On March 16, 2018 the IRS issued a private letter ruling (PLR 201811009) analyzing and applying the controlled group rules to two related 501(c)(3) entities. The first entity is a Medical Center, organized in part for the purpose of operating an academic medical center as part of a health system affiliated with the other entity, a University.
The PLR reiterates the general rule that one 501(c)(3) entity (the University) in this case) does not “Control” another 501(c)(3) entity (the Medical Center) for purposes of the IRS controlled group rules where:
- The University holds the power to approve and remove without cause four of the Medical Center’s 11 directors.
- With the exception of the University’s chancellor, no employee of the University may serve as a director of the Medical Center.
- The University holds no right or power to require the use of the Medical Center’s funds or assets for the University’s purposes.
- Rather, the Medical Center determines its budget, issues debt and expends funds without oversight from the University.
- The Medical Center has sole control over collection of its receivables and sole responsibility for satisfaction of its liabilities.
- The University does not control hiring, firing or salaries of the Medical Center’s Employees.
The PLR states that the above facts evidence the Medical Center’s operational independence from the University and support a conclusion that the University does not directly control the Medical Center.
The PLR goes on to conclude that the University does not directly control the Medical Center, even though the University has the right to prohibit the Medical Center from taking certain actions, including:
- any major corporate transaction not within the ordinary course of business;
- any action that would result in a change in the Medical Center’s exempt status under §§ 501(c)(3) and 509(a) of the Code;
- any material change to the Medical Center’s purposes;
- any change in the fundamental, nonprofit, charitable, tax-exempt mission of the Medical Center;
- any action that would grant any third party the right to appoint directors of the Medical Center;
- a joint operating agreement or similar arrangement under which the Medical Center’s governance is substantially subject to a board or similar body that the Medical Center does not control; and
- the sale or transfer of all or substantially all of the Medical Center’s assets.
The IRS determined that, although the above rights certainly represent a form of control over the Medical Center, such control is qualitatively different from the operational control factors that were not present here.
The key to the ruling is that the University’s rights do not confer the power to cause the Medical Center to act. Rather they confer the power to bar the Medical Center from taking certain actions. The right merely limits the Medical Center’s capacity to deviate from the charitable mission it shares with the university and diminishes the chance that the Medical Center will stray from the quality standards and community focus that the University wants in an academic medical center.
Background on Tax Exempt Control Group Rules
In the case of an organization that is exempt from tax under Code section 501(a), the employer includes the exempt organization and any other organization that is under common control with that exempt organization under the special rules set forth in Treas. Reg. §1.414(c)-5(b).
For this purpose, common control exists between an exempt organization and another organization if at least 80 percent of the directors or trustees of one organization are either representatives of, or directly or indirectly controlled by, the other organization. Treas. Reg. §1.414(c)-5(b). A trustee or director is treated as a representative of another organization if he or she also is a trustee, director, agent, or employee of the other organization. A trustee or director is controlled by another organization if the other organization has the general power to remove such trustee or director and designate a new trustee or director. Whether a person has the power to remove or designate a trustee or director is based on all the facts and circumstances. Id.
In the case of PLR 201811009, the University controlled far less than 80% of the Medical Center’s board positions, so the analysis focuses on the “facts and circumstances” element of control. The key takeaway is that the power to prevent another entity from acting does not necessarily result in control. Keep in mind, however, that PLRs are fact specific and can only be relied on by the taxpayer to whom they are issued. We therefore cannot conclude that the power to preclude action by another 501(c)(3) entity will never result in control.