Tax-exempt hospitals appear to be swinging back from the days of experimenting with for profit ventures that assumed managed care risk or operated physician practices. What are the tax consequences of liquidating these ventures and transferring the remaining assets to a tax-exempt hospital?
Internal Revenue Code (the Code) §337(a) provides, as a general rule, that no gain or loss is recognized to a subsidiary corporation on a liquidating distribution to a parent corporation that owns at least 80% (in value and voting power) of its stock provided that the distribution is in complete redemption of all of the subsidiary's stock and the transfer of all of its property occurs within a certain period of time. However, Code §337(b)(2) provides that the general rule does not apply where the parent is a tax-exempt organization and the subsidiary is a for-profit corporation.
Pursuant to Code §337(b)(2), where the parent is a tax-exempt organization, the for-profit subsidiary will recognize taxable income to the extent that the fair market value of its assets exceeds the tax basis of its assets unless, and to the extent that, the parent uses the property in an unrelated trade or business. (Special rules apply if the parent, after using the property for its exempt purposes, then uses the property in a taxable unrelated trade or business.)
On December 28, 1998, the Internal Revenue Service issued final Regulations under Code §337(d) which went into effect January 28, 1999. The Regulations affect for-profit corporations that transfer all or substantially all of their assets to an exempt entity, or convert from a taxable corporation to an exempt entity. In general, the Regulations require such a for-profit corporation to recognize gain or loss as if it had sold the assets at fair market value. (Special rules apply to certain tax-exempt organizations, and to some subsidiaries that were both taxable and tax-exempt during their histories.)
Tax-exempt entities that are closing down, or acquiring, taxable entities should be sensitive to these new Regulations.