Tax Implications of Tax-exempt Corporate Structures
| Publication year | 1995 |
| Pages | 801 |
| Citation | Vol. 24 No. 4 Pg. 801 |
1995, April, Pg. 801. Tax Implications of Tax-Exempt Corporate Structures
During the last ten years, perhaps the most significant development in the health care industry has been the reorganization of hospitals into systems.(fn1) In the tax-exempt arena, these "systems" typically consist of a tax-exempt parent corporation and a number of tax-exempt and for-profit subsidiaries.
Hospital systems establish subsidiary corporations and affiliate with other entities for non-tax and tax reasons. With regard to non-tax purposes, a parent may set up a subsidiary to (1) limit liability, (2) conform its operations with state law, (3) minimize governmental disclosures and reporting, (4) create additional leadership opportunities or (5) qualify for additional funding opportunities. As to tax-driven motives, a parent may create a subsidiary to (1) avoid loss of tax-exempt status,(fn2) (2) create opportunities for tax-exempt financing, (3) seek foundation status or (4) seek state or local tax savings.
Regardless of a parent's reasons for creating affiliated structures, it is imperative that the subsidiary corporation achieve and maintain independent legal status, avoid challenges of its capitalization structure and minimize unrelated business taxable income for the parent corporation.
The Internal Revenue Service ("Service") generally tolerates the organization of a hospital system with tax-exempt and for-profit subsidiaries. However, the Serv- ice has imputed a subsidiary's loss of exemption to a system parent by disregarding the subsidiary's legal existence. For example, in one case the Service challenged tax exemption of a hospital system parent after it concluded that the activities of a purported tax-exempt subsidiary inured to the benefit of private physicians.
Generally, the Service will not succeed in imputing the activities of a separately incorporated subsidiary to its parent organization, unless the facts provide clear and convincing evidence that the subsidiary's existence can be disregarded or the subsidiary is in reality an arm, agent or integral part of the parent. The Service has successfully disregarded a corporate entity when the entity was a sham or fraud, without any valid business purpose, or when a corporation acted as a true agent for another corporation.
An evaluation of the ability to disregard a corporation typically begins with the seminal case of Moline Properties v. Commissioner.(fn3) In Moline Properties, a corporation received gain from real estate but desired to treat the gain as taxable to the corporation's sole shareholder. The corporation asked the court to ignore its separate status, noting that the corporation never had a bank account or a book or record of account. The corporation also explained that the sole individual shareholder paid all corporate expenses directly and caused the corporation to assume his mortgage.
The U.S. Supreme Court held that the corporation was a separate entity, stating:
The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors, or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of a business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity.(fn4)
The U.S. Court of Appeals for the Fifth Circuit followed and extended the Moline Properties doctrine in Britt v. Commissioner,(fn5) holding that Moline's separate entity test can be satisfied by even minimal business activity. In Britt, several brothers managed orange groves through three corporations and a partnership. The brothers held the stock of the corporations, which, in turn, held interests in the partnership. The IRS disregarded the corporations, asserting that they did not conduct sufficient business activity. In effect, the government argued that the...
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