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The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance Issuescorporations was shareholder value. One dramatic difference between businesscorporations and nonprofits is that the former has almost a singular purpose—theoverarching purpose of business corporations is to promote the welfare of shareholders,specifically to maximize shareholder value. The objective of corporate governanceinitiatives in this sector then is to protect investors and promote fair and efficientmarkets that both encourage investors to provide capital and protect investors who doso. For example, such initiatives endeavor to protect shareholders from attempts bymanagement to benefit itself to the detriment of shareholders, to prevent insiders fromtrading on non-public information, and to require timely public release of accuratefinancial information that investors should have in determining whether to buy, sell orhold securities. But even with that more limited and approachable standard, theempirical data involving the for-profit sector either fails to support or is inconclusive orcontroversial with respect to the efficacy of many “good governance practices.”The nonprofit world, on the other hand, is virtually bereft of studies examining theefficacy of specific governance practices. 183 The purposes of nonprofit organizationsare more diverse and complicated and, concomitantly, the roles of their boards arebroader and more nuanced. This may suggest that specific good governance practicesare even less likely to be effective in the nonprofit context. 184183See supra notes 39-40 and accompanying text.184See Reiser, supra note 47.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 84
The Appropriate Role Of The Internal Revenue Service With Respect To Tax-Exempt Organization Good Governance IssuesAPPENDIX 3. HEALTH CARE The law of charity has always evolved to reflect the changing needs of society and thatflexibility has been critical in considering under what circumstances hospitals and otherhealth care organizations qualify for exemption. 185 The voluntary hospital of todayoperates very differently from Pennsylvania Hospital in 1751 or even the typicalcommunity hospital of the 1950s; 186 and other types of health care organizations thatcould not have been imagined five, ten, twenty or forty years ago have developed overthe years. Thus, the IRS has been required to distinguish a health care organizationthat qualifies for exemption from one that is merely the for-profit practice of medicine. Invarious situations, the IRS has imposed such governance requirements as a communityor independent board, mandated specific board approval of transactions, and requiredadoption of a conflict of interest policy.In Revenue Ruling 56-185, 187 the IRS established for the first time a specific standardfor nonprofit hospital exemption, relying principally on the “relief of poverty” rationale.However, with the passage of the Medicare and Medicaid statutes in 1965, whichprovided for government reimbursement of a substantial portion of the free carepreviously subsidized by tax-exempt hospitals, the IRS rethought the basis for hospitalexemption. The challenge was to acknowledge that “promotion of health” was a type ofcommunity benefit, like the “relief of poverty,” that could constitute the basis forexemption, while at the same time distinguishing a hospital organized and operated forcharitable purposes from one that primarily served private interests. In Revenue Ruling69-545, 188 the IRS provided an example of a hospital qualifying for exemption and anexample of a hospital that did not qualify for exemption. One of the factors the IRS citedas distinguishing the “good hospital” from the “bad hospital” was that the former wasgoverned by a board of trustees comprised of independent civic leaders. The emphasison a community board can be viewed as an early foray into imposing a governance185See, e.g., Mary Jo Salins et al., Evolution of the Health Care Field, Exempt Org. Continuing Prof. Educ. Tech. InstructionProgram 1992 at 157, 158-59.186For an historical discussion of the law of charities as applied to hospitals, see, generally, Robert S. Bromberg, Tax Planning forHospitals and Health Care Organizations (1977), Chapter 7; Douglas Mancino, Income Tax Exemption of the ContemporaryNonprofit Hospital, 32 St. Louis U. L.J. 1015 (1988).187Rev. Rul. 56-185, 1956-1 C.B. 202. The IRS set forth a number of criteria for exemption, including: the hospital must “beoperated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who areable to pay;” the hospital must not restrict the use of its facilities to a particular group of physicians and surgeons to the exclusion ofall other qualified doctors; and the hospital may set aside earnings to be used for improvements and additions to hospital facilities.188Rev. Rul. 69-545, 1969-2 C.B. 117, contrasted two hospitals, one that qualified for exemption and one that did not. The keyfactors in the IRS’s favorable ruling were: the hospital operated a full-time emergency room that treated all persons requiringemergency care regardless of ability to pay; the hospital provided care to all persons in the community who could pay for services,either by themselves or through private health insurance or public programs such as Medicare and Medicaid; medical staff privilegeswere available to all qualified physicians in the area, consistent with the hospital’s size and the nature of its facilities; the hospitalwas governed by a board of trustees comprised of independent civic leaders; transactions between the hospital and members of themedical staff were at arm’s length; and the hospital used its surplus of receipts over disbursements to improve the quality of patientcare, expand facilities and advance its medical training, education and research programs. The emergency room requirementstemmed from the fact that indigent persons who were not covered by Medicare or Medicaid (or cared for in public hospitals) tendedto receive their care in hospital emergency rooms or on admission to the hospital through the emergency room. Many hospitals onlyprovided emergency care for indigents and then transferred poor uninsured patients to public hospitals or other hospitals that servedcharity cases. Subsequently, in Revenue Ruling 83-157, C.B., 1983-2 94, the IRS acknowledged that the operation of anemergency room is not an absolute requirement for exemption. While Medicaid is not explicitly referenced in the revenue ruling, theIRS applies this requirement equally to Medicaid. See, e.g., Salins, supra, note 186, at 159.ADVISORY COMMITTEE ON TAX EXEMPT AND GOVERNMENT ENTITIES (ACT) June 11, 2008 85
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