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Nonprofit Hospital Advocates Address Type III Supporting Organization Rules

Nonprofit Hospital Advocates Address Type III Supporting Organization Rules

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Attached are handouts from a Treasury meeting on November 15, 2006

 

with Rachel Jones of The Nickles Group and representatives of the

 

American Hospital Association.

 

 

Treatment of Nonprofit Hospital Systems under the New Functionally

 

Integrated Type III Supporting Organization Rules in the Pension

 

Protection Act of 2006

 

 

("PPA")

 

 

I. Background

  • Nonprofit hospital systems often have a Type III supporting organization serving as the parent entity in a system of multiple charitable hospitals.

  • The parent supporting organization engages in important system-wide activities on behalf of its supported charitable hospitals, clinics, and related charitable entities to promote health care. For example, the parent supporting organization undertakes quality care initiatives that are implemented system-wide, designs and implements system-wide information technology programs, negotiates on behalf of the system to purchase supplies in bulk, and undertakes other activities to streamline and enhance the delivery of charitable health services by the hospitals in the system.

  • To address abuses in which donors have received large charitable tax deductions for gifts to Type III supporting organizations of assets that produce little income that can be given to charities as grants, PPA adopts a series of changes to the Federal tax rules governing Type III supporting organizations. (See chart summary of PPA provisions at Attachment A.) By contrast, rather than making grants to others, hospital system parent supporting organizations actively carry on activities to assist the charitable entities in their system in promoting charitable health care purposes. Hence, these hospital parent supporting organizations qualify under the current law regulations as what has become known as "functionally integrated" Type III supporting organizations.

  • PPA recognizes that, as activities-based organizations, "functionally integrated" Type III supporting organizations do not present the potential for abuse cited with respect to grant-making Type Ill's, and accordingly "functionally integrated" Type Ill's are not subjected to the new minimum pay-out requirement to be promulgated under new Treasury regulations mandated by PPA and various other new Type III restrictions.

  • PPA leaves the definition of "functionally integrated" Type III supporting organization to Treasury regulations. While the label "functionally integrated" has come to be attached to existing concepts in the current regulations under the so-called "integral part" test (supporting organization's activities perform the functions or carry out the purposes of the supported organizations and but for the presence of the supporting organization normally would be undertaken by the supported organization), there is no specific defined term "functionally integrated" in the existing regulations, and hence Treasury will have to come up with a definition.

  • Nonprofit hospital systems, which have relied upon current law "functionally integrated" rules in the existing regulations and IRS rulings, should be able to continue such reliance, to provide the necessary certainty for their charitable status. They should not have to risk entanglement in new rules directed at abuses committed by others.

 

II. Current Regulations and Rulings by Service

Under I.R.C. section 4943(f)(5)(B), as amended by the PPA, Treasury must issue new regulations on Type III supporting organizations which are considered "functionally integrated Type III supporting organizations." The term "functionally integrated" is not defined in the Code or existing regulations, but has evolved as a description of the "activities" test for the "integral part" test for a Type III. Reg. 1.509(a)-(4)(i)(3)(i) and (ii) states as follows:

 

(3) Integral part test; general rule. -- (i) For purposes of this paragraph, a supporting organization will be considered to meet the "integral part test" if it maintains a significant involvement in the operations of one or more publicly supported organizations and such publicly supported organizations are in turn dependent upon the supporting organization for the type of support which it provides. In order to meet this test, either subdivision (ii) or subdivision (iii) of this subparagraph must be satisfied.

(ii) (a) The activities engaged in for or on behalf of the publicly supported organizations are activities to perform the functions of, or to carry out the purposes of, such organizations, and but for the involvement of the supporting organization, would normally be engaged in by the publicly supported organizations themselves.

 

The Service has in a number of rulings considered various components of a supporting organization's activity which make it possible for such organizations to satisfy the "functionally integrated" organization test. Several of the rulings consider activities of hospital systems and appropriately conclude that the Type III meets the requirements for a "functionally integrated" organization. For example, the Service has ruled that "qualifying activities" include overall coordination and supervision of a hospital system, including approving the budgets, strategic planning, marketing, resource allocation, endowment management and managing community education programs. (See a summary chart of the existing rulings addressing "qualifying" and "non-qualifying" activities at Attachment B.)

None of the examples in current regulations, however, incorporate the hospital system rulings, nor has the Service issued any specific guidance in respect of "functionally integrated" organizations. Set forth below are examples drawn directly from the rulings summarized in the attached chart that would clarify the definition of "functionally integrated" Type III supporting organizations. These examples could be added to the existing regulations, and could be used to issue guidance before proposed regulations are promulgated.

Section 1.509(a)-4(i)(3)(ii)(a). This subdivision may be illustrated by the following examples:

 

Example (1). X, an organization described in section 501(c)(3), is the parent corporation of an integrated educational and health care system. X is responsible for coordinating the policy-making and long-range planning for the system, providing essential support services, and formulating relationships within the system. Support services include food services, maintenance, transportation, laundry, typing pool, accounting, data processing, payroll, purchasing, personnel, security, and general administration. X meets the responsiveness test described in subparagraph (2) of this paragraph. Under these circumstances, X will be treated as performing functions of the related exempt organizations which, but for the involvement of X, would normally be performed by such organizations themselves.

Example (2). X, an organization described in section 501(c)(3), is the parent of an integrated hospital system. X manages and supervises the activities of its exempt subsidiary organizations and coordinates policy-making and long-range planning to meet patient needs. X also provides services to non- exempt entities which do not account for a substantial portion of its total income. X meets the responsiveness test described in subparagraph (2) of this paragraph. Under these circumstances, X will be treated as performing functions of the exempt subsidiary organizations which, but for the involvement of X, would normally be performed by such organizations themselves, even though X is performing similar services to nonexempt entities.

Example (3). X, an organization described in section 501(c)(3), is the parent of a healthcare system. P engages in the overall coordination and supervision of the system's exempt subsidiary corporations in approval of budgets, strategic planning, marketing, resource allocation, endowment management, securing tax-exempt bond financing, and community education. X meets the responsiveness test described in subparagraph (2) of this paragraph. Under these circumstances, X will be treated as performing functions of the subsidiary organizations which, but for the involvement of X, would normally be undertaken by such organizations themselves.

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