What Every Health Care Professional Should Know About Nonprofits

Andrew Grumet and Christina Cahill May 4, 2021 Topics for Discussion

. State and Federal Law . Types of Tax Exempt Organizations . Common Organizational Structures . Tax on Unrelated Business Income . Working with For-Profit Entities (Joint Ventures, Mgmt Agmts) . Excess Benefit Transactions . Section 501(r) Requirements

2 Intersection of State and Federal Law

State Law Federal Law

Defines how the organization Determines how the legally exists and operates organization is taxed

. A nonprofit organization MAY = tax exempt

. While most nonprofits are tax-exempt, there are “taxable nonprofits” . Example: OneFifteen in Dayton, Ohio – Joint Venture between Verily, Premier Health and Kettering Health Network

. Critical question when structuring: Does the benefit of tax exemption outweigh the burden of paying taxes?

3 State Nonprofit Corporation Acts

. Most states have a nonprofit corporation act, but some do not (e.g. Delaware, Kansas)

. No one “owns” a nonprofit corporation

. Control is by member(s) or self-perpetuating board; members are similar to stockholders without financial benefits

. Boards have certain fiduciary duties (i.e. care, loyalty, obedience, etc.)

4 Federal Tax Exemption

Section 501(a) of the Internal Revenue Code of 1986 provides:

(a) Exemption from taxation

An organization described in subsection (c) or (d) or section 401(a) shall be exempt from taxation under this subtitle unless such exemption is denied under section 502 or 503.

5 Tax-Exempt vs. Charitable

Charitable Organizations § 501(c)(3)

Tax-Exempt Organizations

6 Federal Tax Exemption, continued

. Section 501(c) Definitions:

. 501(c)(3) – Charitable, educational, scientific, religious organizations

. 501(c)(4) – Social welfare organizations

. 501(c)(6) – Trade associations

. 501(c)(7) – Social clubs

. 501(c)(29) – Qualified nonprofit health insurance issuers

. Many other types; each with their own distinct requirements

7 Section 501(c)(3) Organizations

There are numerous different types of Section 501(c)(3) organizations and each has its own rules 5 Main Types: . Public Charities . Quasi Public Charities (or Supporting Organizations) . Private Foundations . Public Safety Testing Entities . Governmental Entities* Most health systems will have two or more of these organizations *Some, but not all, governmental entities are 501(c)(3) organizations 8 Two Types of Public Charities

. “Per se” or “de facto” public charities qualify for tax exemption because of their activities . They do something specifically exempt (e.g. churches, schools and hospitals)

. Publicly supported organizations qualify because of their support sources . They receive donations from many sources (e.g. Komen or American Cancer Society); or . They perform certain “exempt” services for a fee (e.g. clinics that are not hospitals, certain museums, Broadway theatres)

9 Quasi Public Charities; Supporting Organizations

. A charitable organization that supports another public charity, known as a Supporting Organization, or a “SO” (other than another SO)

. 4 Types of SO’s: This is the most common type and the . Type I (parent-subsidiary) supported entity is typically the corporate parent/member of the SO . Type II (brother-sister)

. Type III (operated in connection with) . Type III functionally integrated (“FISO”) FISOs are often the parent . Type III non-functionally integrated (“Non-FISO”) entity in a hospital system

Note: An SO can also support a 501(c)(4), (5) or (6) if the parent is publicly supported. 10 Private Foundations

. All charitable entities that don’t fit another category default to private foundations (PF)

. PFs are usually funded by one or a few sources

. PFs are subject to numerous restrictions and excise taxes; this is the worst category to be and it should be avoided when possible

11 Healthcare Organization Structure - Example 1

Hospital

Drs Management Co Cardiologists LLC Rehab Pharmacy

12 Healthcare Organization Structure - Example 2

Health System Holding Company Fundraising Foundation

Billing Hospital 1 Hospital 2 Hospital 3

Drs Management Co Cardiologists LLC Rehab Pharmacy

501(c)(4) / PAC 13 Unrelated Business Income (UBI)

. If an exempt org has income from an activity that is (1) a trade or business (2) regularly carried on (3) not related to its tax-exempt purpose

Then income is subject to UBI . Too much UBI jeopardizes tax-exempt status

14 Unrelated Business Income (UBI), continued

. Generally passive income (rents, royalties, dividends, interest, capital gains) is not subject to UBI

. Exception: debt-financed property (unless “substantially” related)

. New “Silo” Regulations governing calculation of UBI

15 Joint Ventures

. Generally Two Types . Whole hospital JVs . Ancillary JVs

. Key Issue: Control by tax-exempt partner . Control = “related” activity = avoid UBI . No Control = “unrelated” activity = possible loss of exemption

16 Management Agreements with For-Profit Enterprises

. Example: Hospital system forms a new entity (maybe exempt entity or a disregarded entity) to provide patient services (e.g., pharmacy, rehabilitation services) and outsources its management to a for-profit enterprise

. Is the arrangement really a JV (or an independent contractor)? . What is the compensation arrangement? Is it FMV? . Is the for-profit enterprise sharing in the “profits” (private inurement is prohibited)? . How much control does the nonprofit have over the arrangement? . Should the venture be conducted as a for-profit entity?

17 Excess Benefit Transactions - Intermediate Sanctions

. “Intermediate Sanctions” = Excise taxes imposed as penalties on arrangements that unduly favor an insider (“excess benefit transactions”)

. Applies to public charities and social welfare organizations

. Board members, holders of key positions, “substantial influence,” certain family members

. Examples: excessive compensation, bargain sale by hospital to insider, split dollar life insurance planning

. Designed to avoid enforcement problems/overly draconian revocation of exempt status

18 Excess Benefit Transactions - Split Dollar Life Insurance

. Compensation strategy allowing employee to acquire permanent life insurance at reduced cost, often with employer paying annual premium as a loan to employee due at future date

. Loans to certain insiders by a nonprofit organization, including all types of supporting organizations (i.e., a healthcare parent entity), are automatic excess benefit transactions

. IRS Warning in Final IRS Regulations in January 2021

19 The Patient Protection and Affordable Care Act-Addition of 501(r)

. Community Health Needs Assessment (CHNA) – every 3 years

. Financial Assistance Policy

. Limitation on charges

. Billing and collection – no extraordinary efforts before determining eligibility for assistance

20 Presenters

Andrew Grumet Practice Group Chair Christina Cahill Shareholder Associate [email protected] [email protected] 212.413.2882 212.413.2847

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