Article Archives >> Lead Stories >> March 16-31, 2004
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Jury Finds St. David's Hospital Has
Enough Control to Retain Exemption
IRS suffers major defeat in its effort to show
that partnership with for-profit was not charitable
The IRS' roller-coaster effort to deny charitable tax exempt status to St. David's Hospital in Austin Texas took a sharp plunge this month when a federal court jury found that the Hospital had retained sufficient control over its partnership with a for-profit organization to assure that the operation was conducted primarily for charitable purposes. ( St. David's Health Care System v. U.S . , W.D. TX , Civ. Action No. A-01-CA-46 JN, 3/4/04.)
The jury's decision effectively restored the exempt status of the Hospital in spite of the IRS' multi-year effort for revocation. The trial court had originally granted the Hospital's motion for summary judgment to restore exemption, but the Fifth Circuit Court of Appeals had remanded for determination of material facts in dispute. The Fifth Circuit's opinion suggested it would be hard to find the Hospital had retained sufficient control to retain its exemption. ( See Nonprofit Issues , October 2003 .)
St. David's originally entered into the partnership with Columbia/HCA Healthcare Corporation in 1996. It contributed its charitable hospital in Austin , while HCA contributed its proprietary hospitals in the area. The IRS revoked St. David's exemption on the ground that it did not control the partnership, as required under Rev. Rul. 98-15 (See Ready Reference Page No. 11 ) and the Redlands Surgical Center case in 2001 (See Nonprofit Issues, March 2001 ).
Under current IRS doctrine, any joint venture not controlled by a charity is deemed not to be charitable and therefore an unrelated business activity. If a charity receives net income from the unrelated business activity, it can be subject to unrelated business income tax. If a charity has too much unrelated business activity, it can lose its exemption since charities may not engage in any substantial non-charitable activity.
The IRS argued that a 50-50 split of the Board positions did not assure control and pointed to a number of other factors which, it argued, prevented St. David's from effectively assuring that the partnership would act primarily for charitable purposes. It cited a long-term management contract with a subsidiary of HCA in which the manager was paid a percentage of net income, and the difficulty St. David's would face if it had to withdraw from the agreement to enforce its need for charitable conduct.
The IRS reportedly did not call any witnesses in the case, and St. David's presented several executives who testified that it had not ceded control over the venture to HCA. On the difficult question of the long-term management contract, the Hospital introduced testimony to the effect that it agreed to such a long term because it felt it had gotten such a good deal.
The Court charged the jury along the lines described by the Fifth Circuit. It told them they "must determine whether St. David's, when it entered the partnership, retained sufficient control over partnership operations to insure that partnership operations primarily further charitable purposes, and that no more than an insubstantial amount of the partnership's activities further non-exempt interests."
It also charged that if the jury found that St. David's "did, in fact, give up control to HCA over partnership activities," it should find for the government. The jury responded that "we do find by a preponderance of the evidence that [St. David's] is entitled to a tax exemption."
YOU NEED TO KNOW
A jury verdict does not establish new law. The jury is charged with finding facts to apply to the law as it exists. The Court basically accepted the IRS position that control is the determinative factor. The jury simply found, as a matter of fact, that St. David's had sufficient control, when the IRS argued, on a more theoretical basis, that it could not have enough control under the structure of the partnership.
Even though the IRS may lose this one, it has established its view of the law here and in the Redlands Surgical Center case which it won. It does not seem likely that the IRS will give up its position in reviewing other joint ventures in which control is not clearly with the charity.
Article Archives >> Lead Stories >> March 16-31, 2004
