Clarifying Tax Status for Volunteer Auxiliaries

The deal has closed. Your for-profit hospital chain just added a new hospital to its ranks - this time a former not-for-profit hospital. Much time and effort went into the purchase. The parties may even have had to obtain approval from the state attorney general's office. Nevertheless, all approvals were granted, the deal has closed and your for-profit chain now owns a hospital that formerly was not-for-profit.

Soon after, however, you are asked by one of the gift shop volunteers whether the hospital's tax-exempt volunteer auxiliary will be affected by the ownership change. Since the hospital first opened, the auxiliary has furnished unpaid volunteers to staff the visitors desk and run the gift shop. The auxiliary has also prided itself on raising money for hospital improvements.

Will the volunteers still be able to provide unpaid services for the hospital? Can they continue to raise money for improvements? The answer depends on whether the auxiliary wants to maintain its tax-exempt status. If so, some of the auxiliary's activities may have to be limited.

Separate Entity Analysis

In deciding what to do about the auxiliary, the first step is to determine if it is a separate entity (corporation, limited liability company, etc.) with its own separate tax-exempt status. If it is, the hospital could choose to keep it in place as a tax-exempt entity, and could simply instruct the auxiliary about its new limitations with respect to activities performed for the hospital.

Sometimes, however, the for-profit chain will discover the auxiliary is not a separate entity with its own tax-exempt status. Instead, the auxiliary's tax-exempt status may have been piggy-backed onto the hospital's. This means the auxiliary automatically lost its tax-exempt status following the sale, when the hospital's tax-exempt status was revoked.

Alternate Approaches

Now the hospital and auxiliary must make certain decisions. One approach is for the auxiliary to become a part of the for-profit hospital without obtaining status as a separate, tax-exempt entity. Auxiliary income would be hospital income, and all auxiliary expenses would be hospital expenses. These items would have to be reflected in the hospital's tax return even though separate books might be kept for the auxiliary.

The advantage to this approach is that it avoids time-consuming, and possibly expensive, legal and accounting fees in setting up a separate entity. It also allows the auxiliary greater flexibility in the use of its funds and services. For example, there would be no prohibition against the auxiliary purchasing equipment for the hospital or otherwise providing direct benefits to the hospital. The obvious disadvantage is that the auxiliary would not be tax-exempt. Auxiliary volunteers may be much less excited about volunteering their time and energy to a taxable, for-profit entity. Further, volunteers or their supporters could not take tax deductions for donations given to the auxiliary.

Another approach would be to obtain separate corporate status for the auxiliary and to apply for tax-exempt status. Current auxiliary members may prefer this approach. It means, however, that the auxiliary cannot use its funds to provide items the hospital normally pays for, such as equipment or personnel.

That is because section 501(c)(3) of the IRS Code provides tax-exempt status for an organization operated exclusively for "religious, charitable, scientific, testing for public safety, literary or educational purposes ... no part of the net earnings of which inures to the benefit of any private shareholder or individual...."

Exemption-Loss Risk

If the IRS finds a tax-exempt auxiliary has used its tax-exempt status for the financial benefit of a private entity, such as the for-profit hospital with which it is affiliated, the auxiliary will lose its exemption and could be subject to tax penalties.

In deciding whether an activity is allowed, the auxiliary should ask the following question: Will the activity result in increased revenue or decreased cost to the hospital? If so, the activity should be avoided even though its primary purpose is to benefit patients or the community. If, on the other hand, the activity will benefit patients and the community but will not result in increased revenue or decreased cost to the hospital, the activity probably is acceptable. Unfortunately, many activities fall into the questionable gray area since they may indirectly benefit the hospital as well as patients and the community.