Harding Hosp., Inc. v. U.S.
| Decision Date | 13 November 1974 |
| Docket Number | No. 73-1661,73-1661 |
| Citation | 505 F.2d 1068 |
| Parties | 74-2 USTC P 9816 HARDING HOSPITAL, INC., Plaintiff-Appellant, Appellant, v. UNITED STATES of America, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Herbert R. Brown, Vorys, Sater, Seymour & Pease, Richard R. Stedman, Byron E. Ford, Columbus, Ohio, for plaintiff-appellant.
William W. Milligan, U.S. Atty., Columbus, Ohio, Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Thomas R. Jones, Donald R. Anderson, Elmer Kelsey, Murray S. Horwitz, Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellee.
Before PHILLIPS, Chief Judge, and EDWARDS and PECK, Circuit Judges.
The sole issue presented in this appeal is whether Harding Hospital, Inc. (the Hospital) qualified under 501(c)(3) of the Internal Revenue Code of 1954 as an organization exempt from federal income taxes during the years 1966, 1967 and 1968. The District Court determined, inter alia, that the Hospital was not operated exclusively for charitable purposes and denied the exemption. We affirm.
Reference is made to the opinion of the District Court for a comprehensive statement of the facts. 358 F.Supp. 805, 806-810 (S.D.Ohio 1973).
The Hospital commenced this civil tax refund suit to recover $141,730 from the United States. That sum represented the aggregate amount of income taxes which the Hospital paid for the three years in question.
The Hospital, a nationally recognized psychiatric institution, treats mental and nervous diseases. It utilizes a method of treatment known as milieu therapy in which a patient's total environment is controlled on an around the clock basis and structured toward rehabilitation.
The Hospital was originally a corporation for profit. In December 1961, its articles of incorporation were amended to adopt its present name and to qualify under Ohio law as a corporation not for profit. In the reorganization, the shareholders of the predecessor corporation exchanged their stock which was valued at approximately $3,800 per share for notes having a face value of $3,000 per share and bearing interest at the annual rate of four per cent.
The reorganization was carried out along guidelines established through conferences with officials of the Exempt Organizations Branch of the Internal Revenue Service (IRS). In 1962 the IRS issued a tentative ruling that the Hospital was exempt from paying federal income taxes under 501(c)(3) of the Code. In a letter dated December 1, 1965, the IRS indicated that it proposed to revoke the tentative exemption ruling issued in 1962. On November 14, 1968, the District Director of the IRS issued a determination letter revoking the tentative ruling of 1962. The Hospital was declared not to be exempt and thus was required to file federal income tax returns. Since the Hospital had relied on the 1962 ruling, the IRS determined that the revocation of the 1962 ruling would not be applied prior to January 1, 1966.
Before amending its articles of incorporation, the Hospital had a contract with a medical partnership composed of seven doctors. This medical partnership performed all the psychiatric treatment on ninety to ninety-five per cent of the patients admitted to the Hospital. Immediately after the Hospital's change in status in 1962, the medical partnership was incorporated as the Harding-Evans Medical Associates, Inc. (the Associates).
Starting in 1962, and for the years in question, the Hospital entered into contracts with the Associates whereby the Associates provided medical supervision in the Hospital, teaching and supervision in the residency and other training programs, and medical service to the Hospital's indigent patients without a charge or at a reduced rate. For these services, the Hospital paid the Associates an annual amount of $25,000. This amount was raised to $35,000 as of July 1, 1968. Further, the agreement provided that the Associates were to pay the Hospital $1,000 per month as rental for facilities, equipment and business office services. This rental was increased to $35,000 per year as of January 1, 1965. It subsequently was lowered to $15,000 per year as of July 1, 1968, at the same time that the amount which the Hospital paid the Associates for medical supervision was increased from $25,000 to $35,000.
Since 1963, individuals not connected with the Associates have constituted a majority of the Board of Trustees of the Hospital. During the years in question, the Board consisted of nine members, only two of whom had any connection with the Associates of the Hospital prior to the 1961 reorganization.
The Harding-Evans Foundation (the Foundation) was set up in 1959 and is an entity separate from the Hospital and the Associates. The Foundation is a tax exempt organization, the principal activity of which is to provide a residency program in the field of psychiatry for the physicians. The Foundation collects charitable funds and expends them on the residency training program at the Hospital.
Since the early days of federal income tax law, corporations organized and operated exclusively for charitable, religious, educational and certain other purposes have been accorded exemption from the tax. Act of Oct. 3, 1913, c. 16, II, G, 38 Stat. 172. The exemption is conferred in recognition of the benefit which the public derives from the activities of such organizations. See, e.g., Trinidad v. Sagrada Orden, 263 U.S. 578, 581, 44 S.Ct. 204, 68 L.Ed. 458 (1924); St. Louis Union Trust Co. v. United States, 374 F.2d 427, 432 (8th Cir. 1967).
'The Government is compensated for the loss of revenue (caused by the exemption) by its relief from financial burden which would otherwise have to be met by appropriations from public funds, and by the benefits resulting from the promotion of the general welfare.' H.Rep.No.1860, 75th Cong., 3d Sess., p. 19 .
An exemption is an exception to the norm of taxation. An organization which seeks to obtain tax exempt status, therefore, bears a heavy burden to prove that it satisfies all the requirements of the exemption statute. The Supreme Court repeatedly has said that exemptions from taxation are not granted by implication. See, e.g., Mescalero Apache Tribe v. Jones, 411 U.S. 145, 156, 93 S.Ct. 1267, 36 L.Ed.2d 114 (1973), and authorities therein cited. The Tax Court has stated consistently that '(a) statute creating an exemption must be strictly construed and any doubt must be resolved in favor of the taxing power.' American Automobile Association v. Commissioner, 19 T.C. 1146, 1158 (1953); Associated Industries of Cleveland v. Commissioner, 7 T.C. 1449, 1464 (1946).
Section 501(a) of the Code provides that the following organizations, which are listed in 501(c)(3), are exempt from federal income taxation:
'Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation, and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of any candidate for public office.'
In the context of the present case, this section essentially imposes three requirements for exemption: 1) the corporation must be organized and operated exclusively for charitable purposes; 2) no part of its net earnings may inure to the benefit of a private individual or shareholder and 3) it cannot engage in certain lobbying and political activities. The Government stipulated that the Hospital did not offend the third requirement for exemption.
The requirements in 501(c)(3) are stated in the conjunctive. A taxpayer's failure to satisfy any one of them therefore causes a loss of the tax exemption. Stevens Bros. Foundation, Inc. v. Commissioner, 324 F.2d 633 (8th Cir. 1963), cert. denied, 376 U.S. 969, 84 S.Ct. 1135, 12 L.Ed.2d 84 (1964). Consequently, the Hospital must satisfy both the first and second requirements listed above in order to qualify for exemption from income taxation during the years in question.
The term 'exclusively', as used in 501(c)(3), means that an organization is not exempt if it has any substantial noncharitable purpose. Better Business Bureau v. United States, 326 U.S. 279, 283, 66 S.Ct. 112, 90 L.Ed. 67 (1945); Seasongood v. Commissioner, 227 F.2d 907, 910 (6th Cir. 1955). This view is supported by Treas.Reg. 1.501(c)(3)-1(c)(2) which states:
'An organization is not operated exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals. * * *'
and by Treas.Reg. 1.501(c)(3)-1(d)(1)(ii) which provides as follows:
The term 'charitable' is used in 501(c)(3) in its generally accepted legal sense and is, therefore, not to be construed as limited by the separate enumeration in 501(c)(3) of other tax exempt purposes which may fall within the broad outlines of 'charity' as developed by judicial decisions. Treas.Reg. 1.501(c)(3)-1(d)(2).
The phrase 'net earnings', as used in 501(c)(3), may include 'more...
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