The IRS soon will issue proposed rules on the payout requirements for Type III functionally integrated supporting organizations. The rules are expected to simplify the requirements’ complexity for integrated health care delivery systems. The Pension Protection Act of 2006 (Pub. L. No. 109- 208) effectively created a new category of Type III supporting organization – the functionally integrated Type III supporting organization – which is not subject to some of the more restrictive requirements of the law. The Act called for new regulations imposing a payout requirement on supporting organizations that are not functionally integrated. Non-functionally integrated Type III supporting organizations are required to distribute a percentage of either income or assets to supported organizations in order to ensure that a significant amount is paid to such organizations.

Integrated Structures

One area addressed in the advance notice of proposed rulemaking involves integrated structures, such as health care systems or universities, where the parent company itself does not qualify as a public charity but is generally recognized to some degree as a supporting organization. According to the IRS, the rules will clarify that, in all those circumstances with parent-subsidiary situations, the IRS is not concerned about the activities and operations of the parent entity, because “if you are controlling an exempt organization, it would obviously follow that you are following exempt purposes and you are engaging in the activities of your subsidiaries.” The IRS will study and consider donor-advised funds in crafting these rules.

Current Litigation

The litigation focus of the IRS in the health care arena remains on two types of tax cases in federal courts: (1) the Vision Services Plan (VSP) cases; and (2) various medical resident Federal Insurance Contributions Act (FICA) tax withholding cases. A recent appeals court decision in one of the VSP cases is the subject of a pending petition for U.S. Supreme Court review, and while the petition argues that the underlying ruling by the U.S. Court of Appeals for the Ninth Circuit threatens to jeopardize the exemptions of all nonprofit health plans and providers, the IRS has dismissed this contention. According to the IRS, the Ninth Circuit’s decision has no conceivable implications for exempt hospitals, nursing homes, or other providers. The VSP board was controlled by providers, served only larger employers, and did not promote the health and welfare of the community as a whole. Exempt HMOs have “little to worry about as long as they are open to individuals, provide equally affordable services, engage in programs that benefit their communities, and help expand access to a broad swath of the community’s members.” It is questionable whether, if the Supreme Court hears the case, it could use broad language to adopt a community board standard or percentage-of-expenditures-for-charity test that focuses on what is ‘charitable’ instead of just what is 501(c)(4) social welfare activity generally. With respect to pending FICA cases, which concern whether medical residents are “students” exempt from withholding or “employees” subject to FICA taxes, the IRS defends its regulations which state that medical residents are not exempt under the FICA student exemption.