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Section 501(a) of the Internal Revenue Code ("IRC" or the "Code") provides for tax exemption for organizations operated per Section 501(c)(3) exclusively in furtherance of charitable purposes. Under Revenue-Ruling 69 545,2 the promotion of health

(i.e., the direct operation of healthcare providers by providers that meet certain conditions) has long been considered a charitable purpose.3 In contrast and of note to healthcare organizations, providing management services is generally not considered a charitable activity.4

Income Tax Regulations issued under Section 501(c)(3) further define the contours of tax exemption and tax-exempt activity. Section 1.50l (c)(3)-1 (c)(l) of the Income Tax

Regulations provides that an organization will be regarded as operated exclusively for exempt purposes only if it engages primarily in activities that accomplish one or more of the purposes specified in section 501(c)(3) of the Code. In contrast, an organization will not be regarded as charitable if more than a nonsubstantial part of its activities is in furtherance of nonexempt purposes. For example, the Supreme Court in Better Business Bureau of Washington, DL., Inc. v. United States,5 held that a single, nonexempt purpose – if substantial in nature – destroys a claim for exemption.6

The Regulations, at Section 1.501(c)(3)-l(d)(l)(ii), further narrow the scope of Section 501(c)(3). Here, the regulations provide that an organization is not organized exclusively for exempt purposes unless it serves public rather than private interests. Specifically,

2 _{Rev. Rul. 69 545,1969 2 C.B. 177.} 3 _Id.

4 _Id.

5 _{Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945).} 6 _{Id. at 283.}

benefits may be received by private individuals provided those benefits are incidental quantitatively and qualitatively to exempt purposes being served.

These sections serve to frame issues such as will an ASC venture or management

relationship further charitable purposes or will it serve private interests? If the venture or relationship serves private interests, will the activity either be so substantial as to destroy the exemption of the participating entity or will the activity benefit “insiders” and be deemed to cause private inurement?

Section 1.501(c)(3)-l(e) of the Regulations permits an organization to engage in noncharitable trades and businesses. It states that an organization may qualify under Section 501(c)(3) even if 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 purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business.

Section 511 of the Code provides for taxes to be paid on the unrelated business income of tax-exempt organizations. “Unrelated business taxable income” is defined as the gross income derived from any unrelated trade or business within the meaning of Section 153. Section 513(a) of the Code defines the term “unrelated trade or business” as any trade or business the conduct of which is not substantially related to the performance of the purposes constituting the basis for its exemption under section 501 [eg., charitable health activities under Section 501(c)(3)].

Section 1.513 l(b) of the Income Tax Regulations provides that the term “trade or business” includes any activity carried on for the production of income from the performance of services.

Section 513(a)(2) of the Code excepts from the definition of “unrelated trade or business” a trade or business that, in the case of an organization described in Section 501(c)(3), is carried on primarily for the convenience of its patients.

Section 1.513-l(d)(l) of the regulations further provides that gross income derives from “unrelated trade or business,” within the meaning of section 513(a), if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. Section 1.513-1 (d) (2) then provides that to be "substantially related," the activity must have a causal relationship to the achievement of exempt purposes and it must contribute importantly to the accomplishment of those purposes.

Determinations per the unrelated business and trade regulations must be made as to whether a joint venture furthers exempt purposes or private purposes. If the relationship is deemed to further private purposes, income will be subject to Unrelated Business Income Tax ("UBIT").

Section 514 of the Code provides for the taxation (under Section 512 of the Code) of income from debt financed property. Section 514(b)(l)(A)(i) of the Code, however, provides that the definition of debt financed property does not include any property substantially all the use of which is substantially related to the exercise or performance by such organization of the charitable purposes constituting the basis for its exemption under Section 501.

From these Code sections and regulations, a number of observations can be made:

 Involvement in a venture in which the private benefits are not incidental to the public benefit can harm a participant entity's tax-exempt status.

 Involvement in a venture or relationship in which the net earnings of the tax- exempt entity "inure" to "insiders" can harm the tax-exempt status of an entity.  Involvement in a venture that does not contribute to tax-exempt purposes but is

not substantial in comparison to the tax-exempt entity's operations and which does not provide for improper or private benefit may not cause harm to the tax-exempt entity but will give rise to taxable income.

 Income from management services and lease revenues, if not substantial as compared to the entire issuance or operation and not creating substantial private benefit or private inurement, can lead to tax not cause a loss of tax-exempt status. In practice, the goal in representing a tax-exempt entity is to structure a joint venture or other activity such that it does not give rise to taxable income or harm tax-exempt status. However, if the activity is not structured to avoid taxable income, then the second goal is that the activity is not viewed as substantial in scope to the tax- exempt entity's operations as a whole, and that the activity or venture will not cause harm to the tax-exempt status of the organization. For example, if involvement in an ASC joint venture encompasses 60% of an entity's activities and that activity is not deemed to serve community purposes, tax- exemption would likely be lost at the hospital entity level.

To avoid the loss of tax-exempt status and the generation of UBIT, entities attempt to assure that the ventures cooperate with IRS guidance relative to joint ventures. In situations where the venture may not meet the UBIT guidelines and where revenue may be deemed "substantial to the tax-exempt entity," the tax-exempt entity may prefer to participate or hold its interest through a for-profit subsidiary. For-profit subsidiary issues are discussed below.