Magazine article The CPA Journal

Revenue Ruling 98-15: Operational Control Saves the Exemption

Magazine article The CPA Journal

Revenue Ruling 98-15: Operational Control Saves the Exemption

Article excerpt

The publication of Revenue Ruling 98-15 has provided longawaited guidance on the tax exemption issues associated with the formation of joint ventures between tax-exempt, nonprofit entities and forprofit companies. The critical, and henceforth largely unresolved, question is under what circumstances may the nonprofit participant retain its tax exemption? The ruling involves whole hospital joint ventures, but its principles are applicable to other comparable joint ventures. A whole hospital joint venture is one in which the tax-exempt partner contributes substantially all its assets to the joint venture in return for a joint venture interest. Meanwhile, the for-profit partner contributes assets and/or cash and receives a joint venture interest. The resulting joint venture operates the hospital, usually pursuant to a management contract with the for-profit partner.

The ruling provides guidance on exemption issues that arise by giving examples of fact patterns that will result in a safe harbor for the tax-exempt participant and by describing a set of facts that will cause a loss of the tax exemption. The instructive fact pattern areas follow:

1. The Safe Harbor. "A" (tax exempt) and "B" (for-profit) constitute a joint venture in the form of an LLC. Pursuant to section 301.7701-3(b) of the Procedure and Administrative Regulations, the LLC is treated as a partnership for tax purposes. A contributes all its assets and B contributes enough assets that each owns 50% percent of the LLC. The governing board consists of three members from A and two from B. The governing documents provide that the board members have a duty to operate the resulting LLC to further the charitable purposes of A. None of the directors, officers, or employees involved in the decision to form the joint venture received any promise of employment or other reward from the for-profit participant or the resulting LLC. The directors appointed by A have no conflicts of interest. Finally, A intends to use the distributions it receives from the LLC to fund grants to support activities that promote community health care.

2. The Loss of Exemption. "D" (tax-exempt) and FE" (forprofit) form an LLC that is structured on a 50/50 basis. The governing board is composed of three representatives from D and three from E. The consent of both parties is required to amend the governing documents. The LLC enters into a management contract with a management company that is an affiliate of E. …

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