IRS denies exemption to a proposed rural hospital without sufficient operating details

Plain-English summary

The IRS denied a corporation's application for exemption under IRC § 501(c)(3) because it had not shown that it was operating or ready to operate a charitable hospital. The corporation planned to buy and run a rural general hospital, but it did not provide enough documentation about its purchase agreement, funding, current activities, or proposed operating policies. The IRS concluded that general statements about future charitable care and community benefits did not establish that the corporation would meet the operational test. The determination also explains the applicant's protest rights and the consequences of not exhausting administrative remedies.

Ruling snapshot

• Question: Did the corporation establish that it was organized and operated exclusively for exempt purposes under IRC § 501(c)(3)?
• Outcome: Denied, because the applicant did not provide sufficient facts and documentation to establish its planned charitable operations.
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1; Rev. Rul. 69-545; Rev. Proc. 2013-9.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201334044 Contact Person:

Release Date: 8/23/2013
Identification Number:

Date: May 29, 2013 Contact Number:
Employer Identification Number:
Form Required To Be Filed:

Tax Years:
UIL Code: 501.33-00

Dear

This is our final determination that you do not qualify for exemption from Federal income tax as
an organization described in Internal Revenue Code section 501(c)(3). Recently, we sent you a
letter in response to your application that proposed an adverse determination. The letter
explained the facts, law and rationale, and gave you 30 days to file a protest. Additionally, in
response to your request, we granted you an additional two weeks to file a protest. Since we
did not receive a protest within the requisite 30 days or the extended period, the proposed
adverse determination is now final.

You must file Federal income tax returns on the form and for the years listed above within 30
days of this letter, unless you request an extension of time to file. File the returns in accordance
with their instructions, and do not send them to this office. Failure to file the returns timely may
result in a penalty.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, follow the
instructions in Notice 437. If you agree with our deletions, you do not need to take any further
action.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
Federal income tax status and responsibilities, please contact IRS Customer Service at

1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933.
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Holly O. Paz
Director, Rulings and Agreements

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: March 14, 2013 Contact Person:
UIL Code: 501.33-00 Identification Number:
Contact Number:
FAX Number:
Employer Identification Number: |
LEGEND

Corporation =
State =
Date 1 =
Date 2 =
Date 3 =
Hospital =
City =
State Taxing Authority =
Newspaper =

Dear

We have considered your application for recognition of exemption from Federal income tax
under Internal Revenue Code (“Code”) section 501(a). Based on the information provided, we
have concluded that you do not qualify for exemption under § 501(c)(3) of the Code. The basis
for our conclusion is set forth below.

Facts

You filed your Articles of Incorporation (the “Articles”) under the nonprofit corporation laws of
State on Date 1. Your Articles state that you are organized exclusively for § 501(c)(3) purposes.
Your specific purposes are, “[t]lo own and operate a general hospital or hospitals, to operate
said hospital or hospitals exclusively for charitable, scientific or educational purposes as set
forth under the provisions of Section 501(c)(3) of the Internal Revenue Code of 1954, as
amended”.

Your Bylaws provide that your primary purpose “shall be operation of Hospital in City, which
shall also be the principal place of business.” In your narrative description, you stated you have
“been formed to provide relief to the poor, distressed and underprivileged.” You stated “[we]

developed one (1) program in furtherance of our purpose...we further our purpose under this

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program by owning and operating a Rural General Acute Care Hospital with a Critical Access
designation for hospitals.” You intended to purchase and operate Hospital.

You indicated you have opened escrow to purchase Hospital and signed a purchase
agreement. Specifically, you stated, “we signed a purchase agreement on Date 2 and opened
escrow to purchase Hospital, located in City. Escrow is scheduled to close on or before Date 3.”
You did not provide a copy of this purchase agreement or any support for an agreement to close
on or before Date 3. You state “Corporation currently doesn’t own a hospital. We are trying to
purchase the city owned hospital in City. The hospital is built on city owned land and BLM land.
In order for the City of City to convey title of the BLM land to the purchaser, the purchaser has to
be a nonprofit 501(c)(3) tax exempt corporation.” Enclosed in our letter to you was a news
article from the website for Newspaper. The article stated generally that the arrangement for
Corporation to purchase Hospital will no longer occur. The article also stated that City is
communicating with an alternate party to purchase Hospital. When asked whether acquisition of
the hospital is still possible and how your future plans have changed for acquiring and operating
a hospital or other operations you stated, you replied, “[t]he hospital currently hasn't been sold.
When Corporation receives its funding and the BLM (Bureau of Land Management) certificate of
Approval, Corporation will submit its Asset Purchase Agreement to the Board of Hospital
Trustees and the City Council of the City for their approval of the purchase agreement.” There is
no statement as to where you will receive your funding to purchase the hospital.

There are no documents in your application or your responses to our requests for more
information that show your current activities. When asked to provide your website you stated
that “Corporation still doesn’t have a website.” You were also asked to provide any proposed
recruitment incentive policies and any other incentives offered to physicians. You indicated that
“[o]nce all definitive agreements are executed by Corporation and the City of City, Corporation's
Board of directors will immediately meet with the Hospital Administration and retain a healthcare
attorney firm, to craft and approve a Physician recruitment policy for the hospital administration
to follow.” You were asked to explain the role your Board has in setting recruitment incentive
policies and what steps your board will take to ensure such recruiting practices are consistent
with your exempt purposes.” You stated, “Corporation does not have any proposed recruitment
incentive policy. The governing board will decide its recruitment incentive policy after
Corporation retains a healthcare attorney.” Then you state “[o]ther recruitment incentives could
be: (a) percentage of student loan repayment, (b) a percentage of relocation expenses and
possibly some sort of medical directorship for services rendered. Before any incentive policies
are adopted the governing board would be advised from its health care attorney.” None of the
proposed policies are accompanied by resolutions or minutes from meetings of your Board.

You provided a proposed policy for determining salaries of employees, a Financial Assistance
Plan, treatment of patients without apparent ability to pay, implementation of the Community
Health Needs Assessment, and provision of charity care.

Law

Section 501(c)(3) of the Code describes corporations, and any community chest, fund, or
foundation, organized and operated exclusively for religious, charitable, scientific, testing for
public safety, literary, or educational purposes, no part of the net earnings of which inures to the
benefit of any private shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the Regulations states that in order to be exempt as an
organization described in § 501(c)(3) of the Code, an organization must be both organized and
operated exclusively for one or more of the purposes specified in that section. If an organization
fails to meet either the organizational test or the operational test, it is not exempt.

Section 1.501(c)(3)-1(d)(1)(ii) of the Regulations states that an organization is not operated
exclusively for one or more exempt purposes unless it serves a public rather than a private
interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to
establish that it is not organized or operated for the benefit of private interests such as
designated individuals, the creator or his family, shareholders of the organization, or persons
controlled, directly or indirectly, by such private interests.

In evaluating whether a nonprofit hospital qualifies as an organization described in § 501(c)(3)
of the Code, Rev. Rul. 69-545, 1969-2 C. B. 117, compares two hospitals. The first hospital
discussed is controlled by a board of trustees composed of independent civic leaders. In
addition, the hospital maintains an open medical staff, with privileges available to all qualified
physicians; it operates a full-time emergency room open to all regardless of ability to pay; and it
otherwise admits all patients able to pay (either themselves, or through third party payers such
as private health insurance or government programs such as Medicare). In contrast, the second
hospital is controlled by physicians who have a substantial economic interest in the hospital.
This hospital restricts the number of physicians admitted to the medical staff, enters into
favorable rental agreements with the individuals who control the hospital, and limits emergency
room and hospital admission substantially to the patients of the physicians who control the
hospital. Rev. Rul. 69-545 notes that in considering whether a nonprofit hospital is operated to
serve a private interest, the Service will weigh all the relevant facts and circumstances in each
case, including the use and control of the hospital. The revenue ruling concludes that the first
hospital continues to qualify as an organization described in § 501(c)(3) of the Code and the
second hospital does not because it is operated for the private benefit of the physicians who
control the hospital.

Rev. Rul. 83-157, 1983-2 C.B. 94, held that a nonprofit hospital identical to the hospital in Rev.
Rul. 69-545, except it did not operate an emergency room, can still qualify under § 501(c)(3) of
the Code if other significant factors establish that it operates exclusively to benefit the
community as a whole.

Rev. Proc. 2013-9, 2013-2 I.R.B. 255, section 4.03, states that exempt status may be
recognized in advance of an organization’s operations if the proposed activities are described in
sufficient detail to permit a conclusion that the organization will clearly meet the particular
requirements for exemption pursuant to the section of the Code under which exemption is
claimed. A mere restatement of exempt purposes or a statement that proposed activities will be
in furtherance of such purposes will not satisfy this requirement. The organization must fully
describe all of the activities in which it expects to engage, including the standards, criteria,
procedures, or other means adopted or planned for carrying out the activities, the anticipated
sources of receipts, and the nature of contemplated expenditures. Where the organization
cannot demonstrate to the satisfaction of the Internal Revenue Service (the “Service”) that it
qualifies for exemption pursuant to the section of the Code under which exemption is claimed,
the Service will generally issue a proposed adverse determination letter or ruling.

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945), the
Supreme Court held that a trade association did not qualify for exemption, because it had an
“underlying commercial motive” that distinguished its educational program from the type
provided by a university. In so holding, the Court ruled that the presence of a single non-
exempt purpose, if substantial in nature, destroys an organization’s basis for tax exemption,
regardless of the number or importance of that organization’s truly exempt purposes.

In Harding Hospital, Inc. v. United States, 505 F2d 1068 (1974), the court held that an
organization seeking a ruling as to recognition of its tax exempt status has the burden of proving
that it satisfies the requirements of the particular exemption statute. Whether an organization
has satisfied the operational test is a question of fact.

New Dynamics Foundation v. United States, 70 Fed. Cl. 782 (2006), was an action for
declaratory judgment that the petitioner brought to challenge the denial of his application for
exempt status. The court found that the actual purposes displayed in the administrative record
supported the conclusion of the IRS. If the petitioner had evidence that contradicted these
findings, it should have submitted it as part of the administrative process. “It is well-accepted
that, in initial qualification cases such as this, gaps in the administrative record are resolved
against the applicant.”

The applicant for tax exempt status under § 501(c)(3) of the Code has the burden of showing it
“comes squarely within the terms of the law conferring the benefit sought.” Nelson v.
Commissioner, 30 T.C. 1151, 1154 (1958).

In Basic Bible Church v. Commissioner, 74 T.C. 846 (1980), the Sixth Circuit court found that
although the organization did serve religious and charitable purposes, it existed to serve the
private benefit of its founders, and thus failed the operational test of § 501(c)(3) of the Code.
Control over financial affairs by the founder created an opportunity for abuse and thus the need
to be open and candid, which the applicant failed to do.

In Bubbling Well Church of Universal Love, Inc. v. Commissioner, 74 T.C. 531 (1980), the Tax
Court stated that an application for tax-exempt status "calls for open and candid disclosure of all
facts bearing upon [an Applicant's] organization, operations, and finances to assure [that there
is not] abuse of the revenue laws. If such disclosure is not made, the logical inference is that the
facts, if disclosed, would show that the [Applicant] fails to meet the requirements of § 501(c)(3)."

in Peoples Prize v. Commissioner, T.C. Memo 2004-12 (2004). Petitioner provided only
generalizations in response to repeated requests by respondent for more detail on prospective
activities. Such generalizations did not satisfy the court that petitioner qualifies for the
exemption.

Analysis

You have not met your burden of proof that you are formed to serve a purpose as described in
§ 501(c)(3) of the Code. To qualify for exemption as an organization described in § 501(c)(3) of
the Code, an organization must be both organized and operated exclusively for one or more of
the purposes specified in that section. Section 1.501(c)(3)-1(a)(1) of the Regulations. Exemption

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from federal income taxation is not a right, it is a matter of legislative grace that is strictly
construed. New Dynamics, 70 Fed. Cl. 782. The burden is on the applicant to prove that it is
entitled to exempt status. Id. An applicant must prove that it is organized and operated
exclusively for exempt purposes and not for the private benefit of its creators, designated
individuals or organizations controlled by such private interests. Section 1.501(c)(3)-1(d)(1)(ii) of
the Regulations. According to your articles of incorporation, you organized to own and operate a
hospital. You do not own or operate a hospital. You have not provided any documentation of
current activities that allow a conclusion that you are operated for any exempt purpose.

You have the burden of providing sufficient documentation or other substantive information
regarding your activities and operations which would establish entitlement to tax exempt status.
Information that is vague or nonspecific is not sufficient to meet the requirements under §
501(c)(3) of the Code. Exempt status may be denied based solely on the applicant's failure to
describe in adequate detail how it will satisfy the operational test. An application for tax-exempt
status “calls for open and candid disclosure of all facts bearing upon [an Applicant's]
organization, operations, and finances to assure [that there is not] abuse of the revenue laws.”
Bubbling Well, 74 T.C. at 535. As the court stated in New Dynamics Foundation, “[i]t is well-
accepted that, in initial qualification cases . . . , gaps in the administrative record are resolved
against the applicant. . . . [and] inferences [can be drawn that are] adverse to a taxpayer
seeking exempt status.” 70 Fed. Cl. at 802. If this was not the case, the result “would be to
encourage [taxpayers] to play a tight-lipped form of ‘cat and mouse’ with [the Service's]
information requests.” Id. When asked to provide a website, you responded that you don't have
one yet. When asked for your recruitment incentive policies, you replied that you don’t have
them yet, but after purchase of Hospital, you will hire a healthcare attorney and then submit
policies to your Board of Directors.

Rev. Rul. 69-545, supra, notes that in considering whether a nonprofit hospital is operated to
serve a private interest, the Service will weigh all the relevant facts and circumstances in each
case and this burden requires an applicant seeking exempt status to provide sufficient
information to make an informed decision. The application must include details, figures, and
documentation to support the informed decision. See Basic Bible Church, 74 T.C. 846. You
stated that your only purpose will be to own and operate Hospital. When presented with a
statement from Newspaper that you will be unable to purchase Hospital, you replied “when
Corporation receives its funding and the BLM Certificate of Approval, Corporation will submit its
asset Purchase Agreement to the Board of Hospital Trustees and the City Council of the City of
City for their approval of the purchase agreement.” You neither provided a description of how
you would obtain funding, nor denied that you would be unable to purchase Hospital. The
information you provided in your application and letters do not provide enough facts and
circumstances to make an informed decision about your ability to achieve funding to purchase
Hospital. The mere prospect or desire to purchase Hospital does not meet the burden required.
The facts and circumstances do not support a reasonable conclusion that you will own or
operate Hospital. If you do not own or operate a hospital, you cannot fulfill your “one (1)
program in furtherance of [your] purpose.”

Rev. Rul. 83-157, supra, provides that a hospital lacking a common element of an exempt
hospital, in that case one that was lacking an emergency room, can still qualify under §
501(c)(3) if other significant factors establish that it operates exclusively to benefit the
community as a whole. You indicated you are “dedicated” to providing care to the “poor,
distressed, and underprivileged.” Any community benefit provided to the “poor, distressed, and

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underprivileged” is entirely contingent on your owning and operating Hospital. You indicated that
you had entered escrow and signed a purchase agreement. You did not provide a copy of the
purchase agreement or documents supporting the transaction and you did not explain why the
transaction did not occur by the purported deadline. “If such disclosure is not made, the logical
reference is that the facts, if disclosed, would show that [the Applicant] fails to meet the
requirements of § 501(c)(3).” Bubbling Well Church of Universal Love, 74 T.C. at 535. The
absence of a clear plan to achieve funding, to purchase Hospital, or an explanation why the
previous purchase was unsuccessful, demonstrates a lack of sufficient detail to permit a
conclusion that your organization will clearly meet its requirements for exemption.

An organization is operated exclusively for one or more exempt purposes only if it engages
primarily in activities that accomplish one or more of the exempt purposes specified in

§ 501(c)(3) of the Code, and if not more than an insubstantial part of its activities furthers a non-
exempt purpose. See Better Business Bureau, 326 U.S. at 283. You have provided a
statement of your exempt purpose and that you will adopt employee recruitment policies,
Community Health Needs Assessments, Financial Assistance Plans, and charity care plans;
however, you also stated that you will only do so after you have purchased Hospital and hired a
healthcare attorney. These are prospective policies for which you have not provided any
indication of implementation; such as a resolution or minutes from meetings of the Board of
Directors.

Although you provide that you plan to satisfy the requirements of exemption after you have
purchased the hospital and have hired an attorney, you have failed to provide details that you
will operate to fulfill a charitable purpose as described in § 501(c)(3) of the Code. Rev. Proc.
2013-9, supra, does provide that you can be granted exempt status in advance of operations,
but you must provide information that satisfies the inquiries that lead to a conclusion that you
will be able to perform your exempt purposes. Instead you have provided a contingent purpose
and community benefit but have only made general statements as to how you will achieve this
purpose or benefit. You stated that you will purchase and operate a hospital, but have not
provided how you will achieve funding to do so. “Such generalizations do not satisfy us that
[applicant] qualifies for the exemption.” Peoples Prize, 87 T.C.M. 813. A mere statement that
your activities will be in furtherance of your exempt purposes is insufficient. The burden is on the
applicant to establish that it is operated to serve one or more exempt purposes. Harding
Hospital, Inc. 505 F2d at 1071, and § 1.501(c)(3)-1(d)(1)(ii) of the Regulations. Rev. Proc.
2013-9, supra, specifically states:

The organization must fully describe all of the activities in which it
expects to engage, including the standards, criteria, procedures, or other
means adopted or planned for carrying out the activities, the anticipated
sources of receipts, and the nature of contemplated expenditures.
Where the organization cannot demonstrate to the satisfaction of the
Internal Revenue Service (the “Service”) that it qualifies for exemption
pursuant to the section of the Code under which exemption is claimed,
the Service will generally issue a proposed adverse determination letter
or ruling.

You have not established a factual basis for your exemption and have not demonstrated that
you have met the burden of proof that you are exclusively operated for tax exempt purposes
under § 501(c)(3) of the Code.

Conclusion

You have not met your burden of proving that you qualify for tax exempt status. Therefore, it is
our conclusion that you have not established that you are operated exclusively for exempt
purposes within the meaning of §501(c)(3) of the Code.

You have the right to file a protest if you believe this determination is incorrect. To protest, you
must submit a statement of your views and fully explain your reasoning. You must submit the
statement, signed by one of your officers, within 30 days from the date of this letter. We will
consider your statement and decide if the information affects our determination.

Your protest statement should be accompanied by the following declaration:

Under penalties of perjury, I declare that I have examined this protest statement, including
accompanying documents, and, to the best of my knowledge and belief, the statement
contains all the relevant facts, and such facts are true, correct, and complete.

You also have a right to request a conference to discuss your protest. This request should be
made when you file your protest statement. An attorney, certified public accountant, or an
individual enrolled to practice before the Internal Revenue Service may represent you. If you
want representation during the conference procedures, you must file a proper power of attorney,
Form 2848, Power of Attorney and Declaration of Representative, if you have not already done
so. For more information about representation, see Publication 947, Practice before the IRS
and Power of Attorney. All forms and publications mentioned in this letter can be found at
www.irs.gov, Forms and Publications.

If you do not file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to protest

as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in

part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

If you do not intend to protest this determination, you do not need to take any further action. If
we do not hear from you within 30 days, we will issue a final adverse determination letter. That
letter will provide information about filing tax returns and other matters.

Please send your protest statement, Form 2848 and any supporting documents to this address:

Internal Revenue Service
SE:T:EO:RA:T:4 (NCA-534-11)
1111 Constitution Ave, N.W.
Washington, DC 20224

You may also fax your statement using the fax number shown in the heading of this letter. ui
you fax your statement, please call the person identified in the heading of this letter to confirm
that he or she received your fax.

If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.

Sincerely,

Holly O. Paz
Director, Rulings and Agreements