American Journal of Law & Medicine

Closing the Gaps and Loopholes: Analyzing Tax Exemption of Non-Profit Hospital Joint Ventures after the Affordable Care Act

CONTENTS  I. INTRODUCTION  II. REQUIREMENTS FOR [section] 501(C)(3) STATUS PRIOR TO THE ACA    A. The Historical Treatment of the Tax Exemption of      Non-Profit Hospitals and Joint Ventures         1. Clarifying the Definition of Charitable Purpose        2. Analyzing Tax Exemption of Hospital Joint Ventures    B. Changes in the Requirements of [section] 501(c)(3) Hospitals         1. The Hospital Compliance Project        2. Codification of New Requirements under IRC [section] 501(r)  III. POTENTIAL CHALLENGES WITH THE IMPLEMENTATION OF IRC      [section] 501(R)    A. Section 501(r)'s Effect on the Tax-Exempt Statuses      of Non-Profit Hospital Joint Ventures         1. An Uncertain Landscape        2. Preservation of the Statutory Purpose and Intent of           [section] 501(c)(3)    B. A Possible Solution         1. Floyd's Pure Community Benefit Approach        2. Abandonment of the Current Control Standard        3. Combining the Control and Community Benefit           Standards  IV. CONCLUSION 


A bustling, non-profit hospital bills an elderly patient more than $2,000 for a magnetic resonance imaging (MRI) scan ordered by his physician. Despite the enormous profits the hospital will accrue during the year, its total revenue stream will be tax-exempt because it qualifies as a [section] 501(c)(3) organization under the Internal Revenue Code (IRC). (1) A hospital's ability to navigate the tax system without serious ramifications presents potential issues, particularly as the healthcare market is undergoing gradual changes in the wake of the Affordable Care Act (ACA). An organization's ability to obtain preferential [section] 501(c)(3) tax status by showing that it is "organized and operated exclusively" for one of the exempt purposes under the statute is a root cause of many problems. (2) This involves fulfilling a two-prong test under IRC [section] 501(c)(3), which includes both an organizational and an operational component. (3) Both tests have to be satisfied or the organization in question loses its tax-exempt status under [section] 501(c)(3). (4)

Traditionally, due to the stream of healthcare services provided to the community, hospitals have been considered to be organizations that fulfill a charitable purpose. (5) As such, these hospitals should qualify as tax-exempt organizations. (6) For some time, however, uncertainty has existed as to the types of charitable purposes that would fall under [section] 501(c)(3). In 1969, the Internal Revenue Service (IRS) issued Revenue Ruling 69-545, which introduced a "community benefit" standard that detailed when non-profit hospitals were eligible for tax-exempt status. (7)

Even with Revenue Ruling 69-545, however, there are still lingering issues due to the vague definition of "community benefit." In addition, the complicated nature of hospitals and their relationships within healthcare networks present systemic problems, such as mergers or consolidations, which slightly alter the hospitals' organizational units. A non-profit hospital's tax-exempt status may carry through its [section] 501(c)(3) status even after the hospital merges with a for-profit entity, and the resulting joint venture organization is exempt from paying taxes despite its very visible profits. Economists, politicians, physicians, and community members alike have debated this issue for decades, and the IRS has published several guidances clarifying how [section] 50l(c)(3) should affect non-profit hospitals and joint ventures. Yet, problems and loopholes still persist. In 2006, the IRS launched the Hospital Compliance Project to investigate and assess the finances and tax-exempt statuses of all non-profit hospitals in order to survey the field and tighten the requirements involved with [section] 501(c)(3). (8)

The Hospital Compliance Project's findings motivated Congress to update the requirements of non-profit hospitals or organizations operating one or more hospital facilities that claimed [section] 501(c)(3) status. (9) Congress then codified these requirements into [section] 501(r) of the IRC by passing these provisions under the ACA, with the first three requirements effective for taxable years after March 23, 2010. (10) These new requirements call for non-profit hospital organizations to (1) establish written financial assistance and emergency medical care policies; (2) limit amounts charged for emergency or other medically necessary care to individuals eligible for assistance under the hospital's financial assistance policy; (3) make reasonable efforts to determine whether an individual is eligible for assistance under the hospital's financial assistance policy before engaging in extraordinary collection actions against the individual; and (4) conduct a community health needs assessment (CHNA) at least once every three years, effective after March 23,2012. (11)

These new standards, while impressive, still do not specifically address the determination of tax-exempt status or analysis of non-profit hospital joint ventures. The current "control" standard focuses on the actions of the partner who controls the board and makes day-to-day decisions for the joint venture. (12) In a recent article, Gail Rebecca Floyd argued that courts should abandon this approach in favor of a new community benefits standard, modeled under the CHNA of IRC [section] 501(r). (13) While Floyd proposes a bold approach in the midst of an evolving healthcare industry, her argument contains several flaws. This Note will argue that under the new IRC [section] 501(r) requirements passed in the ACA, courts should analyze the tax exemption of non-profit hospital joint ventures using a combination of the control standard and Floyd's proposed community benefit standard. This will help fill in major gaps and loopholes and ensure that joint ventures continue to fulfill the organizational and operational tests of [section] 501(c)(3) charitable organizations.

Part II of this Note first introduces the history of IRC [section] 501(c)(3 requirements and IRS revenue rulings on joint ventures and explains how courts applied the law to hospital joint ventures in two separate cases. The rest of the section discusses the changes that Congress has implemented for non-profit hospitals under IRC [section] 501(r) within ACA. Part III discusses why Floyd's community benefit standard alone is insufficient to analyze non-profit hospital joint ventures, and does not ensure full compliance with the organizational and operational prongs of [section] 501(c)(3). The section ultimately concludes that an analysis post-ACA must recall the statutory purpose of [section] 501(c)(3). An analysis that combines the community benefit standard with the current control standard will help close the gaps and loopholes associated with [section] 501 (c)(3) tax exemption of non-profit hospital joint ventures.



Section 501(c)(3) of the IRC exempts "[c]orporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes" from taxation. (14) No substantial part of the organization's activities may "inure to the benefit of any private shareholder or individual." (15) These [section] 501(c)(3) organizations receive preferential tax treatment based on the assumption that they will be using the subsidy to perform public services that relieve government burdens. (16) Generally, the promotion of health has long been considered a charitable purpose under the traditional law of charitable trusts. (17) As such, it follows that many non-profit hospitals are viewed as promoting a charitable purpose because they provide medical services to the community. (18) Receiving tax-exempt status as a [section] 501(c)(3) organization also depends on whether a hospital can fulfill a test with two functional components: organizational and operational. (19)

1. Clarifying the Definition of Charitable Purpose

After the original [section] 501 provisions were enacted, there was some uncertainty as to their application. Many organizations had difficulty substantiating their [section] 501(c)(3) statuses, but courts have since ruled that tax exemption hinges on the satisfaction of both the aforementioned organizational and operational tests. (20) As dictated in Nationalist Movement v. Commissioner of Internal Revenue, the organizational test is fulfilled if the organization: (1) limits its purposes to one or more of the exempt purposes in IRC [section] 501(c)(3); and (2) does not expressly empower the organization to engage substantially in activities which are not in furtherance of one or more exempt purposes. (21) The second prong, the operational test, requires that the organization also be operated exclusively for one or more exempt purposes. (22) This operational test has four elements: (1) the organization must engage primarily in activities which accomplish one or more of the exempt purposes specified in [section] 501(c)(3); (2) the organization's net earnings may not inure to the benefit of private shareholders or individuals; (3) the organization must not expend a substantial part of its resources attempting to influence legislation or political campaigns; and (4) the organization must serve a valid purpose and confer a public benefit. …

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