A few months ago, I wrote a blog post about a hospital that had its Section 501(c)(3) status revoked by the IRS. In that case, the IRS found that the hospital had committed willful and egregious violations of the Patient Protection and Affordable Care Act (the “ACA”).  For example, the hospital was not conducting a community health needs assessment every three years as required by the ACA, and was not shy about telling the IRS that the hospital had neither the financial wherewithal nor the employees to conduct a needed assessment every three years. 

 It has happened again. (See PLR 201744019). This time, a hospital that had qualified for Section 501(c)(3) status lost its tax-exempt status because although the hospital retained title to the hospital facility, it no longer had operational control over the hospital.  When the hospital applied for its tax-exempt status in 1989, it intended to own and operate the hospital in a charitable manner, and did so for many years.  However, the hospital eventually ran into financial difficulty.  At that point in time, looking for the miracle cure to its financial ills, it turned to a for-profit entity that specialized in operating rural hospitals.  Initially, the hospital entered into a management contract with the for‑profit entity, while retaining control over patient revenues.  Later, the hospital ceded even more control to the for‑profit operator, in the form of a lease.  The for‑profit entity took over revenue collection responsibility.

In reaching its decision to revoke this hospital’s Section 501(c)(3) status, the IRS noted that a Section 501(c)(3) hospital’s “entire focus must be on community welfare.”   In this regard, the IRS noted that ensuring adequate medical care in a rural community is a qualifying purpose, and that under certain circumstances, this qualifying purpose can be achieved by an entity that maintains and leases hospital facilities to other entities with that goal in mind. See, e.g., Rev. Rul. 73-313 and Rev. Rul. 80‑309.   (Thus, the lease of the hospital facility to a for‑profit entity in and of itself was not fatal.)  Ensuring adequate medical care in a rural community may have been the hospital’s continuing goal in this case. However, as the IRS pointed out, the hospital was dealing with a for-profit entity, and a for-profit entity’s primary goal is to maximize profits, which is usually inconsistent with (i.e., an antidote to) providing charity care and community outreach.  Given the competing goals, the IRS finds it paramount that any time a Section 501(c)(3) hospital enters into a joint venture with a for-profit entity, the Section 501(c)(3) hospital maintains control over the joint venture (assuming the parties want the joint venture to qualify for Section 501(c)(3) tax favorable treatment).

The IRS found that the hospital in PLR 201744019 failed the operational test by ceding too much management and control over the hospital to the for-profit entity. Per the IRS, the hospital did not adequately demonstrate to the IRS that the arrangement between the hospital and for-profit entity had the goal of promoting and protecting the health of the local community. In addition, the IRS also noted that although there was a provision in the lease agreement pursuant to which the for-profit entity agreed to provide charity care in each lease year in a manner consistent with the hospital’s past practice, the hospital did not have any authority to enforce this provision.  In fact, the hospital did not even have access to the for-profit entity’s books and records.   Thus, unfortunately, as the rock band Queen might say, another financially unhealthy Section 501(c)(3) hospital bites the dust.