HOSPITAL JOINT VENTURES: New IRS Rules May Invalidate Most For- Profit/Not-for-Profit Partnerships
A 1998 IRS ruling on the tax-exempt status of joint ventures between hospitals of different tax status is forcing 177-bed Redlands Community Hospital, 60 miles east of Los Angeles, to reorganize the administration of its ambulatory surgery center. It may sound small-time, but don't be deceived: the new rules set a precedent that observers expect will have "broad-reaching impact on the industry." An article in this month's California Medicine sounds a note of caution: Because the ruling is retroactive, it applies to all existing joint ventures, a fact that stands to impact roughly 2,500 hospitals in the United States that operate approximately 10,000 joint ventures.
The Redlands Story
In 1990, like thousands of other not-for-profit hospitals seeking to prop themselves up in the face of increasing economic pressure, Redlands administrators forged an alliance with a local not-for-profit ambulatory surgery center. The two entities teamed up with Nashville-based Surgical Care Affiliates, a for-profit company specializing in facility management later purchased by Birmingham, AL-based HealthSouth. Redland successfully integrated the ambulatory surgery center into its continuum of services and put profits toward development of a free clinic -- an undertaking that hospital President and CEO Jim Holmes says is evidence of Redlands' commitment to charity care. But the IRS declined granting tax-exempt status to the center on grounds that its 50-50 governance structure "does not give charitable services priority over maximizing profits." As a result, Redlands claims it has spent nearly the same amount initially invested in the joint venture to restructure its terms for compliance with the IRS.
98-15's Charity Challenge
Ruling 98-15 offers guidance for hospitals seeking to structure a joint venture with a for-profit company while at the same time protecting their not-for-profit status. The ruling states that to achieve tax exemption, the non-profit entity must retain majority control over the joint venture's governing board, contract with an independent management company to supervise operations, and specify in governing documents that the venture's "tax-exempt interests override any fiduciary duty to maximize profits." Marcus Owens, director of the IRS exempt organizations division, says the ruling seeks to ensure that in "non- profit/for-profit partnerships, community health care needs take precedent over the private needs of doctors, investment bankers, and what have you by ensuring that the charity's assets are used appropriately through various control devices."
Consumer advocacy groups have welcomed the ruling. Linda Miller, president and executive director of Volunteer Trustees of Not- for-Profit Hospitals feels "these joint ventures are just a way for for-profits to scam the community, controlling a hospital institution by buying half an interest instead of 100 percent, while taking over the purse strings." Julio Mateo, an attorney with Consumers Union, said, "These joint ventures ... may not benefit the community and could create a private benefit." Not-for-profit hospitals like Redlands object, explaining their "inability to stay profitable and competitive" make such partnerships "an absolute necessity sometimes."
An End to Joint Ventures As We Know Them?
To date, the ruling has not found a single whole hospital joint venture that complies with 98-15. Observers suspect a less-than-equitable control split would not be of interest to most for-profit companies. Several joint ventures have recently collapsed in the wake of the IRS ruling and recent audits, as non-profits like Virginia's Arlington Health Foundation back out of partnerships for fear of jeopardizing tax exempt status. For-profits are also feeling the sting: Both Columbia/HCA and Tenet Healthcare Corp., the nation's largest for- profit providers, have lost prospective and existing joint ventures as a result of the ruling (8-9/99 issue).