## Facts

- St. Luke’s Hospital of Kansas City was a nonprofit hospital recognized as tax-exempt under I.R.C. § 501(c)(3), with stated purposes that included operating a medical education program for medical students, interns, residents, physicians, and nurses.
- The hospital operated a general-care facility in Kansas City, Missouri, including an in-house pathology department.
- Staff physicians treated both hospital patients and private office patients who were not admitted to the hospital.
- For certain private office patients of staff physicians, tissue specimens were collected in physicians’ offices, transported by a hospital employee to the hospital, analyzed in the hospital’s pathology department, and billed by the hospital directly to the patients.
- The IRS assessed unrelated business income tax (UBIT) on income from these pathology services to non-admitted private office patients.
- The hospital used the private-patient tissue specimens in its teaching program, increasing the volume and range of instructional material beyond specimens from admitted patients.
- The outside-testing activity was small relative to the pathology department’s overall operations, and the hospital did not actively solicit this work through advertising or similar methods.

## Issues

1. Whether pathology and diagnostic testing performed by a § 501(c)(3) hospital on specimens from private office patients of staff physicians constitutes an “unrelated trade or business” under I.R.C. § 513, producing taxable UBIT under §§ 511–512.
2. Whether the activity, even if a trade or business, is excluded from “unrelated trade or business” by I.R.C. § 513(a)(2) as conducted primarily for the convenience of the hospital’s “members,” and whether staff physicians can qualify as “members” for that purpose.

## Decision

- The court entered judgment for the hospital in its refund suit, holding the challenged pathology-testing income was not taxable as unrelated business income.
- The court held the testing was substantially related to the hospital’s exempt educational and charitable purposes because the specimens were used in the hospital’s instructional program and contributed importantly to that function.
- As an independent alternative ground, the court held staff physicians could be treated as “members” of the hospital and that the testing was performed primarily for their convenience, bringing the activity within the § 513(a)(2) exclusion.

## Legal Principles

- An exempt organization’s revenue-generating activity is not an “unrelated trade or business” under I.R.C. § 513 if the activity is substantially related to accomplishing the organization’s exempt purposes and contributes importantly to those purposes beyond producing income.
- In assessing relatedness, courts may consider how the activity functions within the organization’s exempt program (including educational use of materials generated by the activity) and whether the activity is conducted in a limited, non-commercial manner (e.g., small scale and no active solicitation).
- I.R.C. § 513(a)(2) excludes from “unrelated trade or business” a trade or business carried on primarily for the convenience of certain covered groups (including “members”); staff physicians integrated into hospital operations may qualify as “members” for this purpose, depending on the facts.

## Conclusion

The court held that a tax-exempt hospital’s limited pathology testing for staff physicians’ private office patients did not generate UBIT because it furthered the hospital’s exempt educational and charitable functions, and, alternatively, because it was performed primarily for the convenience of staff physicians treated as hospital members under § 513(a)(2).


St. Luke’s Hosp. of Kan. City v. United States, 494 F. Supp. 85 (W.D. Mo. 1980)