Determination 1350043: IRS denies exemption for rural hospital management and private benefit

Plain-English summary

The IRS denied exemption under IRC § 501(c)(3) to an organization formed to support rural hospitals through management services, specialty medical lines, physician recruitment, and shared resources. The organization planned to charge member hospitals fees for management and consulting services, while several directors and related physicians had financial or professional ties to the hospital network. The IRS found that the proposed activities were commercial in nature, that private benefits to directors and physicians were substantial, and that the organization had not shown a primary charitable purpose. It therefore concluded that the organization failed the operational test and did not qualify for exemption.

Ruling snapshot

• Question: Did the organization's proposed rural hospital management, consulting, and physician-related activities satisfy IRC § 501(c)(3)'s operational and private-benefit limits?
• Outcome: Denied
• Key authorities: IRC §§ 170, 501(a), 501(c)(3), 501(m), 509(a)(2), 513, 6110, and 7428; Treas. Reg. § 1.501(c)(3)-1

Full text (IRS public release)

Transcriber's note: this document is a scan. Obvious OCR misreads were corrected by comparison with all 18 official PDF page images. Redacted placeholders remain as published, and source wording and source errors are otherwise preserved.

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
Contact Person:

Number: 201350043
Release Date: 12/13/2013 Identification Number:

Contact Number:

Date: September 17, 2013 Employer Identification Number:
Form Required To Be Filed:
UIL: 501.33-01
Tax Years:
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. Since we did not
receive a protest within the requisite 30 days, the proposed adverse determination is now final.

Because you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. 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


2

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

Sincerely,

Karen Schiller
Acting Director, Exempt Organizations
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: July 29, 2013 Contact Person:

UIL: 501.33-01 Identification Number:
Contact Number:
FAX Number:

Employer Identification Number:

B =
D =
N =
P =
S =
Letter 1 =
Letter 2 =
Letter 3 =
X =

Dear

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

FACTS:

You were incorporated as a nonprofit corporation under State law. You filed a Form 1023
seeking exemption from federal taxation under § 501(c)(3). Your Articles of Incorporation state
that your purpose is:


[T]o protect and enhance the abilities of rural hospitals and healthcare providers to serve
the healthcare needs of rural and underserved communities.

You amended your Articles to include the following:

The Corporation is organized exclusively for charitable purposes under section 501(c)(3)
of the Internal Revenue Code of 1986, as amended, or corresponding section of any
future tax code.

In your Form 1023 materials, you state that you have three members of your board of directors,
none of whom resided in State. According to your Bylaws, your members serve four year terms
without term limitations. Further, “the successors to those Directors whose terms of office expire
shall be elected each year by the remaining directors.” Since your initial application materials,
you have increased to a five member board of directors, including Attorney, your CEO, and one
non-voting member. The non-voting member of your board, Doctor, provides medical services
to you on an independent contractor basis. He is also closely related to Attorney.

You state in your Form 1023, your purpose includes providing hospital care to rural
communities. In furtherance of this purpose, your primary goal is to create a network of facilities
with shared management and resources. You will develop relationships between hospitals and
healthcare providers and with other physicians and groups to enable physicians to be able to
develop medical specialty service lines at member hospitals. You state that these specialty
services will improve the quality of care and increase the reimbursements available to your
hospitals which will help to ensure their sustainability. You also state that you will provide and
expand transportation services to improve access to care by rural patients. You plan to
organize and conduct training and education for physicians, staff, and third parties who will
perform specialty procedures. In addition, you state that the development of the specialty lines
of services at the member hospitals will create economic benefits to the surrounding
communities.

You initially state that you plan to accomplish these goals by acquiring and purchasing Hospital,
a ## bed critical access hospital, as well as expanding to additional healthcare facilities.
Hospital received a determination letter of § 501(c)(3) status on Date. You will expand and
renovate Hospital's surgical services by adding a second operating room. You state that a
substantial portion of the healthcare market you serve is presently controlled by out-of-state
healthcare businesses and these businesses funnel assets and charitable funds out of State.
By purchasing and operating Hospital, you will be keeping this hospital locally owned and
operated and thus further supporting the rural community.

You state that as sole member of LLC, you entered into an asset purchase agreement to
purchase and operate Hospital. You provided a copy of an executed asset purchase agreement
between LLC and Hospital, along with a copy of a check for $x payable to Hospital signed by
Founder. However, in subsequent documents, you state that the above LLC does not nor did it
ever exist.

Letter1 states that rather than following through with the asset purchase agreement to acquire
Hospital, you and Hospital settled on a “change of control” model. There are no written


agreements between you and Hospital describing this change in control model. Under this
model, Hospital will retain all assets, including real estate and the State license. In Letter1, you
state that you also control all seats on the board of Hospital. You further amended the
corporate structure in Letter2, where Hospital amended its Articles of Incorporation to become
incorporated as a directorship. You explained in Letter3, that a directorship is “a nonprofit
corporate structure in which the board of directors exclusively retains power and control over the
corporation, and members if any, have no voting power or control.” In this same letter, you
further explain that Hospital is now a membership organization with you as the sole corporate
member. As a result of this change of control and further changes to incorporation, you
assumed control of all of the seats of Hospital's board of directors.

Before you assumed control of the board of directors, Hospital had a fifteen member community
represented board. Members of the board included individuals from the farming community,
local business community, and a physician, all of whom primarily resided within the community
Hospital serves. As you state in Letter 3, Hospital's Bylaws now provide that all Hospital
directors shall be appointed exclusively by you and serve at your discretion. You fill any
vacancies on Hospital’s board.

You maintain that you are not operating Hospital, but are merely a corporate member in the
organization. To this effect, you submitted in Letter3 updated and amended Bylaws and Articles
of Incorporation for both you and Hospital. Hospital’s amended Bylaws state that their purpose
“shall be consistent with and supportive of the corporate purposes of [you].” Hospital will
support institutions sponsored by you. You also state that since you are no longer operating
Hospital nor do you have any plans of operating a hospital in the future, you need not answer
the questions pertaining to the requirements of any provisions dealing specifically with hospitals.

You entered into an agreement with Hospital to provide consulting and management services.
This agreement includes the payment of a management fee. The fee consists of payment for
the services you provide, costs you incur, and monies you have advanced in addition to a fixed
monthly fee.

You will utilize Hospital as the base of your operations. You do not have any agreements with
other hospitals or physicians at this time. You state that due to your proximity to City (not
located in State), you will be able market your services to individuals, physicians, and others
who come to City. You will maintain activities in City and eventually may open a satellite office

in City.

In addition, you state you will create a network of facilities to provide the level and quality of
services at major urban hospitals. One of the ways you will create this network is by developing
specialty medicine service lines. By developing the facility and recruitment of physicians who
practice in areas such as Specialty, you contend that the result will be an economic increase to
the hospitals and the communities they serve. You contend that people will travel to Hospital to
receive specialty services and this in turn will increase the amount of resources available for
Hospital to treat and serve the entire community.

You will continue to seek out and attempt to attract highly regarded specialty physicians to
become co-managers of service lines and or medical directors of the hospitals in your network.


Your goal is to help rural hospitals generate revenue based upon these specialty lines of
service.

One of the lines of services that you intend to develop at Hospital is Specialty. In order to
accomplish this goal, you will be working with PLLC and Firm. Principal members of these
organizations have previous as well as current working and personal relationships. Doctor
provides Specialty services and owns PLLC. Hospital has entered into a lease with PLLC to
lease medical equipment from PLLC. The assessment of fair market value for the lease was
taken from PLLC’s representations and the comparison of other quotes for this equipment.

Firm, where Attorney works, has been selected to provide legal counsel at a fair market value
for legal services. You state you have paid Firm $y for legal services rendered. There was no
written agreement or contract between you and Attorney or Firm. You state that you intended to
create a contract for services in the near future. In subsequent follow up, you state that neither
you nor Hospital has ever done any business with Firm. You acknowledge that Attorney has
worked on legal and regulatory matters on your behalf.

Attorney and Founder started a business of LLC2 whose primary purpose was to provide
healthcare business consulting services to healthcare professionals. PLLC has used the
services of LLC2 to provide consulting services to their practice. You have stated that you plan
to specifically prohibit your organization from doing any business with LLC2. Furthermore,
LLC2 is in the process of winding up and will no longer be providing services to anyone. Upon
further development regarding these relationships from this office, you state in Letter3 that Firm
does not exist and there is no relationship between you and Firm.

LAW

Section 501(c)(3) provides that an organization may be exempted from tax if it is organized and
operated exclusively for religious, charitable, scientific, testing for public safety, literary, or
educational purposes and “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 provides that in order to be exempt under §
501(c)(3), an organization must be both organized and operated exclusively for one or more of
the exempt purposes specified in that section. If an organization fails to meet either the
organizational test or the operational test, it does not qualify for exemption.

Section 1.501(a)(1)-1(c) defines a “private shareholder or individuals” as “persons having a
personal and private interest in the activities of the organization.” Thus, 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.

Section 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as operated
exclusively for one or more exempt purposes only if it engages primarily in activities which
accomplish one or more of such exempt purposes specified in § 501(c)(3). An organization will


not be so regarded if more than an insubstantial part of its activities is not in furtherance of an
exempt purpose.

Section 1.501(c)(3)-1(c)(2) provides that “[a]n organization is not operated exclusively for one or
more exempt purposes if its net earnings inure in whole or in part to the benefit of private
shareholders or individuals... .”

Section 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not organized or operated
exclusively for one or more exempt purposes unless it serves a public rather than a private
interest. To meet the requirement of this subsection, the burden of proof is on the organization
to show 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.

Section 1.501(c)(3)-1(d)(2) states, in part, that the term “charitable” in § 501(c)(3) includes relief
of the poor and distressed or of the underprivileged; advancement of religion; advancement of
education or science; lessening of the burdens of government; and promotion of social welfare
by organizations designed to accomplish any of the above purposes.

Section 1.501(c)(3)-1(d)(3)(i) states that the term “educational” in § 501(c)(3) includes the
instruction of the public on subjects useful to the individual and beneficial to the community.

Section 1.501(c)(3)-1(e)(1) provides that an organization may meet the requirements of

§ 501(c)(3) although it operates a trade or business as a substantial part of its activities, if the
operation of such trade or business is in furtherance of the organization's exempt purpose or
purposes and if the organization is not organized or operated for the primary purpose of carrying
on an unrelated trade or business as defined in § 513. In determining the existence or
nonexistence of such primary purpose, all the circumstances must be considered, including the
size and extent of the trade or business and the size and extent of the activities which are in
furtherance of one or more exempt purposes. An organization which is organized and operated
for the primary purpose of carrying on an unrelated trade or business is not exempt under

§ 501(c)(3).

Rev. Rul. 69-545, 1969-2 C.B. 117, recognizes that the promotion of health, in and of itself, can
be a charitable purpose, at least where the community as a whole is benefitted. In explaining
why an explicit level of charity care is not required, the ruling states that the “promotion of
health...is deemed beneficial to the community as a whole even though the class of
beneficiaries eligible to receive a direct benefit from its activities does not include all members of
the community, such as indigent members of the community, provided that the class is not so
small that its relief is not of benefit to the community.”

Rev. Rul. 71-529, 1971 C.B. 234, describes a nonprofit organization that provides assistance in
the management of participating colleges’ and universities’ endowment or investment funds.
Because the organization is performing an essential function for tax-exempt organizations for a
charge “substantially below cost,” it qualifies for exemption under § 501(c)(3).

Rev. Rul. 72-369, 1972-2 C.B. 245, concerns an organization formed to provide managerial and
consulting services to unrelated § 501(c)(3) organizations. The organization enters into


agreements with unrelated nonprofit organizations to furnish managerial and consulting services
on a cost basis. The ruling states that providing managerial and consulting services ona
regular basis for a fee is a trade or business ordinarily carried on for profit. The fact that the
services in this case are provided at cost and solely for exempt organizations is not sufficient to
characterize this activity as charitable within the meaning of § 501(c)(3). Furnishing the
services at cost lacks the donative element necessary to establish this activity as charitable.
Accordingly, the ruling holds that the organization's activities are not charitable and,
consequently, the organization does not qualify for exemption under § 501(c)(3).

Rev. Rul. 73-313, 1973-2 C.B. 174, held that attracting a physician to a community having no
available medical services furthered the charitable purpose of promoting the health of the
community. In the ruling, residents of an isolated rural community had to travel a considerable
distance to obtain care. Faced with the total lack of local services, the community formed an
organization to raise funds and build a medical office building to attract a doctor to the locality.
The ruling stated certain facts are particularly relevant: (1) the demonstrated need fora
physician to avert a real and substantial threat to the community; (2) evidence that the lack of a
suitable office had impeded efforts to attract a physician; (3) the arrangements were completely
at arm’s-length; and (4) there was no relationship between any person connected with the
organization and the recruited physician. The ruling said the arrangement used to induce the
doctor to locate a practice in the area bears a reasonable relationship to promotion and
protection of the health of the community and any private benefit to the physician is incidental to
the public purpose achieved. It concluded the activity furthers a charitable purpose and the
organization qualified for § 501(c)(3) exemption.

Rev. Rul. 76-419, 1976-2 C.B. 146, held that a nonprofit organization that purchased blighted
land in an economically depressed community, converted the land into an industrial park, and
induced industrial enterprises to locate new facilities in the park through favorable lease terms
that required employment and training opportunities for unemployed and underemployed
residents in the area, is operated exclusively for charitable purposes.

Rev. Rul. 77-111, 1977-1 C.B. 144, held that an organization formed to increase business
patronage in a deteriorated area by providing information about the shopping opportunities is
not operated for charitable purposes and is not exempt under §501(c)(3). Increasing business
patronage and reviving lagging sales are not charitable purposes.

Rev. Rul. 77-69, 1977-1 C.B. 143, describes and agency that was organized and operated
pursuant to federal statute to establish and maintain a system of health planning and resource
development aimed at providing adequate health care for a specified geographic area. It was
funded by federal grants and managed by government officials and members of the public. The
organization gathered and analyzed health data, established health system plans and goals,
coordinated activities with professional standards review organizations, reviewed and approved
grant applications for federal funds, and assisted states in reviewing health services capital
expenditures. The organization promoted the health of the residents of the area in which it
functioned, and met the requirements of lessening the burdens of government, and therefore
operated for charitable purposes under § 501(c)(3).


Rev. Rul. 80-287, 1980-2 C.B. 195, provides that a nonprofit lawyer referral service does not
qualify for exemption under § 501(c)(3). The organization aided persons who did not have an
attorney by helping them select one, in exchange for a nominal service charge. Any attorney
who was a member of a local bar association could apply for placement on the referral list, in
exchange for an application fee. Because a substantial purpose of the organization was aiding
the legal profession, the organization was not organized or operated exclusively for charitable
purposes, even though its lawyer referral service did provide some public benefit.

Rev. Rul. 81-276, 1981-2 C.B. 128, describes a professional standards review organization
established pursuant to a federal statute to review health care practitioners’ and institutions’
provision of health care services and items for which payment is made under Medicare and
Medicaid, and determine whether the quality of services met professionally recognized
standards of care. The IRS ruled that by taking on the government's burden of reviewing the
quality of services under Medicare and Medicaid, the organization lessened the burdens of
government within the meaning of § 1.501(c)(3)-1(d)(2). Any benefit to members of the medical
profession from such activities was incidental to the benefit the organization provided in
lessening the burdens of government. Therefore, the organization qualified for exemption under
§ 501(c)(3).

Rev. Rul. 85-110, 1985-2 C.B. 166, holds that the performance of diagnostic laboratory testing
on referred specimens from private patients of hospital staff physicians, by a hospital exempt
under § 501(c)(3), is unrelated trade or business if such services are otherwise available in the
community.

Rev. Rul. 97-21, 1997-1 C.B. 121, involved various “situations” in which incentives were used to
recruit private practice physicians to join a hospital's medical staff or to provide medical services
in the community. Situation 1 involved Hospital A, located in rural County V, which was the only
hospital within a 100-mile radius. The U.S. Public Health Service designated County V as a
Health Professional Shortage Area for primary medical care professionals. Hospital A recruited
physician M to establish and maintain a full-time private OB/GYN practice in its service area and
become a member of its medical staff. The ruling held Situation 1 did not affect Hospital A's
exempt status and, like the organization described in Rev. Rul. 73-313, Hospital A had objective
evidence demonstrating a need for obstetricians and gynecologists in its service area and
engaged in physician recruitment activity bearing a reasonable relationship to promoting and
protecting the health of the community in accordance with Rev. Rul. 69-545.

In Rev. Rul. 98-15, 1998-1 C.B. 718, the IRS noted that “not every activity that promotes health
supports tax exemption under section 501(c)(3). For example, selling prescription
pharmaceuticals certainly promotes health, but pharmacies cannot qualify for recognition of
exemption under [section] 501(c)(3) on that basis alone.”

In Better Business Bureau of Washington D.C., Inc. v. U.S., 326 U.S. 279 (1945), the Supreme
Court held that the presence of a single non-exempt purpose, if substantial in nature, will
destroy the exemption regardless of the number or importance of truly exempt purposes. The
Court found that a trade association had an "underlying commercial motive" that distinguished
its educational program from that carried out by a university, and therefore, the association did
not qualify for exemption.


In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the Tax Court considered an
organization that provided consulting services to groups that were mostly § 501(c)(3)
organizations. The organization charged fees for its services set at or close to its own cost.

The court concluded that there was nothing to distinguish these activities from those of an
ordinary commercial consulting enterprise, and affirmed the Service's denial of exemption under
§ 501(c)(3).

In Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687 (1979), aff'd, 625 F.2d 804
(8th Cir. 1980), the court held that, while selling prescription pharmaceuticals to elderly persons
at a discount promotes health, the pharmacy did not qualify for recognition of exemption under
§ 501(c)(3) on that basis alone. Because the pharmacy operated for a substantial commercial
purpose, it did not qualify for exemption under § 501(c)(3).

IHC Health Plans, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003), involved an operator of
health maintenance organizations (“HMOs”) that served approximately one-quarter of Utah’s
residents and approximately one-half of its Medicaid population. The court held that the
organization failed to meet the community benefit standard to qualify for exemption under

§ 501(c)(3) because its sole activity was arranging for health care services for its members, in
exchange for a fee. The court said that providing health-care products or services to all in the
community is necessary but not sufficient to meet the community benefit standard. Rather, the
organization must provide some additional benefit that likely would not be provided in the
community but for the tax exemption, and that this public benefit must be the primary purpose
for which the organization operates.

In Harding Hospital, Inc., 505 F.2d 1068 (6th Cir. 1974), the court denied exempt status under
§ 501(c)(3) to a non-profit hospital due to a contract that the hospital entered into with a
partnership composed of physicians. The contract gave the physicians control over care of the
hospital's patients and the stream of income generated by the patients while also guaranteeing
the physicians thousands of dollars in payment for various supervisory activities. The Court
concluded by holding that the benefits derived from the contract constituted sufficient private
benefit to preclude exemption.

In Geisinger Health Plan v. Commissioner, 985 F.2d 1210 (3d Cir. 1993), the court held that a
pre-paid health care organization that arranged for the provision of health care services only for
its members, benefited its members, not the community as a whole and therefore did not further
charitable purposes within the meaning of § 501(c)(3).

In Church by Mail v. Commissioner, 765 F.2d 1387, 1392 (9th Cir. 1985), the court in
determining that a non-profit was operated for substantial non-exempt purposes and that
income inured to the benefit of private persons stated that “[t]he critical inquiry is not whether
particular...payments to a related for-profit organization are reasonable or excessive, but
whether the entire enterprise is carried on in such a manner that the for-profit organization
benefits substantially from the operation of the [non-profit].”. The court additionally upheld the
Tax Court's determination that the church was operated for substantial nonexempt purpose of
providing a market for services of advertising agency, a for-profit organization owned and
controlled by ministers of church.


In Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C. 2003), the court concluded
that an organization did not qualify for tax-exemption under § 501(c)(3) because it was operated
for nonexempt commercial purposes rather than for exempt purposes. Among the major factors
the court considered in reaching this conclusion was the organization's competition with for-
profit commercial entities, the extent and degree of below cost services provided, the pricing
policies, and the reasonableness of financial reserves. Additional factors included whether the
organization used commercial promotional methods, such as advertising, and the extent to
which the organization received charitable donations.

The Tax Court has 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 section 501(c)(3).” Bubbling Well Church of Universal Love, Inc. v. Comm’r, 74
T.C. 531 (1980). See also, Founding Church of Scientology v. United States, 188 Ct. Cl. 490,
498, 412 F.2d 1197, 1201 (1969), cert. denied, 397 U.S. 1009 (1970). Furthermore, the courts
have repeatedly upheld the Service’s determination that an organization has failed to establish
exemption where the organization fails to provide requested information. “[Applicant] has, for
the most part, provided only generalizations in response to repeated requests by [the Service]
for more detail on prospective activities....Such generalizations do not satisfy us that [applicant]
qualifies for the exemption.” Peoples Prize v. Comm'r, T.C. Memo 2004-12 (2004).

Analysis

To satisfy the operational test under § 1.501(c)(3)-1(c)(1), an organization must establish that it
is operated exclusively for one or more exempt purposes. An organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it engages primarily in activities
that accomplish one or more of such exempt purposes specified in § 501(c)(3). Under the
operational test, the purpose towards which an organization's activities are directed, and not the
nature of the activities themselves, is ultimately dispositive of the organization’s right to be
classified as a § 501(c)(3) organization. B.S.W. Group, supra. Your activities are not directed
toward one or more exempt purposes.

Promotion of Health

The promotion of health has long been recognized as a charitable purpose under common law.
However, not every activity that generally promotes health furthers exclusively charitable
purposes under § 501(c)(3). For example, selling prescription pharmaceuticals promotes
health, but pharmacies cannot qualify for recognition of exemption under § 501(c)(3) on that
basis alone. Federation Pharmacy Services, Inc, supra. Nor does a hospital primarily further a
charitable purpose solely by offering health care services to the public in exchange for a fee.
See Rev. Rul. 69-545, supra. Rather, a hospital must be organized and operated primarily for
the benefit of the community, as evidenced by such factors as a board that represents the
community, operation of an emergency room, provision of charity care, medical training, or
medical research. For example, a health maintenance organization that is operated primarily for
the purpose of benefiting its paying subscribers does not qualify for exemption solely because


10

the community also derives health benefits from its activities. See Geisinger Health Plan, supra;
and IHC Health Plans, Inc., supra.

You do not provide healthcare services directly to patients, unlike the hospital in Rev. Rul. 69-

545. Your activities consist of the provision of management services, sharing of medical
equipment, and developing specialty lines of services.

While your activities are related to providing health care, providing management and consulting
services focusing on developing new and more lucrative lines of medical treatment does not
promote health or benefit the community in a charitable manner. While a hospital does not
primarily further a charitable purpose simply by offering health care services to the public in
exchange for a fee, similarly providing health care-related management and consulting services
and equipment sharing in a commercial manner does not further charitable purposes. See Rev.
Rul. 69-545, supra, Rev. Rul. 77-111, supra. Also, as the court noted in IHC Health Plans, Inc.,
supra at 1197:

In giving form to the community-benefit standard, we stress that ‘not every
activity that promotes health supports tax exemption under § 501(c)(3). For
example, selling prescription pharmaceuticals certainly promotes health, but
pharmacies cannot qualify for . . . exemption under § 501(c)(3) on that basis
alone.’ Rev. Rul. 98-15. In other words, engaging in an activity that promotes
health, standing alone, offers an insufficient indicium of an organization's
purpose. Numerous for-profit enterprises offer products or services that promote
health.

In several revenue rulings, the Internal Revenue Service concluded that an organization was
promoting health within the meaning of § 501(c)(3) even though it was not directly providing
medical care to patients because it improved the effectiveness of health care provided by
others. See Rev Rul. 77-69, supra; and Rev. Rul. 81-276, supra. However, the organizations in
these revenue rulings were created pursuant to federal statutes and worked closely with the
government to support its health care responsibilities. You were not established pursuant to
any federal statute and no government agency supports your activities, and as such you are not
like the organizations described in the above-referenced rulings.

In some instances, incentivizing physicians to practice in rural areas can promote the health of a
community. See Rev. Rul. 97-21, supra and Rev. Rul. 73-313, supra. However, the
organization in Situation 1 of Rev. Rul. 97-21 recruited a physician based on objective evidence
demonstrating for a need for a particular practice in the organization’s service area and
engaged in recruitment activity bearing a reasonable relationship to promoting and protecting
the health of the community in accordance with Rev. Rul. 69-545. You have not provided any
evidence indicating that your contemplated specialty services are needed in Hospital's
community. Also, you are unlike the charitable organization in Rev. Rul. 73-313 in two primary
ways. First, you were not formed to assist an isolated rural community without access to any
medical services. Prior to your involvement, Hospital received exemption under § 501(c)(3) on
Date, and you indicate it has operated continuously in the community since that time. Second,
there are multiple relationships between you and at least one of your board members and


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connected physicians. Attorney and Doctor have a family relationship, and you indicate that
Doctor will serve to develop Specialty at Hospital.

Therefore, although some of your activities may indirectly promote health in a general sense,
they do not primarily promote health in a charitable manner within the meaning of § 501(c)(3)
and § 1.501(c)(3)-1(d)(2).

Education

Furthering education is an exempt purpose within the meaning of § 501(c)(3). See

§ 1.501(c)(3)-1(d)(3). The regulations explain that the term “educational” in § 501(c)(3) includes
the instruction of the public on subjects useful to the individual and beneficial to the community.
See § 1.501(c)(3)-1(d)(3)(i).

While you state you plan to organize and conduct training and education for physicians, staff,
and third parties who will perform specialty procedures, these educational activities only benefit
your affiliated physicians for use in their private businesses and your management consulting
clients. You will not be providing educational services to individuals or to the community. Your
activities will not constitute instructing the public on subjects that are beneficial to the community
within the meaning of § 1.501(c)(3)-1(d)(3). Therefore, your primary activities do not further
education within the meaning of § 1.501(c)(3)-1(d)(3).

Combating Community Deterioration

Combating community deterioration is an exempt purpose within the meaning of § 501(c)(3).
See § 1.501(c)(3)-1(d)(2)(iv). Organizations combating community deterioration in a charitable
manner provide economic development activities in which the good received by the general
public outweighs the private benefit afforded to the beneficiaries.

Rev. Rul. 76-419, supra deals with an organization that purchases land in a blighted area and
converts it into an industrial park. Lots are leased at favorable rates to industrial tenants. These
enterprises are required to hire and train people from this economically depressed area. By
inducing industry to locate an economically depressed area and hire the unemployed, the
organization benefits the community.

Unlike the organization described in Rev. Rul. 76-419, supra, you are not created with the
specific intent to revitalize the neighboring areas and hiring and training people from the area.
You are intended to recruit specialty physicians from outside the area to bring them to Hospital
to expand the specialty lines at Hospital. Although you claim the activity will bring economic
benefit to the Hospital community, the economic benefits from the recruitment of the specialty
physicians to develop specialty services will primarily benefit the physicians themselves and
Hospital far more than the surrounding areas.

Rev. Rul. 77-111, supra demonstrates that even though an organization’s activities may
contribute to the achievement of charitable purposes the facts may show that the overall thrust
and end result would be the achievement of non-exempt purposes, the benefit of private
individuals or businesses. The organization was formed to increase business patronage in a


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deteriorated area by providing information about shopping opportunities is not operated for
charitable purposes. Increasing business patronage and reviving lagging sales are not
charitable purposes. Much like the organization described in Rev. Rul. 77-111, supra you are
primarily established to increase revenue for and Hospital and the specialty physicians.

Because the private benefits outweigh any charitable purposes, your primary activities do not
combat community deterioration within the meaning of § 1.501(c)(3)-1(d)(2)(iv).

Substantial Non-Exempt Purpose

An organization is operated exclusively for one or more exempt purposes only if it engages
primarily in activities which accomplish one or more of such exempt purposes specified in
§ 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its
activities is not in furtherance of an exempt purpose. See § 1.501(c)(3)-1(c)(1).

Providing services of an ordinary commercial nature, regardiess of whether the undertaking is
conducted on a nonprofit basis and is beneficial to the community, does not further a charitable
purpose, unless the service directly accomplishes a tax-exempt purpose. See Rev. Rul. 80-
287, supra. The sale of health-related goods and services (e.g., laboratory services,
pharmaceuticals, HMO services, consulting services) does not exclusively further charitable
purposes because such activities serve a substantial non-exempt, commercial purpose. See,
e.g., Federation Pharmacy Services, supra (sale of pharmaceuticals to senior citizens was
presumptively commercial, because such activity was normally pursued by commercial
enterprises); Rev. Rul. 85-110, supra (exempt hospital’s provision of laboratory testing services
to non-patients served non-charitable purposes).

You are established to provide fee-based consulting and management services to hospitals and
networks of healthcare providers. These types of services are commercial in nature rather than
charitable. Your activities of providing management, advisory, and consulting services in return
for a fee to member hospitals does not constitute an exempt activity. See B.S.W. Group, Inc.,

supra.

The activities you perform are more akin to those of a trade or business that is ordinarily carried
on by for-profit commercial organizations. In Airlie Foundation v. Commissioner, 283 F. Supp.
2d 58 (D.D.C. 2003) the court relied on the “commerciality” doctrine in determining whether an
organization was operated for exempt purposes. The Court in Airlie concluded that the
organization was operated for a non-exempt commercial purpose because of the commercial
manner in which the organization conducted its activities.

Like the organizations in Airlie and B.S.W. Group, you are not organized for an exempt purpose.
Rather, you are operated for a nonexempt commercial purpose; your management services
agreement recovers costs plus fees for the services rendered.

You are managed by your board of directors, several of whom have substantial ties to the
financial success of Hospital. In addition to facilitating the physician-led development of
specialty medical services, you will provide to Hospital and your other member organizations
services such as: management, administrative, and business services as necessary, provide or


13

finance medically related equipment as required by Hospital, assist Hospital with the
establishment and implementation of procedures, advise Hospital on contractual arrangements
with third parties, maintain and establish billings and collections policies for Hospital, and other
consulting services.

Thus, your activities are not inherently charitable but are more like activities carried on by for-
profit businesses, a factor that supports the commercial nature of your activities. See, e.g.,
Living Faith, Inc., supra (organization’s health food stores and restaurants were in competition
with for-profit organizations); and IHC Health Plans, supra (health plans resembled and
competed with commercial insurance providers). Because your primary activities are providing
consulting services in the manner of a commercial business (as nearly all of your activities are
focused on increasing revenues for your physicians and network members), your activities
serve a substantial non-exempt purpose under § 1.501(c)(3)-1(c)(1).

The provision of commercial services may serve primarily charitable purposes when those
services are provided exclusively to tax-exempt organizations, are an essential function of such
organizations, and are provided for a fee that is substantially below cost. See Rev. Rul. 71-529
(an organization that provides assistance in the management of participating colleges’ and
universities’ endowment or investment funds for a charge substantially below cost qualifies for
exemption under § 501(c)(3)), supra; and Rev. Rul. 72-369 (an organization that provides
managerial and consulting services at cost to unrelated exempt organizations does not qualify
for exemption under § 501(c)(3)), supra. While Hospital and other potential new members may
be exempt under § 501(c)(3), you are like the non-exempt organization in Rev. Rul. 72-369. In
fact, you require your members to pay cost plus an additional fee for your managerial and
consulting services.

Any charitable or educational benefits the public may derive from your consulting and
managerial services are merely incidental to your principal purpose of increasing your members’
revenue and benefiting your board of directors and specialty physicians. Thus, your activities
do not primarily further an exempt purpose. Therefore, you are not “operated exclusively” for
one more exempt purpose under § 501(c)(3). See § 1.501(c)(3)-1(c)(1) (an organization will not
be regarded as “operated exclusively” for one or more exempt purposes under § 501(c)(3) if
more than an insubstantial part of its activities is not in furtherance of an exempt purpose).
Better Business Bureau of Washington D.C., Inc., supra.

Private Benefit

Organizations seeking exemption under § 501(c)(3) must be organized and operated
exclusively for exempt purposes pursuant to § 1.501(c)(3)-1(a). An entity that is organized or
operated to serve private rather than public interests cannot be recognized as operating
exclusively for exempt purposes. See § 1.501(c)(3)-1(d)(1)(ii) and American Campaign
Academy, supra. The Tax Court explained that prohibited private benefits may include an
“advantage, profit, fruit, privilege, gain, or interest.” See American Campaign Academy, at
1065. In determining whether an organization’s activities confer an impermissible private
benefit, the court in American Campaign Academy, supra, looked to whether the beneficiaries of
the organization's activities are also the parties who founded, fund, and direct the organization.


14

Your proposed activities are presumably intended to promote the health through increased
member revenues, and by extension, increased revenues for you physician co-managers.
However, not every activity that promotes health supports tax exemption under § 501(c)(3); “an
institution for the promotion of health is not a charitable institution if it is privately owned and is
run for the profit of the owners.” 4A Austin W. Scott and William F. Fratcher, the Law of Trusts §
372.1 (4th ed. 1989). See also Restatement (Second) of Trusts, § 376 (1959). As currently
structured, your activities are primarily beneficial to your members’ physicians and co-managers
because you are focused on maximizing their collective revenue streams in their private
businesses. Although you assert that keeping your rural members’ medical centers as “locally
owned and operated,” your activities primarily benefit the physician co-managers by allowing
such individuals to develop specialty lines of practice with maximum profit as the end goal, not
ensuring sufficient medical treatment for the benefit of the entire community as contemplated by
Rev. Rul. 69-545. See also Harding Hospital, supra.

In addition, your board of directors is self-perpetuating and composed of five persons, many of
whom have personal and business relationships. Three of your directors have previous
business relationships and one, Doctor, stands to directly benefit from any additional revenues
brought in to Hospital. The fact that your board lacks public participation of any kind indicates
that you are operated for the benefit of your directors rather than the public. Because your
operations substantially benefit your directors, you have not demonstrated that your operations
serve a public rather than a private interest as required under § 1.501(c)(3)-1(d)(1)(ii). See also
Better Business Bureau of Washington D.C., Inc., supra, and Church by Mail, Inc., supra.

Inurement

Organizations seeking exemption under § 501(c)(3) are also subject to the inurement provision
contained in § 1.501(c)(3)-1(c)(2), which states that an organization is not operated exclusively
for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of
private shareholders or individuals (often referred to as “insiders”). The inurement proscription
applies to persons who because of their particular relationship with an organization have an
opportunity to control or influence its activities. You have on your board a physician, Doctor,
who works in Specialty at Hospital. One of your primary business models is that by the
development of specialty service lines at rural hospitals, you will derive more revenues for the
hospitals and participating physicians. These physicians are insiders because they are in a
position to have control over your activities through participation in and influence over the board
of directors and your activities.

The taxpayer must also demonstrate that it is organized and operated exclusively for exempt
purposes and that no part of its earnings inures to private individuals. You appear to operate for
the benefit of some of your officers and directors. Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii).. Your
primary purpose is providing managerial and consulting services for a fee for Hospital with the
goal of increasing its revenues, including revenues to your specialty physician co-managers,
including Doctor. In addition, you have provided conflicting information regarding your business
relationships with Attorney and Firm.

The burden is on the taxpayer to demonstrate that it is not organized or operated for the benefit
of private interests, such as designated individuals, the creator or his family, the shareholders of

15

the organizations, or persons controlled, directly or indirectly, by such private interests, and will
not allow its assets to inure to such private interests. Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii); see
also Church of Spiritual Technology, 18 Cl.Ct. at 250 (the applicant “must put into the record
sufficient materials to warrant the grant of tax exempt status.”); Bubbling Well Church of
Universal Love, 74 T.C. 531 (stating that an application for tax-exempt status “calls for open and
candid disclosure of all facts . . . 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 section
501(c)(3).”) Any gaps contained in the administrative record are resolved in favor of the
Service. New Dynamics Foundation, 70 Fed. Cl. at 802 (‘in initial qualification cases such as
this, gaps in the administrative record are resolved against the applicant’).

CONCLUSION:

Based on the information provided in your Form 1023 and supporting documentation, we
conclude that you are not operated exclusively for purposes described in § 501(c)(3).

Accordingly, you do not qualify for exemption as an organization described in § 501(c)(3) and
you must file federal income tax returns.

Contributions to you are not deductible under § 170.

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 § 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


16

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

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. If
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,

Karen Schiller
Acting Director, Rulings and Agreements