## Facts

- The IRS addressed whether a § 501(c)(3) nonprofit hospital that contributes its hospital and substantially all operating assets to an LLC jointly owned with a for-profit hospital company continues to qualify for exemption.
- In both situations, the nonprofit hospital and the for-profit contribute assets to an LLC treated as a partnership for federal tax purposes; each receives an ownership interest proportional to contributed value and receives proportional distributions.
- Both nonprofits intended to use distributions for community health activities and indigent-care grants.
- **Situation 1:** The LLC’s governing board had five members, with the nonprofit selecting three and the for-profit selecting two; major decisions required approval of a majority of three.
- **Situation 1:** The LLC’s governing documents required operation of the hospital to further charitable purposes and comply with the community benefit standard, including emergency care regardless of ability to pay and access for Medicaid and indigent patients.
- **Situation 1:** The LLC engaged an unrelated management company under reasonable, comparable terms; the nonprofit’s board majority and reserved powers preserved ultimate authority over operations and the management relationship.
- **Situation 2:** The LLC’s governing board had six members split evenly (three selected by the nonprofit, three by the for-profit), with major decisions requiring a board majority, preventing the nonprofit from acting without the for-profit’s agreement.
- **Situation 2:** The LLC’s governing documents stated general operational purposes and did not impose enforceable charitable-operation obligations comparable to the community benefit standard; the agreement included a required minimum distribution level.
- **Situation 2:** The LLC entered an exclusive long-term management contract with a subsidiary of the for-profit partner, renewable at the subsidiary’s discretion and terminable only for cause; the fee was based on gross revenues.

## Issues

1. Whether a § 501(c)(3) hospital remains “organized and operated exclusively” for charitable purposes after transferring its hospital operations to a partnership-classified LLC jointly owned with a for-profit.
2. Whether the joint venture structure results in more than incidental private benefit or impermissible private inurement to the for-profit participant.
3. What governance, purpose, and management features are necessary for a whole-hospital joint venture to preserve the nonprofit hospital’s § 501(c)(3) exemption.

## Decision

- **Situation 1:** The nonprofit hospital retained its § 501(c)(3) status; any private benefit to the for-profit partner was incidental.
- **Situation 2:** The nonprofit hospital failed the operational test and did not continue to qualify for § 501(c)(3) exemption after contributing its hospital assets to the LLC.

## Legal Principles

- A § 501(c)(3) organization must satisfy the organizational and operational tests and must not permit net earnings to inure to private interests; any private benefit must be incidental in both nature and amount.
- For a whole-hospital joint venture conducted through a partnership/LLC, exemption depends primarily on whether the exempt participant maintains effective control to ensure the venture operates in furtherance of charitable purposes.
- Governing documents should legally bind the venture to charitable operation consistent with the community benefit standard, including emergency care regardless of ability to pay and nondiscriminatory access for government-program and indigent patients.
- Reserved powers and board composition matter: majority board control and decision rules that allow the exempt participant to approve major actions support continued charitable operation; equal control without a tie-break mechanism does not.
- Management arrangements must preserve the exempt participant’s ultimate authority and avoid structural features that confer non-incidental benefit on a for-profit, particularly related-party, long-term, difficult-to-terminate contracts, even if stated compensation is otherwise reasonable.
- Using distributions for charitable grants does not, by itself, satisfy § 501(c)(3); the venture’s own hospital operations must be structured and conducted primarily to accomplish charitable purposes.

## Conclusion

The IRS concluded that a nonprofit hospital may contribute its hospital to a joint-venture LLC with a for-profit and keep § 501(c)(3) status only if the nonprofit retains effective governance control and the venture’s governing and management arrangements enforce charitable operation; where control is shared equally and the for-profit (or its affiliate) effectively controls operations through governance and management rights, exemption is lost.


Rev. Rul. 98-15, 1998-1 C.B. 718 (1998)