Hospital's joint venture with its medical staff could jeopardize exempt status.

• Author: Fiore, Nicholas J.

Tax-exempt hospital H proposed to establish a for-profit stock corporation for certain purposes that would be jointly owned in equal shares by H and physicians on its medical staff. The new corporation would in turn establish and serve as the general partner in four limited partnerships (LPs). The LPs were to be formed to allow medical staff physician participation in the operation of four H outpatient departments. The four departments, Outpatient Surgery, Outpatient Diagnostic (CT Scan, Ultrasound, etc.), Ophthalmology and Cardiac Nuclear Medicine, represented in the aggregate about 4% of H's gross revenues.

H stated that it would "in effect, lease the individual departments for a limited time period to the limited partnership[s]." Apparently, the LPs would pay H an actuarially establish price (discounted to present value) for the revenue stream of each of the subject departments. In addition, the LPs would pay H a fee for managing the facilities and reimburse the hospital for all fixed and variable costs incurred in operating the departments. Thus, according to H, physician-investors would benefit only if use of the facilities increased because, in effect, they shared only in profits over and above the level H already received.

H represented that it would retain, through its interest in the for-profit corporation, an interest in each LP. Fifty percent of each LP would be held by the corporation and 50% sold to medical staff physicians. H also stated that it would retain actual control of the facilities through a management agreement, and that it alone would determine the rates charged patients for services in those facilities.

The stated reason for the proposed transactions was to maintain or increase use of H's various services, both inpatient and outpatient, so that it could provide the highest level of service at the lowest price to the public. H argued that failure to undertake the proposed transaction would raise a probability that it would be unable to continue providing the same high level of service to the community so, it reasoned, the transaction should be viewed as furthering its charitable purposes.

H maintained that the ventures would help it by creating incentives for medical staff physicians to increase inpatient admissions. The ventures would also create incentives for medical staff physicians to increase referrals to ancillary departments. These factors, combined with a feared loss of outpatient department business to...