Last year, the Internal Revenue Service (IRS) issued Private Letter Ruling 200716034. That Ruling addressed whether an otherwise tax-exempt hospital is subject to Unrelated Business Income Tax (UBIT) regarding profits from an associated medical practice.
Generally, a tax-exempt entity, such as a charitable hospital, owes no federal or state income tax on its income. However, when a tax-exempt entity engages in an active business that is unrelated to its charitable purpose, the net taxable income from such a business is subject to the federal Unrelated Business Income Tax.
The classic example of an unrelated trade or business operated by a tax-exempt entity was New York University's operation of Mueller's pasta company.
Private Letter Ruling 200716034 applied UBIT principles to a tax-exempt hospital that beneficially owned six medical practices that were nominally owned by six designated doctors. The hospital was deemed the true owner of the six medical practices because the hospital had the contractual rights to do the following:
1. Cause each physician shareholder to no longer be employed by the particular professional corporation;
2. Cause each physician to sell his stock to another physician of the hospital's choosing at the same nominal price that the selling physician initially paid for the stock;
3. Provide management, professional, and administrative services to each professional corporation; and
4. Receive the net profits of each medical practice after payment of a fixed salary to the physician shareholder.
The IRS further ruled that provision of medical services to the six medical practices' patients was unrelated to the hospital's charitable purpose, and was, therefore, unrelated business taxable income that was subject to federal income tax at ordinary corporate income tax rates.
This result was reached because the provision of medical services by medical practices is generally a for profit business, and the six professional corporations were being operated as for profit businesses, except that they were obligated to pay their profits to the hospital.
It is unknown whether a different result might have been reached had the six medical practices been operated in a way that was well integrated with the hospital's charitable mission.