A recent Internal Revenue Service decision could make it easier for not-for-profit hospitals to apply their tax-exempt status to joint ventures with for-profit companies-although perhaps not by much.
More broadly, however, the IRS decision may signal the emergence of greater flexibility in tax regulators' thinking on such ventures, healthcare tax lawyers said.
In a December 2000 letter that became public last week, the IRS granted tax-exempt status to a joint venture among three unnamed not-for-profit hospitals and an also unidentified for-profit home infusion company.
At the time of the IRS decision, the not-for-profit hospitals owned a 65% interest in the home infusion venture, and the for-profit home infusion company, which managed the venture, held the remainder. In addition, the not-for-profit partners named five of the seven members of the management committee, which was responsible for major company decisions. The management contract's term was four years, with two-year renewal options by mutual consent.
Though the IRS doesn't publish determination letters, the contents of the letter began circulating last week among healthcare tax attorneys.
Notably, the IRS required the joint venture to adopt a charitable-purpose policy, similar to the hospitals', and to promise that its charitable mission would take priority over profit maximization.
Phil Royalty, a lawyer in the Washington office of Ernst & Young who represents the joint venture, said the hospitals and the home infusion company did not want to be identified. The partnership applied for tax-exempt status in 1997. "It was difficult," Royalty said of the venture's effort to win the exemption. "The IRS was initially averse to this. We had to make some changes."
Regardless, the letter is important because it appears to relax requirements of an earlier IRS decision-Revenue Ruling 9815-Royalty said. That opinion requires a not-for-profit company to control enough of a joint venture with a for-profit partner to ensure that the venture would further the not-for-profit's charitable purpose.
The recent IRS letter may give for-profit companies more support for managing joint ventures and may make their not-for-profit partners' tax-exemptions a bit safer, Royalty said. He added that the likelihood that not-for-profits will face liabilities for unrelated business income may be lessened by the ruling. "It's a small step, but it's a step forward," he said. "It indicates in certain circumstances you can have a management contract with for-profit partners."
T.J. Sullivan, a healthcare tax lawyer with Gardner, Carton & Douglas and a former IRS official, said the determination letter doesn't break new ground.
Meanwhile, Thomas Hyatt, a healthcare tax lawyer with Ober, Kaler, Grimes & Shriver, characterized the new ruling as a "baby step forward."
Both Sullivan and Hyatt said they expect the IRS to issue more determination letters on joint ventures' tax status, which may have been held up while a lawsuit over the tax status of a Redlands, Calif., joint venture played out (March 19, p. 4).
In 1995, the IRS denied tax-exempt status to a surgery center owned by a partnership between not-for-profit Redlands Health Systems and for-profit Surgical Care Affiliates of Nashville. Supporting the decision in a ruling last month, the 9th U.S. Circuit Court of Appeals said hospitals can't extend tax-exempt status to joint ventures with for-profit companies if the hospitals cede too much control.