Healthcare nonprofit's effective control over partnership will determine exempt status.

• Author: Magin, Elizabeth

In St. David's Health Care System, Inc., 5th Cir., 11/7/03, the Fifth Circuit held that healthcare nonprofit organizations must retain effective control over their partnerships with for-profit entities to retain their tax-exempt status. The court vacated a summary judgment holding that St. David's Health Care System Inc., an organization that operated hospitals in central Texas through a joint venture with a for-profit healthcare company, was entitled to exempt status under Sec. 501(c)(3). The Fifth Circuit stated that, to determine whether the organization is operated exclusively for a charitable purpose, the trial court must ascertain who formally and/or effectively controls the partnership.

The case will now go back to a Texas district court to determine whether St. David's ceded control to its for-profit partner. When the trial court again hears this case, St. David's will have $40 million in back taxes--as well as millions more in future taxes--at stake. Moreover, other entities considering or involved in hospital joint ventures should closely watch the outcome to determine whether partnership contracts are structured so as to survive IR.S scrutiny.

Background

In 1996, due to financial difficulties, St. David's, an exempt organization that owned and operated healthcare facilities in Texas, entered into a hospital joint venture with a subsidiary of Columbia/HCA Healthcare Corp. (HCA), a taxable, for-profit healthcare company. St. David's contributed all of its facilities to the partnership; HCA contributed its Austin, TX facilities. St. David's received 45.9% general and limited partnership interests.

The partnership agreement required that all hospitals owned by the joint venture operate under Rev. Rul. 69-545's "community benefit standard." St. David's retained the unilateral right to dissolve the partnership with HCA if the hospitals' operations failed to meet that standard. The partnership agreement established a board of governors to oversee the joint venture's operations. The board votes in two equal blocks, one composed of members appointed by St. David's. St. David's reserved the right to appoint the board's chairman and to unilaterally remove the joint venture's day-to-day manager (an HCA subsidiary) and the manager's chief executive officer (CEO).

In 2000, on completion of its examination of 1996 Form 990, Return of Organization Exempt from Tax, the IRS proposed to revoke St. David's exempt status retroactive to 1996...