Many transactions in the healthcare marketplace are between for-profits and tax-exempt 501(c)(3) organizations. The for-profit may view these transactions with trepidation if it is unfamiliar with the particular characteristics of tax-exempt organizations and their limitations. Understanding the more significant aspects of doing business with a tax-exempt organization can alleviate these fears.
Background
Any non-profit corporation or association can seek exemption from federal income taxes under Section 501 (c)(3) of the Internal Revenue Code. Benefits of tax exemption include:
Exemption from federal income taxation
Ability to receive tax deductible charitable contributions
Ability to access capital through tax-exempt bonds
How does an organization qualify for tax exemption? It must be organized and operated for charitable purposes and no assets or revenues can be used for the benefit of private individuals. Next, an application must be filed with the IRS.
Tax exempt organizations do not automatically qualify for exemptions from state income tax, sales tax, real estate tax and the like. State tax exemptions are decided under state law. However, qualification as a Section 501 (c)(3) is likely to be a factor. In order to get an exemption in Pennsylvania, for example, the organization must demonstrate that it is exempt from federal tax under Section 501 (c)(3) in addition to meeting many other criteria.
Unique Characteristics
Generally, a tax-exempt organization possesses several unique characteristics:
Assets are viewed as forever committed to its charitable purposes.
Profits or "excess revenues" may be realized but must be used to further its charitable purposes.
It is not "owned" by anyone. Any members who exercise corporate governance powers are not entitled to share in profits or receive a distribution upon sale or dissolution.
Board members typically serve without pay.
Individuals may not profit from their involvement. Reasonable compensation may be paid, but excess compensation is not permitted.
Participation in revenue-producing activities not related to its charitable purposes must be insubstantial, and the resulting revenues are subject to tax.
It can own for-profit subsidiary organizations.
Involvement in political activities should be severely limited.
It is typically subject to state oversight to ensure that its activities remain consistent with its charitable purposes.
Those having compensation arrangements with the organization are subject to excise taxes on any "excess benefit" received.
It files annual returns with the IRS which are subject to public inspection.
Transactions with a Tax-Exempt Organization
Generally, a tax-exempt organization may enter into a broad range of transactions with for-profit business entities, but wrinkles may occur.
Contracts
The most significant restriction is ensuring that the tax-exempt is treated fairly. This requirement is usually not a problem if the contract is negotiated at arm's length. However, concerns will be raised if it involves an entity having some insider relationship to the tax-exempt organization. For example, if a tax-exempt organization wished to enter into a contract with a firm owned by a member of its board of directors, extra care should be taken.
Many tax-exempt healthcare facilities are managed by a for-profit management company, and such arrangements can be successfully structured to minimize tax-exemption concerns. However, where tax-exempt financing is in place, extreme caution should be used to ensure that the tax-exempt status is not jeopardized.
Joint Ventures
Although regulatory waters become murky, a tax-exempt organization may enter into joint venture arrangements with for-profit business entities so long as the relationship furthers its charitable purposes and is commercially reasonable, negotiated at arm's length and consistent with fair market terms; and the transaction allows the organization to act exclusively in furtherance of its charitable purposes and does not cause it to be primarily engaged in an unrelated trade or business.
Sales Transactions
If for-profit entities are seeking to acquire tax-exempt facilities, the following items should be considered:
Net proceeds must be held by the 501(c) (3) organization for support of its charitable purposes. This is typically done as an endowment or trust fund.
No proceeds can be distributed to the tax-exempt organization’s members or directors. Rich golden handcuff or golden parachute type packages may be subject to significant excise taxes if they cannot be justified as reasonable, fair and consistent with fair market value.
Tax-exempt bonds will likely have to be defeased or otherwise dealt with at closing.
Advanced approval of the transaction from the state may have to be secured.
An IRS ruling that the sale will not jeopardize is tax exemption may be secured.
With proper planning and an appropriate understanding of the underlying unique rules, a for-profit business should not hesitate to pursue worthwhile transactions with tax-exempt organizations.
For more information, please contact mstadler@cohenlaw.com.
