This Client Alert reviews the chapter dealing with health care organizations. Subsequent Alerts will consider other chapters of the 2002 CPE Text.
The 1999 CPE Text and the 2001 CPE Text contained extensive discussions dealing with health care joint ventures. The 2002 CPE Text updates these discussions. The CPE Text begins by discussing Revenue Ruling 98-15, issued in March 1998. Revenue Ruling 98-15, described in detail below, contains examples illustrating the treatment of tax-exempt hospitals that participate in so-called whole hospital joint ventures with for-profit entities. Two solutions are posed, one where tax-exempt status is maintained and a second where tax exemption is lost. The CPE Text observes that, since that Ruling was issued, the IRS has conducted "coordinated examination program audits" involving whole hospital joint venture arrangements, suggesting that the audits have led to a refinement of the conclusions of the Ruling. In addition, the IRS notes that it is continuing to consider exemption applications from organizations involved in ancillary health care joint ventures. Ancillary joint ventures with a single purpose tax-exempt member present similar issues to whole hospital joint ventures. In addition, even if the exempt member already has a determination letter based on other activities, the same issues may control the treatment of income as unrelated business taxable income.
The CPE Text observes that news reports in the past year have described whole hospital joint ventures that have been unwound or that are unwinding. Further, the CPE Text takes note of the revocation of the exempt status of St. David Health Systems ("St. David"), a hospital in Texas that had entered into a joint venture with HCA (f/k/a Columbia/HCA). Without comment, the CPE Text notes that St. David had filed a claim for refund, which was disallowed. St. Davidís has filed a refund suit in the Western District of Texas arguing that it qualified as a Section 501(c)(3) organization, notwithstanding that the hospital operations had been contributed to a joint venture with a for-profit entity.
The CPE Text addresses the recent decision in Redlands Surgical Services, Inc. v. Commissioner. See, GT Alert, April 2001 "Appellate Court Rejects Joint Venture Appeal" for a detailed discussion of the Redlands Surgical Services decision. The CPE Text notes that the per curiam opinion of the Ninth Circuit Court of Appeals affirmed a Tax Court decision that Redlands Surgical Services did not qualify for tax-exempt status under Section 501(c)(3).
In Revenue Ruling 98-15, the facts supporting retention of exempt status included the tax-exempt organization having effective control over the operation of the hospital and the absence of a management agreement with any affiliate of the for-profit entity. In the bad example, where the organization was denied exempt status, the for-profit entity controlled the joint ventureís activities and managed the operations through a management agreement, which agreement could not be terminated by the tax-exempt organization.
The CPE Text provides additional guidance on whole hospital joint venture as well as ancillary joint ventures by addressing fact patterns not found in Revenue Ruling 98-15; situations that fall short of the obviously favorable facts in Situation 1 contained in Revenue Ruling 98-15. In one example, a tax-exempt hospital forms a subsidiary organization to provide home care infusion services for patients discharged from the hospital and other local tax-exempt hospitals. Applicantís sole activity is participating in a general partnership with a for-profit management company to operate the home care infusion services. The partnership uses the hospitalís home health and labor and delivery nurses. The Applicant owns sixty-five percent of the partnership and the for-profit management company thirty-five percent. Profits and losses are allocated in the same ratio. The for-profit entity will manage the service through an armís length agreement with a fixed-fee payment for services for a five-year term that can be renewed for subsequent two-year terms by the agreement of both partners. The fee is comparable to what others pay for similar services. While the management company is responsible for day-to-day operations, it is controlled by the partnershipsí management committee.
The management committee is composed of five members appointed by the Applicant and two members by the for-profit. While some decisions require unanimous approval, charity care and other community benefit issues are not actions that require unanimous approval. Importantly, the partnership agreement provides that the partnership is formed for charitable purposes and those purposes may take precedent over profit maximization, presumably the result of specific provisions in the partnership agreement. This provision is binding and legally enforceable under the law of the jurisdiction in which the partnership is organized. A large percentage of the patients are indigent or are covered by Medicare and Medicaid and fees are set on a sliding scale based on ability to pay. The CPE Text concludes that the Applicant will qualify for exempt status even though a management company controls the day-to-day activities of the partnership. Participation in the partnership furthers the charitable purposes of its parent, the tax-exempt hospital, and allows Applicant to operate exclusively for charitable purposes. The control of charity care policy decisions and the ability to ensure that charitable purposes prevail offsets the day-to-day operations by the management company.
The conclusion of the IRS on the facts presented reflects the importance of charitable care taking precedent over profits and the ability of the tax-exempt organization to control charitable care policy decisions in finding that a single purpose entity can qualify for exempt status. The example illustrates the importance that charity care takes in ensuring that the tax-exempt partner is operated exclusively for charitable purposes. Partnership agreements that require that the provision of charity care dominate over profits have a better chance to pass muster under Revenue Ruling 98-15.
The CPE Text also offers insight on the requirement that the tax-exempt organization be in control of the joint venture. Majority control in favor of the tax-exempt organization, according to the CPE Text, is one of the most important favorable factors in establishing that profit motives do not subvert the charitable mission of the tax-exempt parties. If the tax-exempt entity lacks majority representation or votes on the board to ensure it controls major decisions, it must have another mechanism to ensure the joint venture will operate to further the exempt organizationís charitable purpose. The CPE Text notes that the IRS has recognized exemptions in very few cases where the tax-exempt entityís share of control was as low as fifty percent and none where control was lower. This, again, illustrates the importance of charitable care. The IRS is looking to ensure that charity care will be the dominant purpose before it will allow exemption, even where major decisions may be effectively controlled by the for-profit participant. The suggestion that lack of majority control precludes exemption is of concern.
The CPE Text also addresses concerns on the valuation of property contributed to joint ventures. The CPE Text suggests certified appraisals by independent third party appraisers to ensure the contributions are valued appropriately. Only with appraisals, observes the CPE Text, can the tax-exempt organization evaluate if the joint venture is "an appropriate way to achieve its charitable purposes, or if the transaction will provide more-than-incidental private benefit to the for-profit partners."
The CPE Text contains a "joint venture issue checklist." While the checklist is not exhaustive, it does provide some guidelines on the issues that should be considered in creating tax-exempt/for-profit ventures that will be favorably reviewed by the IRS. Exempt organizations contemplating a venture with a for-profit entity should always measure the proposed structure against the checklist before finalizing arrangement with a for-profit partner. The standards should not only be useful where exemption is sought for a single purpose entity, but also in the case where exempt status is not in question; the same standards should be applicable in determining if the income allocated to the tax-exempt organization will be treated as unrelated business taxable income.
The Community Benefit Standard
In Revenue Ruling 69-545, the IRS established the "community benefit standard" that a hospital must meet to qualify for exempt status. The same standard applies to other health care providers such as clinics as well as traditional hospitals. The CPE Text notes that in order to satisfy the community benefit standard, the organization must establish the presence of significant factors which demonstrate that the organizationís operations promote the health of a class of person broad enough so that the community as a whole benefits. Significant factors are sufficient. It is not required that all of the factors listed in Revenue Ruling 69-545 be present to satisfy the Community Benefit Standard. The CPE text offers the illustration of the absence of a full-time emergency room in Revenue Ruling 83-175 not precluding exempt status if other significant factors are present. In that ruling, other significant factors included a board of directors drawn from the community, an open medical staff policy, treatment of persons paying their bills with the aid of public programs like Medicare and Medicaid, and the application of any surplus to improving facilitiesí equipment, patient care and medical training, education and research. The CPE Text contains examples where the absence of an emergency room did not preclude exemption, where an entity was controlled by a community board of directors and had a conflicts of interest policy. The organization provided free medical screening for several hours once a week to inner-city neighborhoods. The organization did not receive revenue from Medicare, Medicaid or health insurance and ninety-nine percent of its patients were uninsured. Instead, it received support from private grants and fundraising. The visits to inter-city neighborhoods to offer free medical checkups and medical treatment to uninsured individuals demonstrated that it benefited a sufficiently broad class of persons so that the community as a whole benefited. Thus, it could have exempt status, notwithstanding the absence of an emergency room.
The CPE Text describes another organization providing free dental care to children from low-income families. It likewise could qualify for exempt status because it provided benefits to a sufficiently broad class of persons.
These examples illustrate that significant care provided on a free or low price basis can support tax-exempt status for a health care organization without providing an emergency room.
The 2002 CPE Text chapter on health care also addresses tax-exempt HMOs. The chapter offers guidance on the application of Section 501(m), which prohibits a tax-exempt HMO from providing "commercial-type insurance."
The chapter updates a 2001 CPE Text discussion of tax-exempt health clubs. The chapter describes two recent private letter rulings where hospital run health clubs were found not to constitute unrelated trade or businesses.
© 2001 Greenberg Traurig
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