An income tax exemption is available to certain entities that the state and/or federal governments want to promote economically. Federal income tax exemption is governed by 28 U.S.C. §501(c)(3), which provides, in pertinent part, that corporations organized and operated exclusively for charitable purposes are exempt from taxation. Factors taken into account when determining whether an organization truly has a charitable purpose include the type and purpose of the entity, its sources of income, its activities, as well as other factors
In the context of health care providers, tax exemption is generally provided to not-for-profit providers that have a charitable purpose. After a health care provider achieves tax-exempt status pursuant to 28 U.S.C. §501(c)(3), it may apply for tax-exempt status under state law as well. In most states, the typical entry point for achieving tax-exempt status is achieving the same status under federal law. This is not dispositive of the issue, however. Thus, there is often much discussion as to what the phrase “with a charitable purpose” means and what it means to be considered “charitable.”
The Internal Revenue Service (the “IRS”) has issued a few Revenue Rulings over the past few decades discussing the federal standard of what it means to be charitable. In 1956, the IRS issued Revenue Ruling 56-185 which set forth a Financial Ability Standard for determining whether a hospital was eligible for tax exemption. That standard listed several requirements for exemption, including that the organization is formally organized as a nonprofit charitable organization, it provides services to those not able to pay to the extent that it is financially able, it provides an open medical staff, and its net earnings cannot serve to the benefit of any private shareholder or individual. Generally, the Financial Ability Standard justifies tax-exemption for hospitals that offer relief to the poor.
Thirteen years later, the IRS issued Revenue Ruling 69-545, which set forth a new standard, known as the Community Benefit Standard. Under this standard, a hospital could achieve tax-exempt status if it promoted the health of a sufficiently broad class of persons such that it benefits the community. Revenue Ruling 69-545 further listed some examples of community benefits that a hospital might offer, including offering an emergency room; accepting Medicare and Medicaid; operating with an open medical staff; and applying funds back into the hospital to improve facilities, equipment and patient care. It is of significance that some courts have opined that not all of these characteristics are necessary for a hospital to achieve tax-exempt status. However, certain courts have also maintained that the presence of any single non-exempt purpose, if substantial in nature, will destroy the tax exemption, regardless of the number or importance of truly exempt purposes.
In the years following Revenue Ruling 69-545, courts were split as to whether that Revenue Ruling supplemented or replaced the earlier issued Revenue Ruling 56-185. The United States Supreme Court addressed this issue in 1976 in Simon v. Eastern Kentucky Welfare Rights Organization, 426 U.S. 26 (1976). In that case, the Supreme Court stated that the Community Benefit Standard replaced the requirements of the Financial Ability Standard set forth prior.
Of note is that in 1983, the IRS issued Revenue Ruling 83-157. That Revenue Ruling did not replace the Community Benefit Standard, but rather elaborated on it. It stated that a hospital did not need to have an operating emergency room open to all regardless of their abilities to pay, in order to achieve tax-exempt status.
Since the Community Benefit Standard was put in place in 1969, there have been numerous guidelines submitted by the IRS and cases interpreting that standard in connection with various factual circumstances. The IRS and U.S. Government are continuously looking at how hospitals are characterized as charitable. For now, however, one can research the wealth of cases on the subject in order to get an idea of how factors are weighed in different circumstances in order to achieve compliance with the Community Benefit Standard for purposes of achieving federal tax exemption.
Please note that this is only a brief overview of federal tax exemption for hospitals. It is not meant to provide any information regarding achieving tax-exempt status on the state level. Please contact VC Law Group at (858) 519-7333 or info@thevclawgroup.com with any questions.