The Internal Revenue Service issued a private letter ruling on April 20, 2007 concluding that captive professional corporations were beneficially owned by the hospital, but that the activities of the professional corporations were conducted on a larger scale then was reasonably necessary for the performance of the hospital’s exempt functions and that the professional corporations’ provision of medical services to their own patients did not have a substantial causal relationship to the achievement of the hospital’s exempt purposes, and that, therefore, income earned from the professional corporations was unrelated taxable business income for the hospital.
PLR 2007160334 has already been criticized by the national commentators as incorrect. An article in BNA’s Health Law Reporter on April 26, 2007 explains some of those comments.
The professional corporations were normally owned by physicians who were employed by the hospitals, because the professional corporation law of the state in question required ownership by license professionals. However, the physician employment agreements with the hospital contained numerous restrictions on the control and disposition of that stock, principal among them being the requirement that the physician must sell the stock to the hospital in the event of the termination of employment. The IRS concluded that the hospital was the beneficial owner of the stock.
It is difficult to justify the conclusion that a hospital could directly employ these physicians to engage in the practice of treating health patients but that the same practice is outside of the hospital’s mission if it is conducted in the captive PC model. Expect further scrutiny and criticism of this decision.