Corporate Restructuring of Tax-Exempt Hospitals: The Bastardization of the Tax-Exempt Concept

Wiles P.M. , Corporate Restructuring: One Answer to TEFRA's Challenge, North Carolina Medical Journal, 45(1): 31 (January 1981). The author is indebted to this article and to L.J. Hoch's lengthy analysis of the restructuring issue (see infra, note 6) for much of the discussion that follows.

DeWitt C. , Getting Down to Business, Hospitals 55(19): 76 (Oct. 1, 1981).

Wiles , supra note 1, at 43.

Id. at 43–44; see also 42 U.S.C.A. § 1395ww(d)(1983).

Wiles , supra note 1, at 43–44.

Hoch L.J. , Corporate Reorganization: Nonprofit Tax-Exempt Hospitals, Topics in Health Care Financing 11(1): 1, 2, 4–5 (Fall 1984).

Id. at 18.

42 U.S.C.A. §1395ww(d)(1983); see also Hoch , supra note 6, at 5; Wiles , supra note 1, at 44.

Wiles , supra note 1, at 44.

Hoch , supra note 6, at 5.

See gen. id.

Wiles , supra note 1, at 43.

Id.; DeWitt , supra note 1, at 77; and Hoch , supra note 6.

Hoch, supra note 6, at 17.

DeWitt , supra note 1; Note, Not-for-Profits Move Toward Corporate Restructuring, Hospitals 55(17): 55 (Sept. 1, 1981).

Hoch , supra note 6, at 17; Wiles , supra note 1, at 45.

Ernst & Whinney, Corporate Reorganization: A Survey of Hospitals That Have Reorganized (Ernst & Whinney, Cincinnati, 1982), pp. 10–11; Hoch , supra note 6, at 20.

Hoch , supra note 6, at 46.

Irvine R.B. Moss C.M. , Investor-Owned v. Not-for-Profit, Ohio State Medical Journal 78(9): 31 (September 1982).

The controlled foundation and the independent foundation models will not be discussed since they are not commonly advocated as effective means to achieve the hospital's ends. See gen. Hoch , supra note 6, at 17–20.

26 U.S.C.A. §§501-28.

Parts I through III, §§501 through 515 (26 U.S.C.A. §§501-15) address the tax-exempt status, generally, of certain organizations, including hospitals and other medical care facilities; Parts IV through VII, §§521 through 528 (26 U.S.C.A. §§521-28) address the tax-exempt status of farmers’ cooperatives, shipowners' protection and indemnity associations, political organizations, and certain homeowners' associations.

See gen. 26 U.S.C.A. §§501-4, 508, 511-14. These general rules include numerous reporting requirements (e.g., Treas. Reg. §1.501(a)-1, Rev. Proc. 84-46, 1984–22 IRB 31, Rev. Proc. 80-28, 1980–1 CB 680, and 26 U.S.C.A. §508).

26 U.S.C.A. §§4940-48, 507-9.

E.g., 26 U.S.C.A. §§4940-48, 502.

26 U.S.C.A. §501 (c)(3). See also text and notes at notes 43-44, infra.

See Bob Jones University v. United States, 461 U.S. 574 (1983).

Federation Pharmacy Services, Inc. v. Commissioner of Internal Revenue, 625 F.2d 804, 807 (8th Cir. 1980).

Bob Jones University, supra note 27, at 2026–29.

26 U.S.C.A. §510(a).

See, e.g., Massachusetts General Laws, c.63, §30, which makes exemption from the business income tax contingent upon exemption under Section 501, and Massachusetts General Laws, c.64H, §6(e), which provides that sales to 501(c)(3) organizations are exempt under the state sales tax provisions.

See, e.g., Rev. Rul. 55-453, 1955–2 CB 54 (contributions by an individual to a governmental entity for hospital expansion, development, or creation qualify for the maximum deduction).

Therefore, the fact that an organization is tax-exempt under Section 501 does not insure that a donor can deduct a contribution to the organization. In fact, the class of organizations to which contributions are deductible is considerably smaller than the class of organizations allowed tax-exempt status under Section 501(a) (T.J. Moss Tie Co., 18 T.C. 188, Dec. 18,945 [Nonacq.]).

26 U.S.C.A. §403(b).

An organization described in section 501(c)(3) which is exempt from income tax under section 501(a) may file a certificate … certifying that it desires to have the insurance system established by title II of the Social Security Act extended to services performed by its employees.

39 U.S.C.A. §401(2), and the regulations promulgated thereunder—specifically, 39 C.F.R. §111.1, which includes, by reference, the Domestic Mail Manual. The Domestic Mail Manual explains the procedure required for a nonprofit organization to qualify for the third-class special bulk rate.

Bromberg R.S. Teplitzky S.V. , Tangling with Tax Law, Hospitals 57(5): 69, 70 (March 1983).

42 U.S.C.A. §§291a-291o. The Hill-Burton Act, also referred to as the Hospital Survey and Construction Act, provides financial assistance to states for the construction and modernization of public and nonprofit hospitals and other medical facilities (42 U.S.C.A. §§291a-291b). This assistance is provided in the form of grants (42 U.S.C.A. §291a) as well as loan guarantees and loans (42 U.S.C.A. §§291j-1-291j-6). With respect to the grant program, the act initially allots money to the individual states based on the state's population, its financial need, and the need for modernization of its facilities (42 U.S.C.A. §291b). Funds are then distributed to each state as needed for each project, up to the established allotment, upon a showing that the particular project complies with the act (42 U.S.C.A. §291f).

42 U.S.C.A. §291i(a),(c).

26 U.S.C.A. §§501,503.

Section 501(a) reads: “An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503” (26 U.S.C.A. §501[a]). Section 401(a) defines qualified pension, profit-sharing, and stock bonus plans and is, therefore, irrelevant for the discussion herein. It should be noted that Section 503(a), related to the denial of exemptions for certain organizations, is inapplicable to 501(c)(3) organizations by the terms of Section 503(a)(1).

26 U.S.C.A. §501(c).

26 U.S.C.A. §501(c)(3). Rev. Rul 56-185, 1956–1 CB 202, as modified by Rev. Rul. 69-545, 1969–2 CB 117, indicates that a hospital may establish itself as an exempt charitable organization under Section 501(c)(3). Further, an organization that provided health care services to its members on a profit basis and to nonmembers on a fee-for-service basis has been granted exemption as a charitable organization (Sound Health Association, 71 T.C. 158, Dec. 35,519). Because hospitals are not specifically listed in Section 501(c), the House of Representatives Ways and Means Committee sought in 1969 to introduce a bill that would establish hospitals as a separate exempt category providing they were “organized and operated exclusively … for the providing of hospital care” (H.R. Rep. No. 413, 91st Cong., 1st Sess. [1969], U.S. Code Cong. & Ad. News 1645, 1688). This committee report indicates that although hospitals have been able in the past to qualify under Section 501(c)(3) as charitable organizations, the bill would seek to avoid any uncertainties occasioned by the somewhat vague wording of the statute and to clarify congressional intent (id). The Senate Finance Committee, however, modified this bill by deleting the explicit language (S. Rep. No. 552, 91st Cong., 1st Sess. [1969], U.S. Code Cong. & Ad. News 2027, 2090). The deleted version was ultimately adopted by the House-Senate Conference Committee, so that there was no statutory change (Pub. L. 172, 83 Stat. 487 [1969]).

26 U.S.C.A. §501(c)(3). It should be noted that there are also numerous reporting requirements for organizations desiring to be granted tax-exempt status as well as for organizations that are already tax-exempt; see, e.g. Treas. Reg. §§1.501(a)-1(3) and 1.6033-1.

Rev. Rul. 56-185, 1956–1 CB 202, as modified by Rev. Rul. 69-545, 1969–2 CB 117. See also The Church of the Visible Intelligence That Governs the Universe v. United States, 4C1. Ct. 55, 61 (1983).

Treas. Reg. §1.501(c)(3)-1(a).

Treas. Reg. §1.501(c)(3)-1(a)(2).

Treas. Reg. § 1.501 (c)(3)-1(b)(1)(ii).

Treas. Reg. §1.501(c)(3)-1(b)(1)(i).

Treas. Reg. § 1.501 (c)(3)-1 (b)(1)(iii).

Treas. Reg. §1.501(c)(3)-1(b)(4).

Treas. Reg. §1.501(c)(3)-1(b)(3).

26 U.S.C.A. §501(c)(3).

Treas. Reg. §1.501(c)(3)-1(c)(1).

Rev. Rul. 69-545, 1969–2 CB 117, 118.

Simon v. Eastern Kentucky Welfare Rights Organization, 426 U.S. 26 (1976), at 42–43. See also Lugo v. Miller, 640 F.2d 823 (6th Cir. 1981).

Rev. Rul. 83-157, 1983–2 CB 94.

26 U.S.C.A. §501(c)(3).

Treas. Reg. §1.501(a)-1(c).

Bubbling Well Church of Universal Love, Inc. v. Commissioner of Internal Revenue, 670 F.2d 104, 105 (9th Cir. 1981). See also Church of the Visible Intelligence, supra note 45.

Incorporated Trustees of Gospel Worker Society v. United States Dept. of Treasury, 510 F. Supp. 374, 379 (D. D.C. 1981); affirmed 672 F.2d 894 (3d Cir. 1981); cert. den'd 456 U.S. 944 (1982).

Rev. Rul. 69-383, 1969–2 CB 113, 114.

B.H.W. Anesthesia Foundation, Inc., 72 T.C. 681, 684 (1979).

University of Maryland Physicians v. Commissioner of Internal Revenue, 41 T.C.M. 732, Dec. 37,633(M), T.C. Memo 1981-23.

Lowry Hospital Association v. Commissioner of Internal Revenue, 66 T.C. 850, 858–60.

Sonora Community Hospital v. Commissioner of Internal Revenue, 397 F.2d 814 (9th Cir. 1966).

26 U.S.C.A. §501(c)(3). If an organization loses its tax-exempt status under Section 501(c)(3) because of substantial lobbying, it cannot at any time thereafter qualify as a tax-exempt organization under Section 501(c)(4) (26 U.S.C.A. §504). Section 501(c)(4) defines tax-exempt civic leagues or organizations operated exclusively for the promotion of social welfare.

Treas. Reg. §1.501(c)(3)-1(c)(3).

26 U.S.C.A. §501(h).

26 U.S.C.A. §§501(h), 4911(c)(2).

26 U.S.C.A. §4911(c)(4).

26 U.S.C.A. §509(a).

See gen. 26 U.S.C.A. 508, 4940–48. See also Change–All Souls Housing Corp. v. United States, 671 F.2d 463 (1982).

26 U.S.C.A. §4940(a).

26 U.S.C.A. §§4941-44.

See H.R. Rep. No. 413 and S. Rep. No. 552, supra note 43; Change-All Souls, supra note 73, at 465.

Church of the Visible Intelligence, supra note 45, at 64, citing 26 U.S.C.A. §§170 and 509(a); S. Rep. No. 552, supra note 43, at 2085; and H.R. Rep. No. 413, supra note 43, at 1686.

William F. Quarrie, Mable E. Quarrie and Margaret K. Quarrie Charitable Fund v. Commissioner of Internal Revenue, 603 F.2d 1274, 1277 (7th Cir. 1979).

26 U.S.C.A. §509(a)(1)-(a)(4).

See 26 U.S.C.A. §§511-14.

26 U.S.C.A. §512(a).

26 U.S.C.A. §513(a).

Rensselaer Polytechnic Institute v. Commissioner of Internal Revenue, 732 F.2d 1058, 1061 (2d Cir. 1984); Service Bolt & Nut Co. v. Commissioner of Internal Revenue, 724 F.2d 519, 524 (6th Cir. 1983).

26 U.S.C.A. §512(a).

26 U.S.C.A. §512(b).

26 U.S.C.A. §512(a).

Treas. Reg. §1.512(a)-1(a).

26 U.S.C.A. §513(a).

Id.

Louisiana Credit Union League v. United States, 693 F.2d 525, 532 (5th Cir. 1982); Carolinas Farm & Power Equipment Dealers Association v. United States, 699 F.2d 167, 170 (4th Cir. 1983); Disabled American Veterans v. United States, 650 F.2d 1178, 1185 (Ct. of Claims 1981), appeal after remand 704 F.2d 1570 (U.S. Ct. App. 1983); and American Bar Endowment v. United States, 4 Cl. Ct. 404, 409 (1984).

Louisiana Credit Union League, supra note 90, at 535–36.

26 U.S.C.A. §§511-13.

Rev. Rul. 69-268, 1969–1 CB 160.

Rev. Rul. 69-267, 1969–1 CB 160 (gift shop); Rev. Rul. 69-269, 1969–1 CB 160 (parking lot).

Rev. Rul. 69-463, 1969–2 CB 131; Gundersen Medical Foundation, Ltd. v. United States, 536 F. Supp. 556 (D. D.C. 1982).

I.R.S. Letter Ruling 8131063.

St. Luke's Hospital of Kansas City, 494 F. Supp. 85 (W.D. Mo. 1980).

Rev. Rul. 68-374, 1968–2 CB 242, 243; Hi-Plains Hospital v. United States, 670 F.2d 528, 531 (5th Cir. 1982). See also Rev. Rul. 68-376, 1968–2 CB 246, which defines a hospital “patient” for the purposes of Section 513(a)(2).

I.R.S. Letter Ruling 8206093, Nov. 10, 1981.

26 U.S.C.A. §§513(e), 501(e)(1)(A).

26 U.S.C.A. §501(e).

26 U.S.C.A. §513(e).

Northern California Central Services, Inc. v. United States, 591 F.2d 620, 623–24 (Ct. of Claims 1979); Hospital Central Services Association v. United States, 623 F.2d 611, 612 (9th Cir. 1980), cert. den'd 450 U.S. 911 (1981); HCSC—Laundry v. United States, 450 U.S. 1, 5 (1981).

Metropolitan Detroit Area Hospital Services, Inc. v. United States, 634 F.2d 330, 335 (6th Cir. 1980), cert. den'd 450 U.S. 1031 (1981).

See 26 U.S.C.A. §§502, 4940-48, and 507-9.

26 U.S.C.A. §502(a).

26 U.S.C.A. §§507-9, 4940-48. See the discussion concerning the more restrictive provisions for private foundations and the congressional intent in enacting these provisions in the text and notes at notes 70 to 77, supra.

Hoch , supra note 6, at 20; Wiles , supra note 1, at 45. The description that follows is derived in large part from Hoch. The reader is directed to his article for more specific information concerning the corporate reorganization of hospitals.

Hoch , supra note 6, at 20.

Id. at 24; and 26 U.S.C.A. §509(a).

26 U.S.C.A. §509(a)(3); Hoch , supra note 6, at 26.

Hoch , supra note 6, at 26-27.

Id. at 49.

Id. at 32-34.

Id. at 20-22.

Id. at 52.

Id. at 51.

See id. at 54-56.

Id. at 61.

Id. at 51.

Id. at 61-62.

Wiles , supra note I, at 46.

26 U.S.C.A. §501(c)(3).

Treas. Reg. §1.501(c)(3)-1(b).

Treas. Reg. §1.501(c)(3)-1(c)(2).

26 U.S.C.A. §511.

See gen. 26 U.S.C.A. §165.

See 26 U.S.C.A. §§168, 46-48.

26 U.S.C.A. §501(c)(3).

26 U.S.C.A. §§501(c)(3), 501(h), 4911(c); Treas. Reg. §1.501(c)(3)-1(c)(3). See also the Federal Election Campaign Act (FECA) of 1971, 2 U.S.C.A. §§431-55 (1983).

Id.; Hastings D.A. Oldaker W.C. Kerman L.J. , Tax-Exempt Hospitals and Electoral Politics, Hospitals 58(15): 80 (Aug. 1, 1984).

See gen. 2 U.S.C.A. §§431-55.

Id. and regulations promulgated thereunder. See also Hastings, Oldaker, Kerman, supra note 131, at 82.

Wiles , supra note 1, at 44.