Hospital charity lost exemption after selling its operations to for-profit buyers

Plain-English summary

A tax-exempt hospital organization stopped operating the hospital after the city that owned the facilities sold the hospital business and leased the facilities to for-profit buyers. The hospital business later changed hands again, while the former exempt organization remained listed in IRS records as a section 501(c)(3) organization. The IRS found no evidence that the exempt entity still existed as an operating charity or planned to resume exempt hospital activities. Its current chief executive agreed with revocation. The IRS revoked the exemption effective August 1 of the redacted year because the organization no longer met the operational test under section 501(c)(3).

Ruling snapshot

• Question: Does the former hospital organization continue to qualify for exemption under section 501(c)(3) after its hospital operations were acquired by for-profit entities?
• Outcome: revocation, because the exempt organization ceased operating for charitable purposes
• Key authorities: IRC §§ 501(c)(3), 170(b)(1)(A)(iii), 509(a)(1); Treas. Reg. § 1.501(c)(3)-1(a), (c); Community Education Foundation v. Commissioner, T.C. Memo. 2016-223

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201944012
Release Date: 11/1/2019
Date: June 5, 2019

UIL Code: 501.03-00

EIN:
Person to Contact:

Identification Number:
Telephone Number:

Fax:

CERTIFIED MAIL - Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT:

Dear                         :

This is a final determination that you do not qualify for exemption from Federal income tax under
Internal Revenue Code (the “Code”) section 501(a) as an organization described in Code
section 501(c)(3), effective August 1, 20XX. Your determination letter dated September 30,
19XX is revoked.

Our adverse determination as to your exempt status was made for the following reasons:

    Organizations described in I.R.C. § 501(c)(3) and exempt under section 501(a) must
    be both organized and operated exclusively for exempt purposes. You have not
    demonstrated that you are operated exclusively for charitable, educational, or other
    exempt purposes within the meaning of I.R.C. section 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. You have not established that you have operated
    exclusively for an exempt purpose.

As such, you failed to meet the requirements of I.R.C. § 501(c)(3) and Treasury Regulation §
1.501(c)(3)-1(a), in that you have not established that you were organized and operated
exclusively for exempt purposes and that no part of your earnings inured to the benefit of private
shareholders or individuals.

Contributions to your organization are no longer deductible under section 170 of the Internal
Revenue Code.

Organizations that are not exempt under section 501 generally are required to file federal
income tax returns and pay tax, where applicable. For further instructions, forms, and
information please visit www.irs.gov.

If you decide to contest this determination, you may file an action for declaratory judgment under
the provisions of section 7428 of the Code in one of the following three venues: 1) United States
Tax Court, 2) the United States Court of Federal Claims, or 3) the United States District Court for
the District of Columbia. A petition or complaint in one of these three courts must be filed within
90 days from the date this determination was mailed to you. Please contact the clerk of the
appropriate court for the rules for initiating suits for declaratory judgment. Please contact the
clerk of the appropriate court for rules and the appropriate forms for filing petitions for
declaratory judgment by referring to the enclosed Publication 892. You may write to the courts
at the following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

US Court of Federal Claims
717 Madison Place, NW
Washington, DC 20005

U. S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, DC 20001

Processing of income tax returns and assessments of any taxes due will not be delayed if you
file a petition for declaratory judgment under section 7428 of the Internal Revenue Code.

You may be eligible for help from the Taxpayer advocate Service (TAS). (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 1-877-777-
4778.

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.

Sincerely yours,

Maria Hooke
Director, EO Examinations

Enclosures:
Publication 892

Department of the Treasury
Internal Revenue Service
Tax Exempt and Government Entities
Exempt Organizations Examinations

Date: March 7, 2019

Taxpayer Identification Number:

Form:
990 Return
Tax Year(s) Ended:

Person to Contact:

Employee ID:
Telephone:
Fax:
Manager's Contact Information:

Employee ID:
Telephone:
Response Due Date:

April 8, 2019

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 revoke your tax-exempt status as an organization described in Internal Revenue
Code (IRC) Section 501(c)(3).

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 adverse letter
determining that you aren't an organization described in IRC Section 501(c)(3) for the periods
above.

After we issue the final adverse determination letter, we'll announce that your organization is no
longer eligible to receive tax deductible contributions under IRC Section 170.

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 adverse determination letter.

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.

For 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,

for Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

Form 886-A
(May 2017)
Department of the Treasury - Internal Revenue Service
Explanations of Items

Name of taxpayer Tax Identification Number (last 4 digits) Year/Period ended
6/30/20XX

ISSUE

Does the organization continue to qualify as an organization exempt from Federal income tax
under Section 501(c)(3) the Internal Revenue Code (IRC)?

FACTS

From information obtained in the initial interview with the CEO and records provided during the
audit,                         (                         ), is a 0-bed hospital in                         ,                         ,
serving the                         ,                         area with emergency, surgery, radiology, laboratory,
physical rehabilitation, acute care and swing bed services.

Information contained on the Form 1023 application for federal tax exemption under IRC section
501(c)(3) received April 13, 19XX, shows                         was initially formed August 1, 19XX, as
                         . The administrative file was requested with only limited information provided. The file did
show the application was forwarded to the IRS National Office, as the application involved issues
for which there was inadequate published precedent at that time. Service records show federal
tax exemption under IRC section 501(c)(3) was granted effective May 1, 19XX. The organization
was classified as a hospital within the meaning of IRC sections 509(a)(1) and 170(b)(1)(A)(iii).
Service records show                         is not required to file Form 990 returns because of its dual status as a
                         and an instrumentality of a governmental entity,
                         Authority (the “City”).

The City is the owner of the hospital building, 0 medical clinics, land, and operations (“hospital
business”). From the date the organization was formed until August 1, 20XX,                         conducted
exempt hospital activity as stated in its original Form 1023 application. Effective August 1, 20XX,
the City, as seller, entered into an Agreement to Purchase and Lease, with
                         (                         , the “buyer”) and                         (                         , “buyers parent”),
both for-profit entities, collectively the “Buyers.” The agreement, provides the City agrees to sell
all personal properties and assets in the use of hospital business, and will lease the hospital
facilities i.e. hospital building, 0 medical clinics, with the land, to the Buyers. In consideration for
the sale, the Buyers assumed liabilities and other contractual obligations of the hospital business.
The resulting new entity,                         d/b/a
(                         ), became the new owner of the hospital business under a new Federal employer
identification number.

Interview with the CEO revealed                         was subsequently acquired by                         (                         ) in
March 20XX and is now the current owner of the hospital business. The CEO of the hospital
indicated no changes to the operations/activities of the hospital have taken place as a result of the
acquisitions. The City continues to own the hospital facilities and continues to lease the hospital
facilities to                         .

                         CEO indicated during an interview, he was uncertain if a request for formal termination of
its IRC section 501(c)(3) tax exempt status had been filed with the Service after its acquisition by
                         , and subsequently by                         . However, he believes such a request has not been made.
Service records indicate                         continues to be recognized as tax exempt under IRC section
501(c)(3).

From information obtained during the audit,                         has effectively discontinued operating as an
IRC section 501(c)(3) organization, because it is no longer organized or operated for exempt
purposes. This is supported by the acquisition and control of the hospital by the newly formed,
non-exempt/for-profit entity                         , and subsequently by its current owner,                         . The newly
formed entity is not organized or operated for exempt purposes and therefore could not have
conducted any exempt activity since its acquisition.

LAW

Internal Revenue Code section 501(c)(3) provides for the exemption from Federal income tax of
corporations organized and operated exclusively for religious, charitable, literary, scientific, and
educational purposes; no part of the net earnings of which inures to any private shareholder or
individual.

Treasury Regulation 1.501(c)(3)-1(a)(1) provides in order to be exempt as an organization
described 501(c)(3) of the Code, the organization must be one that is both organized and
operated exclusively for one or more of the purposes specified in that section.

Treasury Regulations section 1.501(c)(3)-1(c)(1) states 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 section 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.

Treasury Regulations section 1.503(c)(3)-1(c)(2) states 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.

In Community Education Foundation v. Commissioner TC Memo. 2016-223, USTC, revocation of
an organization’s exemption was supported due to a long extended period of inactivity. The
organization did not meet the operational test in Treasury Regulations 1.501(c)(3)-1(c).

GOVERNMENT POSITION

It is clearly evident                         is an operating hospital facility. However, it is a newly formed entity and
does not have a 501(c)(3) determination letter in its current organizational and operational
structure. From the acquisition agreement it is evident the building continues to be owned by The
City, and is leased to the current owner. It follows that the former tax-exempt hospital (                         ), has
been inactive effective with its acquisition by                         and subsequently by its current owner,
                         . Any activity, governing officials, and employees are now part of the newly formed entity.
Currently there is no evidence                         continues to exist as a federally tax-exempt organization and
therefore is not engaged in exempt activity.

It is the government's position that the organization’s IRC section 501(c)(3) tax exemption should
be revoked as it is no longer organized or operated exclusively for the purposes described in IRC
section 501(c)(3).

The audit finds that when                         was acquired by the mentioned for-profit entities, it ceased to be
organized and operated in furtherance of tax-exempt purposes. The hospital CEO states there
are no future plans to operate as a 501(c)(3) exempt hospital.

As the hospital officials are no longer representing an exempt organization, they cannot request
termination under 501(c)(3), as such a request is required to come from the exempt organization,
which has become non-existent. Therefore, the 501(c)(3) tax exemption is recommended for
revocation as provided for in the Regulations.

TAXPAYER’S POSITION

The current hospital CEO has indicated agreement with revocation.

CONCLUSION

To qualify under IRC section 501(c)(3), an organization must be both “organized” and “operated”
exclusively for one or more purposes specified in that section. If the organization fails to meet
either the organizational test or the operational test, it is not exempt. (Regs. 1.501 (c)(3)-1(a)(1)).
The organizational test relates to the rules for governing an organization and the purposes stated
in its articles of organization. The operational test relates to the organization's activities.

                         has effectively discontinued operations as an IRC section 501(c)(3) organization because it
is no longer operated for exempt purposes, effective with the acquisition of                         by the non-
exempt (for-profit) entity.

As a result of the examination, the IRS has determined that                         has failed to operate for exempt
purposes described in IRC section 501(c)(3).                         ceased operations as a tax-exempt
organization and sold their “hospital business” assets. There is no expectation that                         will be
conducting any exempt activity in the future. Where it is evident that a 501(c)(3) organization is no
longer actively operating in furtherance of its exempt purpose, it cannot pass the operational test
and its tax-exempt status must be revoked.

Accordingly, it is proposed that the exemption from Federal income tax as an organization
described in IRC section 501(c)(3) be revoked effective August 1, 20XX.

Contributions to your organization are no longer deductible by donors under section 170(c)(2) of
the Code.

In accordance with this determination and should you operate in the future, you are required to file
any appropriate Federal income tax returns as required.

In accordance with the provisions of section 6104(c) of the Code a copy of this letter will be sent to
the appropriate State officials.

If you accept our findings, please sign and return the enclosed Form 6018, Consent to Proposed
Action - Section 7428.