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Could joint venture produce excess benefits?

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Could joint venture produce excess benefits?

Recently I was retained by a healthcare joint-venture housed in a Limited Liability Company where a 501(c)(3) a hospital holds 35% equity and a for-profit LLC owned by a number of physicians holds 65%. There are 5 managers on the joint venture LLC’s management committee, 2 appointed by the hospital and 3 appointed by the for-profit.

The LLC’s operating agreement contains the charitable purpose and tax-exempt organization limitations language you’d expect to see.  There is currently a disagreement between the 501(c)(3) and the for-profit LLC regarding whether the CEO’s compensation, were it to be found excessive/unfair/unreasonable, could cause private inurement, private benefit, excess benefit, and/or unrelated business taxable income issues for the hospital.  Do you think it could?  

This sounds like a very risky situation.

I assume that this venture does not have its own exemption because it appears as though it is not controlled by the charity and therefore would probably not qualify for exemption.  If it has its own exemption, obviously, the private benefit and excess benefit rules would clearly apply. 

If this venture is being treated as a pass through partnership and therefore treated for tax purposes as an activity of the hospital, I think the hospital has some potential jeopardy under Rev. Rul. 98-15 and the St. David’s case referred to in Rev. Rul. 2004-51, both for unrelated business taxable income and, if “too large” a part of its activities, for its own exemption.  (See Ready Reference Page: IRS Says Charities Must Control Joint Ventures.)

But even if it somehow deals satisfactorily with those problems, I think the IRS would still look for excess benefits at the joint venture, especially if the operating agreement has language that the venture is going to operate as a charity.   Private inurement, private benefit or excess benefits cannot redound to the benefit of the hospital.  The physicians’ LLC probably won’t have a problem if the physicians’ LLC is a for-profit entity and does not have the charitable limitations in its governing documents.  But the activity attributed to the 501(c)(3) hospital could create problems for it.

Tuesday, August 20, 2019

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