St. David's Health Care System v. United States
2003 WL 22416061, 349 F.3d 232 (2003)
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Rule of Law:
A non-profit organization fails to operate "exclusively" for charitable purposes, and thus loses its tax-exempt status under § 501(c)(3), if it enters into a partnership with a for-profit entity and cedes effective control of the partnership's operations to the for-profit partner.
Facts:
- For many years, St. David’s Health Care System, Inc. ('St. David’s') was a non-profit hospital recognized as a tax-exempt charitable organization.
- Facing financial difficulties in the 1990s, St. David's decided to consolidate its operations with another healthcare provider.
- In 1996, St. David’s formed a partnership with Columbia/HCA Healthcare Corporation ('HCA'), a for-profit company.
- St. David’s contributed all of its hospital facilities to the new partnership, and HCA contributed its own local facilities.
- The partnership hired Galen Health Care, Inc., a subsidiary of HCA, to manage the day-to-day operations of the partnership's medical facilities.
- The partnership agreement created a Board of Governors on which St. David's and HCA each appointed half the members, giving St. David’s veto power but not majority control.
- The agreement gave St. David's the power to unilaterally remove the CEO and to terminate the management agreement if its tax-exempt status was jeopardized.
Procedural Posture:
- The IRS audited St. David’s and concluded that its partnership with HCA disqualified it from tax-exempt status for the 1996 tax year.
- St. David’s paid the assessed taxes under protest.
- St. David’s filed suit against the U.S. Government in federal district court, seeking a refund of the taxes paid.
- Both parties filed cross-motions for summary judgment.
- The district court granted summary judgment in favor of St. David’s, ordering the Government to refund the taxes and pay attorney's fees.
- The Government (appellant) appealed the district court's decision to the U.S. Court of Appeals for the Fifth Circuit, with St. David's as the appellee.
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Issue:
Does a non-profit organization fail the 'operational test' for tax-exempt status under § 501(c)(3) when it forms a partnership with a for-profit entity and cedes effective control of the partnership's operations to its for-profit partner?
Opinions:
Majority - Garza, J.
Yes. A non-profit organization that cedes control to a for-profit partner is presumed to be operating for the substantial non-charitable purpose of its partner, thereby failing the operational test for tax exemption. To qualify for tax-exempt status, an organization must operate 'exclusively' for a charitable purpose, meaning no more than an 'insubstantial part' of its activities can further a non-charitable purpose. When a non-profit partners with a for-profit entity, the critical inquiry is one of control. If the non-profit gives up effective control, a presumption arises that the partnership's activities substantially further the private, profit-seeking interests of the for-profit partner, which destroys the exemption. In this case, while St. David’s retained some contractual protections like veto power and the ability to fire the CEO, other factors create a genuine issue of material fact as to whether it ceded control. These factors include its lack of a board majority, the hiring of an HCA subsidiary as the day-to-day manager, and evidence that St. David’s was unable to enforce a key charitable-reporting provision. Because it is uncertain whether St. David's retained sufficient control to ensure the primacy of its charitable mission, summary judgment was inappropriate and the case must be remanded for a factual determination.
Analysis:
This decision solidifies the 'control test' as the central inquiry for determining the tax-exempt status of non-profits in joint ventures with for-profit entities. It clarifies that merely performing charitable functions is insufficient; the non-profit must retain demonstrable and effective control over the partnership's operations to ensure its charitable mission remains primary. The ruling signals to non-profits that they cannot simply rely on contractual veto powers or exit clauses, especially if these powers are impractical to exercise. This case provides a critical framework for structuring such partnerships and serves as a warning that the IRS and courts will closely scrutinize the operational realities of control, not just the formal partnership agreements.
