Rev. Rul. 98-15's impact: Columbia/Arlington venture unwound.

Rev. Rul. 98-15--the long-awaited guidance on the treatment of exempt hospitals involved in whole hospital joint ventures with for-profit entities--continues to affect the nonprofit health-care community. Earlier this year, Columbia/HCA Healthcare Corp. and the Arlington (Virginia) Health Foundation announced that they would undo their joint venture (the Columbia Arlington Healthcare System, LLC), principally because the Service would not approve the arrangement. The unraveling was not a response to an IRS audit, but resulted from the parties' prior agreement to dissolve the joint venture if they could not obtain the Service's approval by a specified date.

The unwinding of the Columbia/Arlington joint venture brings to the forefront the fate of other whole hospital joint ventures and the status of enforcement efforts under Rev. Rul. 98-15. The ruling specifically addressed whether an exempt organization operating an acute care hospital may retain its exempt status when it forms a limited liability company (LLC) with a for-profit corporation and then contributes its hospital and all its related operating assets to the LLC, which then operates the hospital.

Rev. Rul. 98-15 analyzed the fact patterns of two whole hospital joint ventures. In the first, the LLC was to be managed by a five-person governing board, with three chosen by the tax-exempt hospital and two by the for-profit member. The LLC's governing document explicitly provided that the hospital was to be operated in a manner that gave precedence to charitable purposes over the duty to operate the hospital for the financial benefit of its owners. Under the first fact pattern, the LLC entered into a management agreement with a management company unrelated to either the tax-exempt or for-profit members. The IRS ruled that the exempt organization's participation in the joint venture did not jeopardize its status.

In the second fact pattern, the LLC was to be managed by a six-person governing board, with three members chosen by the hospital and three by the for-profit member. The LLC's governing document did not contain any language about operating the hospital in a manner that furthered charitable purposes over the duty to maximize profits. The management agreement entered into by the LLC was with a management company that was a wholly owned subsidiary of the for-profit member. In this situation, the Service ruled that formation of the LLC violated Sec. 501(c)(3), resulting in revocation of the organization's exempt status.

Fallout of Rev. Rul. 98-15

The reaction to Rev. Rul. 98-15 has been mixed. Tax practitioners initially welcomed the ruling because of the previous lack of published guidance. On close review, however, many practitioners have suggested that the two fact patterns in the ruling represent extreme or unrealistic alternatives in forming whole hospital joint ventures. As a practical matter, most whole hospital joint ventures currently in place fall somewhere in between.

Currently, it is unclear whether the IRS, in enforcing the principles of Rev. Rul. 98-15, will require that a whole hospital joint venture be structured in accordance with the ruling's first fact pattern. The fact that Columbia/Arlington was unable to get a favorable ruling for its joint venture may indicate how strictly the Service will scrutinize these transactions. If the IRS interprets the ruling on such a strict basis, some whole hospital joint ventures currently in place may follow in the footsteps of the Columbia/Arlington joint venture.

Another important issue raised by Rev. Rul. 98-15 is the extent to which its analysis will be applied to joint ventures that are not whole hospital joint ventures. The Service believes the principles of Rev. Rul. 98-15 have broad application to any joint venture between a tax-exempt entity and a forprofit entity. This raises the question of whether the ruling would be applied to ancillary joint ventures (i.e., joint ventures in which only a small portion of a tax-exempt hospital's assets or operations are placed in the joint venture with a for-profit partner). To date, the IRS has not taken a formal position on the extent to which Rev. Rul. 98-15 applies to ancillary joint ventures. It appears that the Service is waiting for the Tax Court to decide a case involving the validity of an ancillary joint venture (Redlands Surgical Services) before taking a position.

Therefore, depending on the outcome in Redlands, the unwinding of the Columbia/Arlington joint venture may be the tip of the iceberg. Tax practitioners advising exempt organizations that participate in joint ventures with for-profit entities should expect continued IRS enforcement of Rev. Rul. 98-15 and look for additional published guidance from the Service in the form of letter rulings and other pronouncements.

FROM MARC R. BERGER, CPA, J.D., LL.M., BALTIMORE, MD