After a six-year Internal Revenue Service investigation costing millions of dollars, it took a federal jury just six hours to decide that Austin, Texas-based St. David's HealthCare System deserved tax-exempt status. The system is part owner of St. David's HealthCare Partnership, a six-hospital system formed through a joint venture between not-for-profit St. David's and investor-owned HCA.
That verdict could open the door for long-awaited IRS guidance on ancillary joint ventures, guidance that could be released as early as this month, according to healthcare tax lawyers.
"This case really puts the IRS in a tough spot," said Jim King, a healthcare tax lawyer with Jones Day. "I'm hopeful that the service, which has long talked about putting out precedential guidance in the ancillary ventures area, will now speed the process and offer some guidance people can live with in how to safely structure their deals."
The March 4 verdict by the Austin jury coincides with heightened interest in the tax-exempt status of hospitals and efforts by state and municipal taxing agencies to seek tax revenue from not-for-profit organizations. Two weeks ago, House Ways and Means Committee Chairman Bill Thomas (R-Calif.) said he would launch an investigation into whether tax-exempt hospitals and other organizations behave too much like for-profit corporations. And in recent months local taxing authorities in Illinois, Indiana and Massachusetts have prevailed in cases challenging the tax-exempt status of not-for-profits.
In 1996 St. David's and Nashville-based HCA signed a 54-year partnership agreement. Each group contributed three hospitals to form St. David's HealthCare Partnership, a whole-hospital joint venture. The partnership agreement required the hospitals to maintain community benefit standards and gave St. David's the right to fire the chief executive officer, name the board chairman and dissolve the partnership with HCA. After an audit in 1998, the IRS ruled that because the St. David's system entered a partnership with a for-profit organization, it no longer operated exclusively for charitable purposes and revoked its tax-exempt status in 2000.
In 2002, U.S. District Court Judge James Nowlin in Austin ruled St. David's was tax-exempt and ordered the IRS to repay St. David's $1.2 million in tax payments and interest and $1 million in legal fees. In November 2003 a three-judge panel from the 5th U.S. Circuit Court of Appeals in New Orleans overruled Nowlin's decision and sent the case to district court for trial (Nov. 17, 2003, p. 8). Healthcare tax specialists said while it's possible the IRS will appeal the jury verdict, it's unlikely.
A U.S. Justice Department source said the government is evaluating its options and has until May 4 to appeal the case to the 5th Circuit.
St. David's President and CEO Neal Kocurek, who testified during the trial, said the case hinged on the jury's agreement that St. David's established enough control in the partnership agreement to maintain its charitable mission.
"We're very pleased and are absolutely certain that this is the correct verdict. We regret that we've spent six years and millions of dollars in an effort to show what we already knew. But I hope it's over," Kocurek said. "I sincerely hope it's over."
Kocurek said the government has not yet paid St. David's the 1996 tax and interest.
The swift verdict surprised King.
"I think the bottom line other tax-exempt organizations can draw from this is that when you have a case like St. David's, in which both parties were engaged in a legitimate business deal, provided a lot of charity care and no egregious conduct was alleged, a district court jury trial is a better venue than a tax court," King said. "People will take this lesson to heart-that a local jury offers them a better shot than a technical forum like a tax court made up of professionals who understand tax law. The jury is more inclined to look at overall behavior than the nuances of vested control."