The federal Taxpayer Relief Act of 1997 (the Act) contains several provisions of importance to tax-exempt health care organizations. Specifically, the Act affects tax-exempt bond financing for non-hospital activities, expands unrelated business income tax liability for certain payments from taxable subsidiaries, and provides a safe haven for certain payments from corporate sponsors.
A. $150 Million Bond Cap
Historically, tax-exempt organizations were prohibited from issuing tax-exempt bonds in excess of $150,000,000 where the bonds were issued for non-hospital purposes. In this context, "non-hospital purposes" include, for example, medical schools, nursing homes, day care centers, ambulatory care facilities, research laboratories and office buildings.
The cap can be troublesome when hospitals affiliate, since organizations under common management and control must be aggregated, and are subject to a single $150,000,000 cap. Two hospital systems, each with their own $150,000,000 cap, can wind up sharing one single cap, with the possible need to refinance outstanding debt on a taxable basis to come below the combined $150,000,000 cap.
The Act repeals the $150,000,000 cap, but only prospectively for bonds issued after the Act's enactment, August 5, 1997, provided that at least 95% of the new bond proceeds are used to finance capital expenditures incurred after that date. The $150,000,000 cap continues to apply to bonds outstanding at the time the Act was enacted, and to future refundings of those bonds.
B. Unrelated Business Income
Although tax-exempt health care organizations generally do not pay income tax on the profits they earn on their core activities, and generally do not pay income tax on their earnings from outside investments, they do pay tax on the unrelated business income (UBI) that they earn. In this context, payments of certain rents, interest, royalties, and annuities are taxable as UBI if they are received from a "controlled organization" to the extent that the payment reduces taxable income of the controlled organization. For this purpose, a controlled organization was historically defined as a subsidiary that had 80% or more of its stock owned directly by the tax-exempt organization.
To avoid paying tax, a tax-exempt organization would frequently structure the ownership of a subsidiary so that the tax-exempt parent would own 79% of the subsidiary, while another affiliate of the tax-exempt organization owned the other 21%. The Act closes this loophole by changing the control standard from 80% or more to a greater than 50% test. In addition, the Act applies the new control test to indirect, as well as direct, ownership or control. Generally, these changes are effective as of August 5, 1997.
C. Corporate Sponsorship Payments
Health care systems often have corporate sponsors for fundraising events and publications. The Internal Revenue Service has frequently taken the position that the payments from businesses in connection with the staging of certain events or issuance of certain publications constitute UBI, and are, therefore, taxable. The Act, however, creates, effective January 1, 1998, a safe harbor for soliciting or receiving "qualified sponsorship payments" that will not be treated as taxable UBI.
A qualified sponsorship payment is a payment from any person conducting a trade or business if there is no agreement or expectation of any substantial return benefit being provided to such person in exchange for the payment, other than the use or acknowledgement of the name or logo or product lines of such person's trade or business. The safe harbor is inapplicable if the payment is contingent upon the attendance level at the event or other factors relating to the degree of public exposure of the event.