- Hospital lab services may not constitute unrelated trade or business: IRS Technical Advice Memorandum
- July 28, 2014 | Author: Wakaba Y. Tessier
- Law Firm: Husch Blackwell LLP - St. Louis Office
On July 11, 2014, the Internal Revenue Service (“IRS”) released a Technical Advice Memorandum (“TAM”) dated March 7, 2008, which concluded that, contrary to the general rule set forth in Revenue Ruling 85-110 (“Rev. Ruling 85-110”), a tax-exempt hospital’s income from laboratory testing services to patients of private physicians is not subject to the unrelated business income tax.
Section 511 of the Internal Revenue Code (“Code”) imposes a tax on the unrelated business taxable income of tax-exempt organizations. Unrelated business taxable income is income derived by a tax-exempt organization from a trade or business unrelated to the exercise or performance of the organization’s purpose or function constituting the basis for its exemption. Previously, in Rev. Ruling 85-110, the IRS had held that a tax-exempt hospital’s provision of laboratory services constituted an unrelated trade or business and therefore provided taxable income.
The facts set forth in the TAM are as follows. A hospital located in a rural, medically underserved area provides laboratory services to both its patients and patients of private physicians who are not the hospital’s patients. While a commercial laboratory is available to these private physicians, the commercial lab is located in a different state, and samples are only picked up once a day at the end of the day. The hospital’s laboratory, on the other hand, operates 24 hours a day, seven days a week, 365 days a year. One of the laboratory’s pathologists is available to provide feedback to physicians 24 hours a day, seven days a week. Most physicians in the area use the hospital’s laboratory, viewing the hospital’s quick turnaround time as a critical distinction that may have important medical consequences for their patients, particularly for older patients.
Differentiating this situation from the facts of Revenue Ruling 85-110, the IRS found the hospital’s provision of laboratory services for the private physicians’ patients did not constitute an unrelated trade or business and that such services contributed to the hospital’s tax-exempt purpose of improving the health of its surrounding communities.
In contrast to the TAM, in Rev. Ruling 85-110, the commercial laboratories that performed testing identical to that performed by the hospital were available in the area and provided testing services on a timely basis. As such, in Rev. Ruling 85-110, the hospital laboratory’s testing for the private physicians’ patients constituted a separate trade or business. However, Rev. Ruling set forth an exception to the general rule stating:
. . . if other laboratories are not available within a reasonable distance from the area served by the Hospital or are clearly unable or inadequate to conduct tests needed by Hospital Nonpatients, a hospital’s testing services may further its exempt function of promoting community health.
The IRS found the situation set forth in the TAM fit within the exception it had carved out in Rev. Ruling 85-110. In reaching its conclusion in the TAM, the IRS found:
. . . although other laboratories are available and able to conduct tests needed by [the hospital’s] non-patients, they are unable to do so adequately [because the commercial laboratory] . . . is not within a reasonable distance of those communities to adequately serve their health care needs, particularly the needs of patients for timely laboratory testing. Because [the hospital] provides adequate laboratory services to its surrounding communities, [the hospital] promotes the health of the community and its laboratory services contribute importantly to the accomplishment of [the hospital’s] tax exempt purpose of improving the health of its community.
The IRS’s conclusion in the TAM highlights the exception set forth in Rev. Ruling 85-110 and provides that the provision of laboratory services in this circumstance is not subject to the unrelated business income tax. The IRS seems to place importance on the number of alternatives available in the area (i.e., commercial laboratories) compared to the needs of the community and the potential medical consequences associated with the lack of alternatives.
The TAM is important in that it demonstrates when a tax-exempt hospital can avoid classification of its laboratory-related services as an unrelated trade or business. This ruling may have potential ripple effects to hospitals providing other services in rural, medically underserved areas, where alternatives for those particular services are lacking.