The Internal Revenue Service likely will apply its recent revenue ruling on whole-hospital joint ventures to other kinds of joint ventures between for-profits and not-for-profits.
"It could pertain to any type of joint venture, in particular ancillary ones," said T.J. Sullivan, a tax attorney with Gardner Carton & Douglas in Washington and a former IRS official. "That's what we've thought all along, and the (IRS) has confirmed that."
The revenue ruling requires the not-for-profit partner to control the board that oversees the joint operating company in order to maintain its tax-exempt status. And that board must control the key operations of the company (March 9, p. 3).
The IRS released the ruling, which carries the legal weight of federal regulation, March 4. It became effective March 23.
"The revenue ruling embodies what the (IRS) has used, is using and will use to look at joint ventures," said Marcus Owens, director of the IRS' exempt organizations division. "It's consistent with the position we've taken on the Redlands (Calif.) case that we're defending in court."
That case involves Redlands Surgical Services, a joint venture company set up to affiliate with a freestanding, for-profit ambulatory surgery center on behalf of tax-exempt healthcare organizations. The IRS denied Redlands' petition for tax-exempt status in 1995 and again in 1996. Redlands and the IRS are continuing their dispute in U.S. Tax Court.
Owens also said the IRS may use intermediate sanctions against joint ventures that do not pass its test, which would allow the IRS to assess punitive excise taxes instead of yanking not-for-profits' tax-exempt status. Regulations on intermediate sanctions are due this year, Owens said.
The ruling also permits not-for-profit corporations that once owned hospitals to remain labeled "public charities" if they structure their joint venture deals as the IRS prescribes.
That means the not-for-profit shell left behind after a whole-hospital joint venture won't be forced to change its mission or pay taxes.
The ruling allows the not-for-profit corporations to keep their public charity classification as hospitals, even though they've sold or "donated" their facilities to the operating company they co-own with a for-profit.
Otherwise, the not-for-profits would have to resort to one of two less attractive options: becoming a supporting organization or a private foundation.
"A lot of these (not-for-profits) converted to supporting organizations, so they have to establish a relationship with another public charity and relinquish some control to the charity they're supporting," said Phil Royalty, a tax partner with Ernst & Young in Washington.
"If the not-for-profits were forced to become supporting organizations, they might have to serve one segment of the population because of the restrictions," said Elizabeth Mills, a tax attorney with McDermott Will & Emery in Chicago.
But private foundations are subject to tight restrictions.
For starters, they can't own more than a 20% interest in a business enterprise. Their grants for the year must total at least 5% of their net investment assets. They also must pay a 2% tax on their net investment income.
"As a successor foundation, you don't provide charity care anymore. You provide grants. But you don't want to become a private foundation" because of the restrictions that come with that label, said Jim McGovern, a principal at KPMG Peat Marwick in Washington. "By allowing not-for-profits to remain public charities, the IRS is recognizing their obligation to control hospitals' affairs after the deal is done."
"This seems to say that you have to use (profits from the joint venture) to promote public health," said Thomas Hyatt, a tax attorney with Ober Kaler Grimes & Shriver in Washington.