## Facts

- Harding Hospital operated as a nationally recognized psychiatric hospital using “milieu therapy” with controlled, around-the-clock treatment.
- The hospital was originally for-profit but amended its articles in December 1961 to become an Ohio nonprofit and sought exemption under I.R.C. § 501(c)(3).
- Former shareholders exchanged stock (valued about $3,800 per share) for notes (face value $3,000 per share) bearing 4% interest; the restructuring followed IRS Exempt Organizations Branch guidance.
- The IRS issued a tentative exemption ruling in 1962, proposed revocation in 1965, and formally revoked the exemption in 1968.
- A closely connected physician group, Harding–Evans Medical Associates, provided roughly 90–95% of psychiatric services at the hospital and exercised dominant control over the hospital’s medical practice.
- Contracts required the Associates to provide medical supervision, teaching/supervision of training programs, and some indigent care at no or reduced charge, in exchange for annual payments from the hospital.
- The Associates rented hospital office space and equipment for monthly fees that were, for several years, below market value.
- The hospital lacked a specific institutional plan for charity care; a separate tax-exempt foundation conducted or funded much of the education and research associated with the hospital.
- The hospital paid federal income taxes for 1966–1968 and sued for a refund of $141,730; the district court denied relief, and the hospital appealed.

## Issues

1. Whether the hospital was “organized and operated exclusively for charitable purposes” within the meaning of I.R.C. § 501(c)(3) for tax years 1966–1968.
2. Whether any part of the hospital’s net earnings inured to the benefit of private individuals, defeating exemption under § 501(c)(3).
3. Whether the hospital carried its burden to prove entitlement to exemption under statutes strictly construed in favor of taxation.

## Decision

- The Sixth Circuit affirmed the judgment against the hospital and denied the requested refund.
- The court held the hospital failed the operational requirement because more than an insubstantial part of its activities served nonexempt purposes tied to private interests.
- The court also found prohibited inurement: hospital arrangements conferred economic benefit on members of the Associates through favorable compensation and below-market rental terms.
- Educational and training activities did not cure the exemption defects because much of that work was conducted or funded through a separate entity and did not negate substantial private benefit/inurement in the hospital’s operations.

## Legal Principles

- An organization must satisfy all conjunctive requirements of I.R.C. § 501(c)(3); failure of any requirement defeats exemption.
- Tax exemptions are strictly construed in favor of taxation; the claimant bears the burden of proving clear entitlement, and doubts are resolved against exemption.
- “Operated exclusively” does not require absolute exclusivity, but exemption fails if more than an insubstantial part of activities does not further an exempt purpose.
- Section 501(c)(3) bars any inurement of net earnings to private shareholders or individuals; a finding of inurement is independently fatal to exemption.
- Substantial private benefit—such as economically favorable, non-arm’s-length arrangements with insiders or a closely related professional group—can demonstrate a nonexempt operational purpose.

## Conclusion

The Sixth Circuit held that the hospital did not qualify for § 501(c)(3) exemption because its operations substantially benefited a dominant physician group and its net earnings inured to private individuals through favorable contractual and rental arrangements, warranting denial of a refund for 1966–1968 taxes.


Harding Hosp., Inc. v. United States, 505 F.2d 1068 (6th Cir. 1974)