State university physician organization receives section 115 income exclusion

Plain-English summary

A state university and an integral state entity operating a teaching hospital combined several departmental foundations into one physician organization. The new corporation would provide clinical faculty and hospital medical staff, treat patients regardless of ability to pay, and support education, research, and public service. Its only shareholders were the university and state entity, its shares had no economic value or dividends, and dissolution assets could pass only to government or another section 115 organization. Physicians would receive reasonable fair-market-value compensation, which the IRS treated as incidental to the public benefit. The IRS ruled that the corporation performed an essential governmental function and that its income accrued to a state or political subdivision, making the income excludable under section 115(1).

Ruling snapshot

• Question: Is the income of a state-controlled integrated physician organization excluded because it performs essential governmental health and education functions?
• Outcome: Approved
• Key authorities: IRC § 115(1); Rev. Ruls. 77-261, 90-74

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201528010                                             Third Party Communication: None
Release Date: 7/10/2015                                       Date of Communication: Not Applicable
Index Number: 115.00-00, 115.03-00
                                                              Person To Contact:
------------------------------------------                    -----------------------------
--------------------------                                    ID No. ----------------
 -----------------------------------                          Telephone Number:
                                                              --------------------
                                                              Refer Reply To:
                                                              CC:TEGE:EOEG:EO
                                                              PLR-128238-14
                                                              Date:
                                                              January 20, 2015


Legend


Act                       = ---------------------------------------------------------------------------------------
Corporation               = ---------------------------------------------------------------------------------------
Hospital                  = ---------------------------------------------------------------------------------------
School                    = ---------------------------------------------------------------------------------------
State                     = ---------------------------------------------------------------------------------------
A                         = ---------------------------------------------------------------------------------------
B                         = ---------------------------------------------------------------------------------------
x                         = ---------------------------------------------------------------------------------------
y                         = ----------------------------

Dear ------------:

This letter responds to a letter from your authorized representative dated June 30, 2014,
and subsequent correspondence submitted on behalf of Corporation, requesting a ruling
that the Corporation’s income is excludable from gross income under Internal Revenue
Code (IRC) §115. Corporation represents the facts as follows.

FACTS

A is a State university.

B is an integral part of State. B owns and operates the Hospital, a teaching hospital. B
was established under the Act, which provides that provision of health care services is
an essential governmental function that protects and promotes the health and welfare of
the citizens of State. Additionally, the Act provides that the education of medical and
health science professionals and the performance of medical and related research are
essential to promote this essential governmental function.
PLR-128238-14                                  2

A operates the School. Different foundations conduct the business operations of each
of the School’s x departments. The foundations further A and B’s purposes by providing
the education and research faculty for A and the medical staff for the Hospital.

A, B, and the foundations determined that their respective missions in a changing
healthcare environment could be better served by combining the foundations into the
Corporation. Accordingly, A and B formed the Corporation to provide a more
strategically, financially, and clinically integrated clinical enterprise; to more effectively
sustain the public and charitable missions of A and B; and to unite and align the
interests of all physicians currently employed by the foundations into a single physician
organization. Like the foundations, the Corporation will provide an integrated faculty
group practice for the delivery of high quality, cost-effective, patient care. The
Corporation will provide the clinical faculty for the School and the medical staff for the
Hospital.

The Corporation’s principal activities will be providing clinical services to the Hospital’s
patients, regardless of their ability to pay, and facilitating and supporting A’s
educational, research, and public service missions. The Corporation will pay the
physicians’ salaries with respect to the provision of medical care to the Hospital’s
patients. Physician compensation will be reasonable and consistent with fair market
value.

The Corporation has two classes of common stock, neither of which has any pecuniary
value. Additionally, neither class will earn dividends. A holds y shares of one class,
and B holds y shares of another class. A and B are the only authorized shareholders;
no other organization, government entity, or natural person may be a shareholder.
Neither A nor B may sell or transfer shares without the approval of all shareholders and
the Corporation’s board of directors.

The Corporation may be dissolved only upon consent of both A and B. Upon
dissolution, any remaining assets will be paid to the State, to a political subdivision of
the State, or to an organization whose income is excluded from gross income under IRC
§115.

LAW AND ANALYSIS

IRC §115(1) provides that gross income does not include income derived from any
public utility or the exercise of any essential governmental function and accruing to a
state or any political subdivision thereof.

Rev. Rul. 77-261, 1977-2 C.B. 45, holds that income generated by an investment fund
that is established by a state to hold revenues in excess of the amounts needed to meet
current expenses is excludable from gross income under IRC §115(1), because such
investment constitutes an essential governmental function. The ruling explains that the
PLR-128238-14                                  3

statutory exclusion is intended to extend not to the income of a state or municipality
resulting from its own participation in activities, but rather to the income of an entity
engaged in the operation of a public utility or the performance of some governmental
function that accrues to either a state or political subdivision of a state. The ruling
points out that it may be assumed that Congress did not desire in any way to restrict a
state’s participation in enterprises that might be useful in carrying out projects that are
desirable from the standpoint of a state government and that are within the ambit of a
sovereign to conduct.

Rev. Rul. 90-74, 1990-2 C.B. 34, holds that the income of an organization formed,
funded, and operated by political subdivisions to pool various risks (e.g., casualty, public
liability, workers’ compensation, and employees’ health) is excludable from gross
income under IRC §115(1) because the organization is performing an essential
governmental function. The revenue ruling states that the income of such an
organization is excluded from gross income so long as private interests do not
participate in the organization or benefit more than incidentally from the organization.
The benefit to the employees of the insurance coverage obtained by the member
political subdivisions was deemed incidental to the public benefit.

A, a State university, and B, an integral part of the State, created the Corporation to
assist A and B in fulfilling their respective governmental purposes and to perform
services that would otherwise be performed by A or B. The Corporation is necessary to
integrate B’s obligation to provide health care services in the State and B’s obligation to
educate healthcare providers and scientists and conduct research in the State.
Specifically, the Corporation provides clinical services to the patients of B’s subsidiary,
the Hospital, regardless of the patients’ ability to pay. The Corporation also facilitates
and supports A’s educational, research, and public service missions. Engaging in such
activities constitutes the performance of an essential government function within the
meaning of IRC §115(1). See Rev. Rul. 90-74 and Rev. Rul. 77-261.

No private interests will participate in, or benefit from, the operation of Corporation other
than as providers of goods or services. The benefit to the physicians employed by the
Corporation is incidental to the public benefit. See Rev. Rul. 90-74.

In accordance with the Corporation’s Articles of Incorporation, in no event, including
dissolution, will the Corporation’s assets be distributed to, or revert to, any entity that is
not the State, a political subdivision of the State, or another entity the income of which is
excluded from its gross income by application of IRC §115.

Based solely on the facts and representations submitted by the Corporation, we
conclude that:
PLR-128238-14                                  4

       Because the income Corporation derives is from the exercise of an essential
       governmental function and will accrue to a state or a political subdivision thereof,
       the Corporation’s income is excludable from gross income under IRC §115(1).

This ruling is based on the representation that the Corporation intends to adopt certain
proposed changes to its Articles of Incorporation in a timely manner.

No opinion is expressed concerning the Federal tax consequences under any IRC
provision other than the one specifically cited above. In particular, no representation is
made that contributions or premiums paid on behalf of or benefits received by
employees, former employees, retirees, spouses, dependents or others will be tax-free.
This ruling concerns only the Federal tax treatment of Trust’s income and may not be
cited or relied upon as to any matter relating to the taxation of accident or health
contributions or benefits.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. IRC § 6110(k)(3) provides that
it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

The ruling contained in this letter is based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                           Sincerely,




                                           Casey Lothamer
                                           Senior Technician Reviewer
                                           Exempt Organizations
                                           (Tax Exempt & Government Entities)




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