Hospital district retained exemption and was reclassified as a governmental public charity

Plain-English summary

A hospital district had stopped directly operating a hospital after selling operating assets to a limited liability company and entering lease arrangements. The governing agreements reserved board appointments and approval rights to the district and required continued services for Medicaid and non-Medicaid indigent patients. The IRS concluded that maintaining and leasing the hospital property under those controls continued to serve exempt health-care purposes rather than a substantial private interest. It also found that the district was a political subdivision because state law gave it taxing and eminent-domain powers and public governance. The organization retained its section 501(c)(3) exemption, but its foundation classification changed to a governmental public charity described in sections 509(a)(1) and 170(b)(1)(A)(v).

Ruling snapshot

• Question: Does the hospital district remain exempt after leasing hospital facilities, and should it be classified as a governmental public charity?
• Outcome: exemption retained and foundation classification modified to sections 509(a)(1) and 170(b)(1)(A)(v)
• Key authorities: IRC §§ 170(b)(1)(A)(v), 501(c)(3), 509(a)(1); Treas. Reg. §§ 1.501(c)(3)-1, 1.103-1; Rev. Rul. 80-309; Rev. Rul. 98-15

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE/GE: EO Examination
1100 Commerce Street, MS 4920 DAL
Dallas, Texas 75242-1100

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: March 8, 2019

Number: 201933019
Release Date: 8/16/2019

Employer Identification Number:

Person to Contact/ID Number:

UIL: 501.03-00

Contact Numbers:
Voice:
Fax:

LAST DATE FOR FILING A PETITION
WITH THE TAX COURT:

CERTIFIED MAIL – RETURN RECEIPT REQUESTED

Dear                 :

This is a final determination regarding your foundation classification. This modifies our
letter dated September 19XX, in which we determined that you were an organization
described in section 509(a)(1) as described in section 170(b)(1)(A)(iii) of the Internal
Revenue Code(Code). We have modified your foundation status to that of an organization
described in section 509(a)(1) as described in section 170(b)(1)(A)(v) as a governmental
unit of the Code as a publicly supported organization, effective for tax years beginning
April 1, 20XX.

Your tax-exempt status under section 501(c)(3) of the Internal Revenue Code is not
affected. Grantors and contributors may rely on this determination, unless the Internal
Revenue Service publishes a notice to the contrary. Because this letter could help resolve
any questions about your private foundation status, please keep it with your permanent
records.

We previously provided you a report of examination explaining the proposed modification
of your tax-exempt status. At that time, we informed you of your right to contact the
Taxpayer Advocate, as well as your appeal rights. On November 15, 20XX, you signed
Form 6018, Consent to Proposed Action – Section 7428, in which you agreed to the
modification of your foundation classification to 509(a)(1) as described in section
170(b)(1)(A)(v) of the Code. This is a final determination letter with regards to your Federal
tax-exempt status under section 501(a) of the Code.

You are required to file Form 990, Return of Organization Exempt from Income Tax. Form
990 must be filed by the 15th day of the fifth month after the end of your annual accounting
periods. A penalty of $20 a day is charged when a return is filed late, unless there is a
reasonable cause for the delay; however, the maximum penalty charged cannot exceed
$10,000 or 5 percent of your gross receipts for the year whichever is less. In addition,
organizations with gross receipts exceeding $1,000,000 for any year will be charged a
penalty of $100 a day when a return is filed late; however, the maximum penalty charged
cannot exceed $50,000. These penalties may also be charged if a return is not complete,
so be sure your return is complete before you file it.

If you are subject to the tax on unrelated business income under section 511 of the Code,
you must also file an income tax return on Form 990-T, Exempt Organization Business
Income Tax Return.

If you decide to contest this determination in court, you must initiate a suit for a declaratory
judgment in the United States Tax Court, the United States Claims Court, or the District
Court of the United States for the District of Columbia before the 91st day after the date this
final determination letter was mailed to you. Contact the clerk of the appropriate court for
rules for initiating suits for declaratory judgment. You may write to the Tax Court at the
following address:

United States Tax Court,
400 Second Street
Washington, D.C. 20217

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS
that can help protect your rights. We can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If
you qualify for our assistance, which is always free, we will do everything possible to
help you. Visit [email protected] or call 1-877-777-4778.

If you have any questions, please call the contact person at the telephone number
shown in the heading of this letter.

Thank you for your cooperation.

Sincerely,

Maria Hooke
Director, Exempt Organizations Examinations

Department of the Treasury
Internal Revenue Service
Tax Exempt and Government Entities
Exempt Organizations Examinations
1100 Commerce Street
Dallas, TX 75242

Date: November 6, 2018

Taxpayer Identification Number:

Form:

Tax Year(s) Ended:

Person to Contact:

Employee ID:
Telephone:
Fax:
Address:

Manager's Contact Information:

Employee ID:
Telephone:
Response Due Date:

CERTIFIED MAIL – Return Receipt Requested

Dear                  :

Why you're receiving this letter
We enclosed a copy of our audit report, Form 886 A, Explanation of items, explaining that we
propose to modify your organization's foundation status under Internal Revenue Code (IRC)
Section 509(a).

Your exempt status under IRC Section 501(c)(3) is still in effect.

If you agree
If you haven't already, please sign the enclosed Form 6018, Consent to Proposed Action, and
return it to the contact person shown at the top of this letter. We’ll issue a final letter modifying
your foundation status.

If you disagree

1. Request a meeting or telephone conference with the manager shown at the top of this
letter.

2. Send any information you want us to consider.

3. File a protest with the IRS Appeals Office. If you request a meeting with the manager or
send additional information as stated in 1 and 2, above, you'll still be able to file a protest
with IRS Appeals Office after the meeting or after we consider the information.

The IRS Appeals Office is independent of the Exempt Organizations division and
resolves most disputes informally. If you file a protest, the auditing agent may ask you to
sign a consent to extend the period of limitations for assessing tax. This is to allow the
IRS Appeals Office enough time to consider your case. For your protest to be valid, it
must contain certain specific information, including a statement of the facts, applicable
law, and arguments in support of your position. For specific information needed for a
valid protest, refer to Publication 892, How to Appeal an IRS Determination on Tax-
Exempt Status.

Fast Track Mediation (FTM) referred to in Publication 3498, The Examination Process,
generally doesn’t apply now that we've issued this letter.

4. Request technical advice from the Office of Associate Chief Counsel (Tax Exempt
Government Entities) if you feel the issue hasn’t been addressed in published precedent
or has been treated inconsistently by the IRS.

If you're considering requesting technical advice, contact the person shown at the top of
this letter. If you disagree with the technical advice decision, you will be able to appeal
to the IRS Appeals Office, as explained above. A decision made in a technical advice
memorandum, however, generally is final and binding on Appeals.

If we don't hear from you
If you don't respond to this proposal within 30 calendar days from the date of this letter, we’ll
issue a final letter modifying your foundation status.

Contacting the Taxpayer Advocate Office is a taxpayer right
The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

Additional information
You can get any of the forms and publications mentioned in this letter by visiting our website at
www.irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676).

If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

Form 886-A
(Rev. January 1994)
EXPLANATIONS OF ITEMS

Name of taxpayer
Tax Identification Number
Year/Period ended
03/31/20XX

ISSUE

Issue 1: Whether the [redacted] current activities qualifies it for exemption under Section
501(c)(3)?

Issue 2: Whether the private foundation status of [redacted] (“[redacted]”) should be reclassified to a
publicly supported organization described in Internal Revenue Code Section 509(a)(1) as described in
Section 170(b)(1)(A)(v) of the Code?

FACTS

[redacted] (“[redacted]”) was granted exemption as and organization described under Section
501(c)(3) of the Code and defined in IRC Section 509(a) and 170(b)(1)(A)(ii) in September of 19XX.
The organization submitted a petition for creation of [redacted] issued the 22nd day of March
19XX. The petition to the State of [redacted] contained the following:

[1] The [redacted] shall upon creation, operation under Articles IX, Section 9, of the
Constitution.
[2] The name of the proposed hospital shall to be the “[redacted].”
[3] The boundaries of the hospital [redacted] shall be coextensive with the boundaries of the
[redacted] of [redacted].
[4] None of the territory in the proposed [redacted] is included in another hospital [redacted].

The following is from the [redacted].

CITATION TO LOCAL LAW

CITATION TO LOCAL LAW

An examination of [redacted] was initiated by the Internal Revenue Service (“Service”) on July 31, 20XX. During
the audit the Service discovered [redacted] operations changed. [redacted] no longer operates a hospital facility. In
20XX [redacted] sold certain assets and the operations of the hospital to a [redacted] Limited Liability Company wholly
owned by [redacted].

The following summary of facts was included in [redacted] annual audit conducted by
[redacted].

[redacted], (the “[redacted]”), located in [redacted], is a political subdivision created
and operating under the laws of the State of [redacted]. In accordance with [redacted]
a special election was held on March 6, 19XX in [redacted]
approving the creation of the special “[redacted].” The [redacted] is governed by a board of
directors elected by the citizens of [redacted].

Prior to the formation of the [redacted], [redacted] (the “Hospital”), a not-for-profit
corporation, owned the hospital operations, equipment, and facilities. Effective October 1, 19XX, the
[redacted] and the Hospital entered into a hospital sublease and transfer of operations agreement.
Under this agreement, the Hospital transferred certain assets and operations and subleased the
facility and equipment to the [redacted]. The lease was a 0 year lease with a five year extension option.
At the end of the original terms, the lease will automatically renew on a year-to-year basis upon the
same terms and conditions unless a written notice of termination is given to the other party at least 0
days prior to termination.

Effective December 31, 20XX, the [redacted] sold certain assets and the operations of
[redacted] ([redacted]) to [redacted] ([redacted]), a Limited Liability Company wholly owned by
[redacted]. The [redacted] remains as a taxing [redacted] with property taxes levied on real property within the
[redacted]. The [redacted] also receives sales tax revenues.

Arrangements with [redacted] - A zero year sublease agreement with [redacted]
became effective in December 20XX. Under the terms of the agreement, [redacted] will sublease the
building and land from the [redacted] for $0 per quarter. The sublease is subject to one renewal option of
three years.

Effective February 1, 20XX, an amendment to the sublease agreement was entered into. Under the
amendment, the rent payments were increased to $0 per quarter. The lease term under the original
sublease agreement remains the same.

Effective August 20XX, the [redacted] entered into another lease agreement with [redacted] for the use
and operation of the [redacted] for $0 per month for 0 years. The lease is subject to zero
renewal options of five years.

If the [redacted] terminates this arrangement, the hospital's operations could be transferred back to the
[redacted], along with the possible liability of the [redacted] to reimburse [redacted] for certain expenditures.
As of March 31, 20XX, no such termination has been made by the [redacted].

The [redacted] has committed to provide funding for certain Medicaid and non-Medicaid indigent care to
support the care of qualifying patients through the [redacted]. Under this program,
[redacted].

[redacted] provide a copy of the ASSET PURCHASE AND ASSUMPTION AGREEMENT entered into with
[redacted] which provided the following:

THIS ASSET PURCHASE AND ASSUMPTION AGREEMENT ("Agreement") is executed as of the 28th
day of September, 20XX, to be effective the 11 day of December ("Execution Date"), by and between
[redacted], a limited liability company wholly owned by [redacted] ("Buyer"), and
[redacted], a political subdivision of the State of [redacted] ("Seller").

5.7.1 Hospital Governance. Buyer shall establish a board of [redacted] directors to oversee the
operations of the Hospital ("Hospital Board"). Seller may appoint three members of the Hospital
Board, which members shall reside within the [redacted]. At Seller's discretion, the
Hospital Board members may be members of Seller's board. Buyer may appoint one member of its
choosing to the Hospital Board, and the chief executive officer of the Hospital shall serve as a
Hospital Board member. Certain actions, as set forth below, will require the approval of at least four
of the Hospital Board members:

(i) Appointment or termination of the chief executive officer;

(ii) Approval of the Hospital budget and strategic plan;

(iii) Authorization to incur indebtedness in excess of $0; and

(iv) Authorization to purchase or sell equipment with a value in excess of $0.

5.7.3 Buyer shall provide hospital services to Medicaid patients and shall provide "Services" to "Non-
Medicaid Indigent" patients at all times it operates the Hospital, where: "Services" shall include the
following basic health care services: primary and preventative services designed to meet the needs of
the community, including:(A) immunizations; (B) medical screening services; and (C) annual physical
examinations; inpatient and outpatient hospital services; rural health clinics; laboratory and X-ray
services; family planning services; physician services; payment for not more than three prescription
drugs a skilled nursing facility services, regardless of the patient's age and (b) "Non-Medicaid Indigent"
patients shall mean patients who are residents of [redacted] with resources not exceeding $0 (or
$0 if an aged or disabled person is in the household), whose countable monthly income does not
exceed 0% of the Federal Poverty Index Guidelines as now existing or amended in the future, and who
are not eligible for healthcare services from private health insurance or federal or state assistance
programs.

5.7.4 Buyer shall make available to Seller upon its request records documenting the amount of care
and other community benefits Buyer provides to residents of the [redacted] community.

5.7.5 Buyer hereby grants Seller a right of first refusal to repurchase the Hospital and Buyer's leasehold
interest in the Lease Property at fair market value in the event Buyer determines it will sell, assign,
lease or transfer its leasehold interest in the Hospital; provided, however, this right of first refusal shall
not apply in the event of any change in the ownership of Buyer's parent [redacted].
Upon receipt of a bona fide offer from a third party to acquire ownership or operation of the Hospital
from Buyer ("Offer"), Buyer shall notify Seller of the Offer, and Seller shall have thirty days after its
receipt of such notice to notify Buyer in writing as to whether it desires to exercise its rights under this
Section. If Seller elects to acquire the Hospital pursuant to this Section, it shall do so on terms no less
favorable to Buyer than those set forth on the Offer, and the parties shall negotiate in good faith any
terms not set forth in the Offer. In the event Buyer does not receive notice from Seller within thirty days
after Seller's receipt of the Offer, or in the event Seller notifies Buyer that Seller does not desire to
acquire the Hospital under this Section, then Buyer may accept the Offer and sell the Hospital to the
third party. Nothing in this Section shall waive any requirement in the Operating Lease for the consent
of Seller to such a transaction.

LAW

Issue 1

Section 1.501(c)(3)-1(a)(1) of the regulations states that, in order to be exempt as an organization
described in section 501(c)(3) of the Code, an organization must be both organized and operated
exclusively for one or more of the purposes specified in such 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(c)(1) of the regulations provides that an organization will not be regarded as operated
exclusively for exempt purposes if more than an insubstantial part of its activities is not in furtherance of
exempt purposes.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations 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. Thus, it
is necessary for an organization to establish that it is not organized and 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) of the regulations provides that the term "charitable" is used in section
501(c)(3) of the Code in its generally accepted legal sense and includes the relief of the poor and
distressed or of the underprivileged as well as the advancement of education.

Section 1.501(c)(3)-1(e)(1) of the regulations provides that an organization may meet the requirements of
section 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 purposes of carrying on an unrelated trade
or business.

In Better Business Bureau Washington D. C, Inc. v. United States, 326 U.S. 279 (1945), the Supreme Court
held that the presence of a single nonexempt purpose, if substantial in nature, will destroy the exemption
regardless of the number or importance of truly exempt purposes. The Court found that the trade
association had an "underlying commercial motive" that distinguished its educational program from that
carried out by a university. An organization is not operated exclusively for charitable purposes, and thus will
not qualify for exemption under section 501(c)(3), if it has a single noncharitable purpose that is substantial
in nature. This is true regardless of the number or importance of the organization's charitable purposes.
See Stevens Bros. Foundation, Inc., v. Commissioner, 324 F2d 633 (8th Cir. 1963), affd. 39 TC 93 (1962),
cert. denied, 376 US 969 (1964). Operating for the benefit of private parties who are not members of a
charitable class constitutes such a substantial nonexempt purpose.

Rev. Rul. 76-152, 1976-1 CB 151. If the private benefit is only incidental to the exempt purposes served,
and not substantial, it will not result in a loss of exempt status. See St. Louis Union Trust Co. v. United
States, 374 F2d 427 (8th Cir. 1967). If an activity serves both exempt and nonexempt purposes, the
organization will be exempt only if the predominant motivation underlying the activity is an exempt purpose.
A private benefit is considered incidental only if it is incidental in both a qualitative and a quantitative sense.
In order to be incidental in a qualitative sense, the benefit must of necessity coexist with the activity which
benefits the public at large.

Rev. Rul. 80-309, 1980-2 CB 183, January 1, 1980, a nonprofit organization was created to construct,
maintain, and operate or lease a public hospital and related facilities for the benefit of a city and
surrounding communities is operated exclusively for charitable purposes and qualifies for exemption under
IRC section 501(c)(3). After construction of these facilities, the organization’s only activity was to lease
facilities to an association exempt under IRC 501(c)(3). The lessee operates the facilities and pays as
consideration an amount sufficient only to retire the organization's indebtedness incurred to finance the
hospital and meet the organization's administrative expenses. The organization's income is derived from
lease payments and disbursements are made for administrative expenses and retirement of indebtedness.

Rev. Rul. 73-313 provides that an organization formed and supported by residents of an isolated rural
community to provide medical building and facilities at reasonable rent to attract a doctor who would
provide medical services to the entire community is exempt under section 501(c)(3). The circumstances in
this case reveal the following facts particularly relevant to the determination of whether the devotion of
resources to the provision of a physical facility for medical practice in the manner described qualifies as a
charitable use: The community was totally lacking in local medical service, and the isolation of the
community was such that the lack of such services posed a real and substantial threat to the health and
safety of the community. The lack of adequate facilities for the conduct of a medical practice in the
community was shown to be a significant factor in the inability of civic leaders of the community to induce a
doctor to locate in the community. Providing the physical facility in the manner described bears a clear
relationship to lessening of the health hazards resulting from the absence of a local practitioner in the
community. The terms of the arrangement entered to induce the doctor to locate his practice in the locality
bear a reasonable relationship to promotion and protection of the health of the community. The
arrangements in question were completely at arm's length, with no relationship between any person
connected with the organization and operation of the organization and the medical practitioner induced to
locate in the community.

Rev. Rul. 69-545 compares two hospitals. Hospital I is controlled by a board of trustees composed of
independent civic leaders; maintains an open medical staff; operates a full-time emergency room open to
all regardless of ability to pay; otherwise admits all patients able to pay; and uses surplus funds to improve
the quality of patient care, expand facilities, and advance is medical training, education and research
programs. Hospital 2 is controlled by physicians who have a substantial economic interest in the hospital,
restricts the number of physicians admitted to the medical staff, enters into favorable rental agreements
with 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 concludes that Hospital I is exempt, while the Hospital 2 is not, and notes that the fact
that Hospital I operates at an annual surplus of receipts over disbursements does not preclude its
exemption. By using its surplus funds to improve the quality of patient care, expand its facilities, and
advance its medical training, education, and research programs, the hospital is operating in furtherance of
its exempt purposes. Furthermore, Hospital I is operated to serve a public rather than a private interest.
Control of the hospital rests with its board of trustees which is composed of independent civic leaders.

Rev. Rul. 98-15 provides examples illustrating whether nonprofit hospitals that participate in joint ventures
with for-profit entities continue to qualify for exemption as organizations described in IRC 501(c)(3).

In Situation I, A is an IRC 501(c)(3) corporation that owns and operates an acute care hospital and B is a
for-profit corporation that owns and operates a number of hospitals. A concludes that it could better serve
its community if it obtained additional funding. B is interested in providing financing for A's hospital,
provided it earns a reasonable rate of return. A and B form a limited liability company, C. A contributes all
of its operating assets, including its hospital to C. B also contributes assets to C. In return, A and B receive
ownership interests in C proportional and equal in value to their respective contributions. C's Articles of
Organization and Operating Agreement ("governing documents") provide that C is to be managed by a
governing board consisting of three individuals chosen by A and two individuals chosen by B. The
governing documents further provide that they may only be amended with the approval of both owners and
that a majority of three board members must approve certain major decisions relating to C's operation,
including, decisions relating to any of the following topics: A. C's annual capital and operating budgets;

8. Distributions of C's earnings;

Rev. Rul. 98-15 cites a number of court cases in analyzing the Situations I and 2. In Broadway Theatre
League of Lynchburg, Virginia. Inc. v. U.S. 293 F. Supp. [illegible] (W.D.Va.1968) ("Broadway Theatre
League"), the court held that an organization that promoted an interest in theatrical arts did not jeopardize
its exempt status when it hired a booking organization to arrange for a series of theatrical performances,
promote the series and sell season tickets to the series because the contract was for a reasonable term
and provided for reasonable compensation and the organization retain ultimate authority over the activities
being managed.

In est of Hawaii v. Commissioner, 71 T.C. 1067 (1979), affd in unpublished opinion 647 F.2d 170 [illegible]
("est of Hawaii"), several for-profit est organizations (Note: "est" stands for Erhard Seminars
Training) exerted significant indirect control over est of Hawaii, a non-profit entity, through contractual
arrangements. The Tax Court concluded that the for-profits were able to use the non-profit as an
"instrument" to further their for-profit purposes. Neither the fact that the for-profits lacked structural control
over the organization nor the fact that amounts paid to the for-profit organizations under the contracts were
reasonable affected the court's conclusion. Consequently, est of Hawaii did not qualify as an organization
described in IRC 501(c)(3).

In Harding Hospital, Inc. v. United States, 505 F.2d 1068 (6th Cir 1974) ("Harding"), a non-profit hospital
with an independent board of directors executed a contract with a medical partnership composed on seven
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 held that the benefits derived from the contract constituted
sufficient private benefit to preclude exemption.

Rev. Rul. 98-15 provides that an IRC 501(c)(3) organization may enter into a management contract with a
private party giving that party authority to conduct activities on behalf of the organization and direct the use
of the organization's assets provided that the organization retains ultimate authority over the assets and
activities being managed (emphasis added) and the terms and conditions of the contract are reasonable,
including reasonable compensation and a reasonable term. See Broadway Theatre League. However, if
the private party is allowed to control or use the nonprofit organization's activities and assets for the benefit
of the private party, and the benefit is not incidental to the accomplishment of exempt purposes, the
organization will fail to be organized and operated exclusively for exempt purposes. See est of Hawaii:
Harding; section 1.501(c)(3)-1(c)(1); and section 1.501(c)(3)-1(d)(1)(ii).

In its analysis of Situation 1, Rev. Rul. 98-15 states that the governing documents of C commits C to
providing health care services for the benefit of the community as a whole and to give charitable purposes
priority over maximizing profits for Cs owners. Furthermore, through A's appointment of members of the
community familiar with the hospital to Cs board, the board's structure, which gives A's appointees voting
control, and the specifically enunciated powers of the board over changes in activities, disposition of
assets, and renewal of the management agreement, A can ensure that the assets its owns through C and
the activities it conducts through C are used primarily to further exempt purposes.

With respect to Situation 2, Rev. Rul. 98-15 concludes that in absence of a binding obligation in F's
governing documents for F to serve charitable purposes or otherwise provide its services to the community
as a whole, F will be able to deny care to segments of the community, such as indigent. Because D will
share control of F with E, D will not be able to initiate programs within to serve new health needs within the
community without the agreement of at least one governing board member appointed by E. As a business
enterprise, E will not necessarily give priority to the health needs of the community over the consequences
for F's profits. The primary source of information for board members appointed by D will be its chief
executives, who have a prior relationship with E and the management company, which is a subsidiary of E.
The management company itself will have broad discretion over F's activities and assets that may not
always be under the board1s supervision. For example, the management company is permitted to enter
into all but “unusually large" contracts without board approval. Thus, D will fail the operational test when it
forms F, contributes its operating assets to F, and then serves as an owner to F.

Rev. Rul. 98-15 holds that A will continue to qualify as an organization described in IRC section 501(c)(3)
because it has established that it will be operating exclusively for charitable purpose and only incidentally
for the purpose of benefiting the private interests of B. Conversely, D will violate the requirements to be an
organization described in IRC section 501(c)(3) when it forms F and contributes all of its operating assets
to F because D has failed to establish that it will be operated exclusively for exempt purposes.

Issue 2

Section 170(a), subject to certain limitations, allows as a deduction any charitable contribution (as defined
in Section 170(c)) payment of which is made within the taxable year.

Section 170(c)(1) of the Code states that the term “charitable contribution” includes a contribution or gift to
or for the use of a State, a possession of the United States, any political subdivision of a State or a
possession of the United States, the United States, or the District of Columbia, but only if the contribution is
made for exclusively public purposes.

For example, Rev. Rul. 79-323, 1979-2 C.B. 106, holds that gifts to an industrial commission established by
a state legislature for exclusively public purposes are deductible under § 170(c)(1). Rev. Rul. 69-90, 1969-1
C.B. 63, holds that voluntary payments by merchants and property owners to a city to be used to provide
unrestricted public parking facilities in the general area of the business and properties of the contributors
are charitable contributions as defined in § 170(c)(1).

Section 103(a) provides, in part, that except as provided in subsection (b), gross income does not include
interest on any state or local bond. Section 103(c)(1) provides that the term “state or local bond” means an
obligation of a state or political subdivision thereof.

Section 1.103-1(b) of the Income Tax Regulations provides that the term “political subdivision” denotes any
division of any state or local governmental unit that is a municipal corporation or that has been delegated
the right to exercise part of the sovereign power of the unit. As thus defined, a political subdivision of any
state or local governmental unit may or may not, for purposes of this section, include special assessment
[redacted] so created, such as road, water, sewer, gas, light, reclamation, drainage, irrigation, levee, school,
harbor, port improvement, and similar [redacted] and divisions of these units.

Rev. Rul. 78-276, 1978-2 C.B. 256, states that the term “political subdivision” has been defined consistently
for all federal tax purposes as denoting either (1) a division of a state or local government that is a
municipal corporation, or (2) a division of such state or local government that has been delegated the right
to exercise sovereign power. The three generally acknowledged sovereign powers are the power to tax, the
power of eminent domain, and the police power.

See Commissioner v. Estate of Shamberg, 3 T.C. 131 (1944), acq., 1945 C.B. 6, affd 144 F.2d 998 (2d Cir.
1944), cert denied, 323 U.S. 792 (1945). It is not necessary that all three sovereign powers enumerated in
Shamberg be delegated. See Rev. Rul. 77-164, 1977-1 C.B. 20. However, possession of only an
insubstantial amount of any or all sovereign powers is not sufficient. In determining whether an entity is a
division of a state or local governmental unit, important considerations are the extent that the entity is (1)
controlled by the state or local government unit, and (2) motivated by a wholly public purpose. Rev. Rul. 83-
131, 1983-2 C.B. 184.

TAXPAYER’S POSITION

The taxpayer’s position is being solicited at this time.

GOVERNMENT’S POSITION

Issue 1

[redacted], (the “[redacted]”), located in [redacted], is a political subdivision created and
operating under the laws of the State of [redacted]. In accordance with [redacted]
a special election was held on March 6, 19XX in [redacted] approving the
creation of the special “[redacted].” The [redacted] is governed by a board of directors elected by
the citizens of [redacted].

Prior to the formation of the [redacted], [redacted] (the “Hospital”), a not-for-profit
corporation, owned the hospital operations, equipment, and facilities. Effective October 1, 19XX, the
[redacted] and the Hospital entered into a hospital sublease and transfer of operations agreement. Under this
agreement, the Hospital transferred certain assets and operations and subleased the facility and equipment
to the [redacted]. The lease was a 0 year lease with a five year extension option. At the end of the original
terms, the lease will automatically renew on a year-to-year basis upon the same terms and conditions
unless a written notice of termination is given to the other party at least 0 days prior to termination.

During the audit conducted in 20XX the Service discovered a change in [redacted] activities occurred in 20XX.
On December 31, 20XX, the [redacted] sold certain assets and the operations of [redacted] ([redacted]) to
[redacted] ([redacted]), a Limited Liability Company wholly owned by [redacted]. The
[redacted] remains as a taxing [redacted] with property taxes levied on real property within the [redacted]. The
[redacted] also receives sales tax revenues.

Under the original agreement [redacted] subleased the building and land from the [redacted] for $0 per quarter.
The sublease is subject to one renewal option of three years. On February 1, 20XX, an amendment to the
sublease agreement was entered into with the rent payments increased to $0 per quarter. The lease term
under the original sublease agreement remains the same.

Effective August 20XX, the [redacted] entered into another lease agreement with [redacted] for the use and
operation of the [redacted] for $0 per month for 0 years. The lease is subject to three renewal
options of five years. If the [redacted] terminates this arrangement, the hospital's operations could be
transferred back to the [redacted], along with the possible liability of the [redacted] to reimburse [redacted] for
certain expenditures. As of March 31, 20XX, no such termination has been made by the [redacted].

The [redacted] has committed to provide funding for certain Medicaid and non-Medicaid indigent care to
support the care of qualifying patients through the [redacted]. Under this program,
[redacted].

The contract between [redacted] and [redacted] can serve exempt purposes by maintaining land, building and
equipment of a hospital to ensure it would continue to be available to the public in a rural community.
Maintaining and leasing medical facilities via a lease to an individual or entity to provide medical care in a
rural community under certain circumstances can be considered to constitute exempt purposes.

The asset purchase and assumption agreement states [redacted] shall establish a board of [redacted] directors
to oversee the operations of the Hospital ("Hospital Board"). Seller may appoint three members of the
Hospital Board, which members shall reside within the [redacted]. At Seller's discretion, the
Hospital Board members may be members of Seller’s board. Buyer may appoint one member of its
choosing to the Hospital Board, and the chief executive officer of the Hospital shall serve as a Hospital
Board member. Certain actions, as set forth below, will require the approval of at least four of the Hospital
Board members: (i) Appointment or termination of the chief executive officer; (ii) Approval of the Hospital
budget and strategic plan; (iii) Authorization to incur indebtedness in excess of $0; and (iv) Authorization to
purchase or sell equipment with a value in excess of $0.

The asset purchase and assumption agreement states [redacted] shall provide hospital services to
Medicaid patients and shall provide "Services" to "Non-Medicaid Indigent" patients at all times it operates
the Hospital, where: "Services" shall include the following basic health care services: primary and
preventative services designed to meet the needs of the community, including: (A) immunizations;
(B)medical screening services; and (C) annual physical examinations; inpatient and outpatient hospital
services; rural health clinics; laboratory and X-ray services; family planning services; physician services;
payment for not more than three prescription drugs a skilled nursing facility services, regardless of the
patient's age and (b) "Non-Medicaid Indigent" patients shall mean patients who are residents of [redacted]
with resources not exceeding $0 (or $0 if an aged or disabled person is in the household), whose countable
monthly income does not exceed 0% of the Federal Poverty Index Guidelines as now existing or amended
in the future, and who are not eligible for healthcare services from private health insurance or federal or
state assistance programs. In addition, [redacted] shall make available to Seller upon its request records
documenting the amount of care and other community benefits Buyer provides to residents of the
community.

The facts are similar to the revenue rulings and court decisions cited above for determining whether a
hospital functions in an exempt manner is control over the operation for exempt purposes. [redacted] has
demonstrated control over the operations of the hospital assets and within its lease arrangement with
[redacted]. The agreement between [redacted] and [redacted] states the hospital shall provide services to Medicaid
patients and shall provide "Services" to "Non-Medicaid Indigent" patients at all times it operates the
Hospital.

[redacted] has operated similar to like the hospital situation in Revenue Ruling 80-309, where the organization
leased the facilities to a for-profit corporation rather than to another non-profit corporation.

Issue 2

The petition creating [redacted] states boundaries shall be coextensive with the boundaries of the
[redacted] of [redacted]. [redacted] was organized under the law of the State of [redacted] Articles IX, Section 9 of
the State Constitution. Upon its creation, [redacted] assumed full responsibility for the furnishing of medical and
hospital care of the indigent and needy persons residing in the Hospital [redacted].

Under the enabling legislation [redacted] may exercise the power of eminent domain to acquire a fee
simple or other interest in property located in [redacted] territory if the interest is necessary for the [redacted] to
exercise a right or authority conferred by this chapter. The [redacted] must exercise the power of eminent
domain in the manner provided by [redacted], except the [redacted] is not required to deposit
in the trial court money or a bond as provided by [redacted]. In a condemnation
proceeding brought by the [redacted], the [redacted] is not required to pay in advance or provide a bond or other
security for costs in the trial court.

The enabling legislation [redacted] may impose a tax on all property in the [redacted] subject to [redacted] taxation. The
tax may be used to pay indebtedness issued or assumed by the [redacted] and the maintenance and operating
expenses of the [redacted]. [redacted] shall be governed by a permanent board on nine directors to be elected form
the [redacted] at large.

The term “political subdivision” is not defined by the Internal Revenue Code. However, the term is defined
by section 1.103-1(b) of the Income Tax Regulations to include any division of a state or local
governmental unit that is a municipal corporation or has been delegated the right to exercise part of the
sovereign power of the unit.

In Commissioner v. Estate of Shamberg, 3 T.C. 131 (1944), acq., 1945 C.B. 6, aff'd 144 F.2d 998 (2nd
Cir.1944), cert. denied, 323 U.S. 792 (1944), the United States Tax Court said that three generally
acknowledged sovereign powers of states are the power to tax, the power of eminent domain, and the
police power. In Rev. Rul. 77-164, 1977-1 C.B. 20, the Internal Revenue Service concluded it is not
necessary that all the powers enumerated in Shamberg be delegated. However, possession of merely an
insubstantial amount of any or all of those powers is not sufficient for political subdivision status. All of the
facts and circumstances must be taken into consideration, including the public purposes of the entity and
its control by a government.

[redacted] was created to perform a significant public purpose. [redacted] has eminent domain power and has powers
to cause tax to be levied and bonds to be issued in its name. [redacted] is a political subdivision for purposes of
the federal income tax.

CONCLUSION

[redacted] continues to qualify for exemption under 501(c)(3) and should be reclassified as a public charity as
defined by IRC Section 509(a)(1) and 170(b)(1)(A)(v).