be collected on sales of tangible personal property and certain services if sales are made on more than six days in any calendar year. PTAs, booster groups and certain student groups are exempt from collecting tax regardless of the number of days they make sales.

Property Tax

• Charitable organizations are generally exempt from real property taxes.

• The property must be owned on January 1 to obtain exemption for the calendar year.

Affiliate Summit Presentation

Financial Reporting and Audited Financials

Kristine Devine April 17, 2012

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OSU Affiliate Entity Partnership Conditions per Policy

As a condition of using the University’s name and resources the following principles shall apply: • • The creation and activities of affiliates must promote, sponsor, or complement educational, scientific, research, charitable, health-care related, or cultural activities for the benefit of the University or one or more of its units.

To promote a more proactive relationship with affiliates, the University’s relationship with each affiliate will be memorialized through a memorandum of agreement.

• • Affiliates will be monitored by the Board of Trustees through a regular reporting process.

Affiliates shall provide for at least one University representative with full voting rights on its governing board.

• • Affiliates must use sound fiscal and accounting procedures.

Affiliates must be managed in a manner consistent with their own enabling documents and the University’s purpose, mission, and procedures, as specifically set forth in this policy.

• • Affiliates must adhere to high standards of ethics and conflicts of interest.

The University’s relationship with an affiliate is not necessarily intended to be perpetual. Relationships with affiliates will be examined at least every five years to determine whether the affiliate/relationship will be continued or whether a sunset provision is appropriate.

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The OSU Board Oversight Responsibilities of Affiliated Entities

The Board of Trustees shall exercise oversight over established affiliates through the following mechanisms: • • inclusion of University representatives on the affiliate’s governing board; provision for reserve powers on behalf of the University in the affiliate’s governing documents; • • • a memorandum of agreement between the University and the affiliate outlining expectations and responsibilities, including governance requirements; a comprehensive reporting process. Regular inquiry by the Board of Trustees as to the need for continued affiliation and/or separate entity status.

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OSU Affiliated Entity Policy-Annual Reporting Requirements

• All Entities • A copy of its financial report, audited by an independent certified public accountant, the management letter, and management's response thereto on at least an annual basis.

• • A copy of its IRS Form 990 and 990-T.

A letter signed by the affiliate’s executive head certifying that the affiliate has complied with this policy and any memorandum of agreement between the University and the affiliate regarding their relationship.

• Other such information that may be requested by the Board of Trustees on a supplied form, e.g., a list of current directors and officers, current copies of governing documents, and a brief description of the affiliate’s activities during the prior year..

• Significant interest affiliates must also submit: • Minutes of meetings of its governing board from the previous year.

• A report listing each real estate purchase and material capital lease, investment, or financing arrangement entered into during the preceding affiliate fiscal year.

OSU MOU

The MOU between a Affiliate and OSU Requires: Governance: • Audit Committee. AFFILIATE shall establish an audit/finance committee of no less than two members who shall report to the AFFILIATE Board of Directors. At least one member shall be independent of AFFILIATE and the University.

Article IV : • Audit. AFFILIATE shall have an annual audit conducted by an independent certified public accountant. A copy of the audit report, management comments, and management’s response shall be made available to the University upon request. • Accounting System. AFFILIATE shall have in place an accounting system to assure financial activities are carried out and reported in accordance with generally accepted business and accounting practices. The Ohio State University – Office of the Controller 2012 Affiliates Summit

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What is the Value of An External Audit?

• Assists both the OSU Board and The Affiliate Board in meeting their fiduciary responsibilities • Review of audit plan, approach and risks • Audit opinion • Internal control • Material weakness • Significant deficiency • Management letter comments and observations • Required Communications: • Audit adjustments • Management estimates • Audit Committee Executive Session

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OSU Affiliated Entities Policy-Appendix B

An audit helps in monitoring oversight of compliance

• • • • • • • • • • • • • Requiring an accounting system with appropriate controls and reporting functions and an annual audit by an independent certified public accountant Annual adoption by the affiliate governing board of a detailed operating budget and capital expenditure plan Transactions between affiliate and University treated as ordinary business transactions, with proper review and approvals Provisions regarding use of University registered marks Recovery of costs incurred for provision of personnel, facilities, or services by the University Provision of administrative services by University to affiliate Responsibilities for insurance Requiring an accounting system with reporting in accordance with GAAP Detailed operating budget and capital expenditure plan Officers/staff members bonded as appropriate; general liability and D&O insurance University’s right to inspect books and records Requiring that no substantial part of operations devoted to lobbying/participating in political campaigns Requiring that no fees or remuneration shall be paid to University employees without University approval

A Closer Look at Accounting for Affiliated Organizations: What’s Consolidated, What’s Not and Why • As part of its responsibility to prepare financial statements in accordance with generally accepted accounting principles, the University Controller’s Office must determine which affiliates meet the criteria for consolidation in the University’s financial report.

• As part of the University’s annual audit, the external auditors review management’s consolidation decisions and verify that affiliates’ financial information is properly included in the University’s financial report.

• GASB Statements 14, 39 and 61 set forth the consolidation rules for governments and public colleges and universities. The following slides take an in-depth look at these accounting rules and how they apply at Ohio State.

The Ohio State University – Office of the Controller 2012 Affiliates Summit

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GASB Consolidation Analysis: Key Decision Points Legally Separate?

No

PG Hold Corporate Powers?

No

Exclude from Financials (Not Part of PG) Include in Financials (Part of PG)

Yes

Appoint Voting Majority of Board?

Yes No Yes

Fiscal Dependency Criteria Apply?

No Yes

Meet GASB 39 Criteria?

No

Misleading To Exclude?

No Yes Yes

PG Able To Impose Its Will?

No

Financial Benefit/Burden Relationship?

No Yes Yes Component Unit

Consolidate In Financials Not a Component Unit – May Need To Disclose

Component Unit

Consolidate In Financials The Ohio State University – Office of the Controller 2012 Affiliates Summit

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OSU – Primary Government, Component Units and Other Affiliates The University includes the following entities in its audited financial reports:

Primary Government

The Ohio State University, including all colleges, the OSU Health System, OARDC and the Ohio Supercomputer Center

Component Units

OSU Foundation, OSU Research Foundation, Transportation Research Center, Campus Partners, OSU Health Plan, OSU Physicians, Adria Kravinsky Foundation, Dental Faculty Practice Association, Oval Limited, OSU China Gateway

Other Affiliates (not included in OSU Financials)

OSU Alumni Association, James Cancer Hospital Foundation, Wexner Foundation, SciTech, Athletics Booster Groups The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Financial Accountability Criteria: Board Appointments and Imposition of Will If OSU appoints a voting majority of the affiliate’s board and can “impose its will” on the affiliate, it must be consolidated in OSU’s financial statements.

Any

one

of the following conditions is a clear indication that OSU can impose its will on an affiliate: • Ability to remove appointed members of affiliate’s governing board at will • Ability to modify or approve the affiliate’s budget • Ability to modify or approve rate or fee changes affecting revenue • Ability to veto, overrule or modify the decisions of the affiliate’s governing body • Ability to appoint, hire, reassign, or dismiss those persons responsible for the day-to-day operations (management) of the affiliate Examples of affiliates consolidated based on ability to appoint a voting majority of the board include the OSU Research Foundation, Transportation Research Center, Campus Partners and OSU Physicians The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Financial Accountability Criteria: Fiscal Dependency An affiliate may be subject to consolidation in OSU’s financial statements, even if OSU cannot appoint a voting majority of its board, if the affiliate is deemed to be “fiscally dependent” on the University.

To be considered fiscally independent, an organization must have the authority to do government

all

another government of the following, without substantive approval by the primary government: • Determine its budget without another government’s having the authority to approve or modify that budget • Levy taxes or set rates or charges without approval by • Issue bonded debt without approval by another The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Financial Accountability Criteria: Fiscal Dependency (continued)

Example of Fiscal Dependency Criteria

OSU Foundation

– A quorum is not present until at least three of the six executive officer (University) board members are present, and the Executive, Finance and Investment committees are controlled by the University. This arrangement gives the University substantive approval authority over Foundation budgets and issuance of bonded debt.

It is increasingly common to see these types of provisions, also known as “reserve powers”, in affiliates’ governing documents.

The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Other GASB Consolidation Criteria: Investments in For-Profit Entities • • If OSU owns a majority of the voting stock of a for-profit corporation, the University’s

intent

investment asset.

for owning the stock determines whether the corporation is consolidated as a component unit or shown as an If intent is to directly enhance ability to provide government services (teaching, research or public service), consolidate as a component unit.

Examples of For-Profit Entities*

• • Component Unit: Prologue (OSU formerly owned 100% of voting stock, and intent was to manage and conduct clinical drug trials) Investment: River Road Hotel Corp. (corporation was a gift to OSU Endowment and was held for investment purposes) * These entities are no longer owned by the University.

The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Implications of GASB Consolidation Rules for OSU • Broad, inclusive rules for consolidation suggest that, for practical purposes, the University should assume that a new affiliate will be “in” (subject to consolidation) unless it can prove otherwise.

• All assets, liabilities, revenues, expenses and relevant footnote disclosures of affiliates subject to consolidation will appear in the University’s financial reports, including all forms of debt, debt guarantees and lease obligations.

• Consolidation of affiliates requires coordination on annual audits and financial reporting timelines. Audit services provided to component units of the university are generally required to be incorporated into the University audit contract, which is administered by the Auditor of State.

The Ohio State University – Office of the Controller 2012 Affiliates Summit

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Affiliated Entities Summit April 17, 2012

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WHAT IS AN AFFILIATED ENTITY?

1. an organization that has a legal existence separate from the University, and 2. which is formed or operated to support or complement the mission of the University, and 3. (a) was created by the University, or (b) is controlled or strongly influenced by the University, or (c) receives significant financial support from the University, or (d) uses University resources, name, or identity.

FORMATION OF AN AFFILIATE

• DETAILED PROPOSAL FOR BOT • GOALS AND OBJECTIVE (MISSION) • ORGANIZAIONAL AND GOVERNING STRUCTURE • BUDGET AND BUSINESS PLAN FOR 5 YEARS • RISK ASSESSMENT • PROPOSED MOA • APPROVAL BY DEAN/VP, B&F, OLA • SENIOR MANAGEMENT COUNSEL • BOARD OF TRUSTEES

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NEW AFFILIATES

• CHINA GATEWAY, LLC • BIOHIO RESEARCH PARK, INC.

• Iagri, LTD. (Tanzanian Research Project) • INDIA GATEWAY, LLC • OHIO STATE INNOVATION FOUNDATION

GOVERNANCE AND OVERSIGHT

• BOARD REPRESENTATION • AT LEAST ONE BOARD MEMBER OF AN AFFILIATE BOARD • SENIOR UNIVERSITY OVERSIGHT OFFICIAL • DEAN OR VP LEVEL • SIGNS REPORTS • REPORTS TO THE BOARD OF TRUSTEES • REPORTING PROCESS • ANNUAL • PROACTIVE • QUARTERLY • MEMORANDUM OF AGREEMENT • RESERVE POWERS

REPORTING

• CURRENT REPORTING • AUDIT BASED • DOCUMENT INTENSIVE • TO OLA, THEN TO AUDIT & COMPLIANCE COMMITTEE • FUTURE ADDITIONAL REPORTING • OPERATION AND MISSION BASED • TO BOT COMMITTEE MOST ALLIGNED WITH MISSION OF AFFILIATE • IS AFFILIATE MEETING THE OBJECTIVES AND OR PROVIDING THE SERVICE FOR WHICH IT WAS FORMED

ANNUAL SUMMARY REPORT TO BOT

REPORTING FORM

RESERVE POWERS

• The Code of Regulations of AFFILIATE shall retain the existing additional quorum requirement that the UNIVERSITY Directors vote in the affirmative to approve the following acts and transactions: (Partial List) • Amendment of Articles or Code of Regulations • Sale of Assets • Borrowing • Dissolution • Formation of a Subsidiary • Action as Member or Shareholder of Another Entity

SERVICE ON AFFILIATE BOARD

• SERVICE OF A UNIVERSITY EMPLOYEE IS IN AN EX OFFICIO CAPACITY • ONE WOULD SERVE AS PART OF THEIR DUTIES AND POSITION OF EMPLOYMENT • IMMUNITY FROM SUIT/LIABILITY WHEN ACTING IN THE COURSE AND SCOPE OF EMPLOYMENT

QUESTIONS?