Associated Hosp. Servs., Inc. v. Comm'r of Internal Revenue

• Citation: 74 T.C. 213
• Decision Date: 06 May 1980
• Docket Number: Docket No. 12004-78X.
• Parties: ASSOCIATED HOSPITAL SERVICES, INC., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

74 T.C. 213

ASSOCIATED HOSPITAL SERVICES, INC., PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 12004-78X.

United States Tax Court

Filed May 6, 1980.

Petitioner is an organization controlled jointly by four tax-exempt hospitals. Its sole function is to furnish laundry services to its member hospitals. Held, under the reenactment doctrine applicable to regulations and interpretations long continued without substantial change applying to unamended or reenacted statutes, and deemed to have congressional approval, petitioner is a feeder organization under sec. 502, I.R.C. 1954, and sec. 1.502-1(b), Income Tax Regs., and is therefore not exempt under sec. 501(c)(3). National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472, (1979); Helvering v. Winmill, 305 U.S. 79 (1938), applied. Nathan Greenberg, for the petitioner.

Elizabeth D. De Priest, for the respondent.

OPINION

NIMS, Judge:

Respondent determined that (1) petitioner is a feeder organization described in section 502; (2) is not an organization described in section 501(e); and (3) therefore is not an exempt organization under section 501(c)(3).¹

Petitioner has invoked the jurisdiction of this Court, pursuant to section 7428, for a declaratory judgment that it is exempt from tax under section 501(c)(3). Petitioner has satisfied the prerequisites for this declaratory judgment action: It has exhausted its administrative remedies as required under section 7428(b)(2); it is the organization the classification of which is at issue, as required under section 7428(b)(1); and it filed its petition herein in a timely fashion as required under section 7428(b)(3).

The case was submitted under Rule 122, Tax Court Rules of Practice and Procedure, pursuant to an order of the Court dated July 18, 1979. The record, on the basis of which the case was submitted, consists of the pleadings, the administrative record to which the parties have stipulated, and a supplemental stipulation of facts. The facts contained in the administrative record and the supplemental stipulation are assumed to be true for the purposes of this proceeding. See Rule 217, Tax Court Rules of Practice and Procedure.

The tax years to which respondent's final adverse ruling relates are the years 1969 to 1977, inclusive. However, this proceeding relates both to the initial qualification and the continuing qualification of petitioner as an organization described in section 501(c)(3).

Petitioner is a Louisiana nonprofit corporation whose principal place of business, at the time of filing the petition herein, was 7639 Townsend Place, New Orleans, La.

The issue for our decision is whether petitioner is a feeder organization under section 502 and, if not, whether it is exempt from tax under section 501(a) by virtue of being an exempt organization under section 501(c)(3).

Petitioner was incorporated on September 8, 1969, by six hospitals: Sara Mayo Hospital, Methodist Hospital, St. Claude General Hospital, Flint Goodridge Hospital of Dillard University, all of which are described in section 501(c) (3); and West Jefferson General Hospital and East Jefferson General Hospital, both of which are owned and operated by Jefferson Parish, a political subdivision of the State of Louisiana. Currently, petitioner has four participating members: Sara Mayo, East Jefferson, Flint Goodridge, and Methodist. Since its inception, petitioner's sole activity has been to provide laundry service to its members.

Under petitioner's articles of incorporation, membership is composed of only one participating class, namely, nonprofit hospitals or other nonprofit health care institutions. Petitioner was organized to serve member hospitals and health care institutions located in Orleans, Jefferson, St. Charles, St. Bernard, Placamines, St. Tammany, and neighboring parishes in Louisiana. The board of directors is composed of two individuals from each participating member.

To commence operations, petitioner in 1971 received a construction loan of $925,000, plus Hill-Burton funds and loans from its four-member hospitals totaling $484,130.

Subsequently, petitioner contracted with its four participating members to provide laundry services for a period of 20 years. Each hospital committed itself to send a minimum poundage of laundry to petitioner and each member agreed to pay its respective pro rata cost of operations, including debt service, taxes, and insurance.

Assessments of participating hospitals are determined annually and vary according to petitioner's cost of operations. The basic pricing unit is per pound of linen serviced. The monthly payments by the member hospitals to petitioner are based upon actual operating expenses, debt service, and business reserves.

Petitioner provides 24-hour service to its members, 6 days per week. It uses bactericides which provide a longer shelf life for the laundry, freer from bacteria than laundry serviced by commercial laundries. Clean linen and soiled linen are handled in separate areas of the plant, and the clean linen is returned to the hospitals on sterilized carts, ready for distribution. Although there are commercial laundries in the parishes served by petitioner, petitioner's type of bacteria-free service is presently unobtainable from commercial laundries. In general, petitioner is operated in such a way that it realizes little or no net income. However, it is not so operated as to furnish its services at less than cost.

The essence of petitioner's argument is that petitioner is an extension of each of the participating institutions which are, themselves, nonprofit hospitals; consequently, petitioner itself is a section 501(c)(3) exempt organization.

Respondent argues that section 501(e) is the exclusive provision under which a hospital service organization may gain tax-exempt status as a charitable organization, and when Congress enacted section 501(e) hospital service organizations performing laundry services were deliberately excluded. Since Congress deliberately excluded laundry services from section 501(e), argues respondent, it was the legislative intent that petitioner may not avail itself of the provisions of section 501(c)(3). Respondent takes the position that petitioner does not qualify for tax-exempt status under section 501(c)(3) because without the shield of section 501(e), petitioner is a feeder organization under section 502 and the regulations thereunder.

Background

The tax history of hospital service organizations, and laundry service organizations in particular, is a long and stormy one. The feeder organization provisions, which respondent contends apply to petitioner here, were first added to the statute by an amendment to section 101 of the 1939 Code. Section 301(b) of the Revenue Act of 1950, Pub. L. 814, ch. 994, 64 Stat. 953, 81st Cong., 2d Sess., September 23, 1950, added an unnumbered penultimate paragraph to section 101 which read in part as follows:

An organization operated for the primary purpose of carrying on a trade or business for profit shall not be exempt under any paragraph of this section on the ground that all of its profits are payable to one or more organizations exempt under this section from taxation. * * *

The above provision of the 1939 Code was carried over intact as section 502 of the 1954 Code. The feeder organization regulations were originally adopted by T.D. 5924 on August 4, 1952, as sec. 29.101-3(b), Regs. 111, subsequently becoming sec. 39.101-2(b), Regs. 118.

Section 39.101-2(b), Regs. 118, provided in part as follows:

if a subsidiary organization of a tax-exempt organization would itself be exempt on the ground that its activities are an integral part of the exempt activities of the parent organization, its exemption will not be lost because, as a matter of accounting between the two organizations, the subsidiary derives a profit from its dealings with its parent organization, for example, a subsidiary organization which is operated for the sole purpose of furnishing electric power used by its parent organization, a tax-exempt educational organization, in carrying on its educational activities. However, the subsidiary organization is not exempt from tax if it is operated for the primary purpose of carrying on a trade or business which would be an unrelated trade or business (that is, unrelated to exempt activities) if regularly carried on by the parent organization. For example, if a subsidiary organization is operated primarily for the purpose of furnishing electric power to consumers other than its parent organization (and the parent's tax-exempt subsidiary organizations), it is not exempt since such business would be an unrelated trade or business if regularly carried on by the parent organization. Similarly, if the subsidiary is owned by several unrelated exempt organizations, and is operated for the purpose of furnishing electric power to each of them, it is not exempt since such business would be an unrelated trade or business if regularly carried on by any one of the tax-exempt organizations.

The above-quoted provision of Regs. 118 was carried over intact to section 1.502-1(b), Income Tax Regs. The applicability of this provision of the regulations is central to a resolution of the problem before us, and is analyzed in detail infra.

Implicit in the adoption of the feeder organization amendment to section 101 of the 1939 Code and the feeder provisions of section 502 is the rejection of the so-called “destination of income” test, under which tax-exempt status turned not on the business source but on the exempt end use to which the income of the organization is put. Trinidad v. Sagrada Orden, 263 U.S. 578 (1924); Roche's Beach, Inc. v. Commissioner, 96 F.2d 776 (2d Cir. 1938); P. Treusch & N. Sugarman, Tax-Exempt Charitable Organizations 177 (1979).

Comprehensive legislative history of the feeder organization provisions up to 1969 is contained in our opinion in University Hill...