T.C. Memo. 1996-251
UNITED STATES TAX COURT
UNIVERSITY MEDICAL RESIDENT SERVICES, P.C., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
UNIVERSITY DENTAL RESIDENT SERVICES, P.C., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 21401-94X, 21402-94X. Filed May 30, 1996.
Lawrence M. Ross, for petitioners.
Joan Ronder Domike, for respondent.
MEMORANDUM OPINION
FOLEY, Judge: Petitioners, University Medical Resident
Services, P.C. (UMRS), and University Dental Resident Services,
P.C. (UDRS), seek a declaratory judgment under section 7428(a)
that they are exempt from Federal income taxation under section
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501(a) as organizations meeting the requirements of section
501(c)(3). Although they filed separate petitions, these cases
were consolidated under Rule 141(a). Pursuant to Rule 122, the
cases were submitted for decision based on the stipulated
administrative records as defined in Rule 210(b)(10).
Petitioners have exhausted their administrative remedies within
the Internal Revenue Service as required by section 7428(b)(2)
and Rule 210(c)(4), received final adverse rulings dated August
26, 1994, and invoked the jurisdiction of this Court by petitions
filed on November 21, 1994.
Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
Background
Petitioners are professional service corporations organized
under the not-for-profit corporation law of the State of New
York. Each petitioner's principal place of business was in
Buffalo, New York, at the time their respective petitions were
filed.
Prior to 1983, the State University of New York at Buffalo,
New York (the University), sponsored graduate clinical training
programs in medicine and dentistry. Within the University, these
programs were administered by the School of Medicine and
Biomedical Sciences and the School of Dental Medicine
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(collectively, the Schools). The clinical training provided is a
prerequisite to the professional licensing of doctors and
dentists in New York State.
The University does not maintain its own medical center. To
provide the necessary clinical training, the University relies on
its affiliation with several teaching hospitals in the Buffalo
area. All clinical programs are conducted at one or more
teaching hospitals.
Prior to 1983, the Schools and the affiliated teaching
hospitals administered their own programs for the clinical
education of medical and dental residents and fellows
(hereinafter residents and fellows will be referred to
collectively as residents). Each hospital employed its own
residents, met its own payroll, and provided its own benefits
packages. No one hospital or school had the resources necessary
to implement a comprehensive program. As a result, the Schools
and the affiliated teaching hospitals had difficulty maintaining
accreditation for their programs.
In 1981, new accreditation standards, effective beginning in
1982, were announced by the Accreditation Council for Graduate
Medical Education (ACGME). These standards required greater
centralization of decision-making where two or more institutions
join together to provide medical education. In such cases, the
standards required the establishment of mechanisms to ensure that
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the operations of individual institutions are consistent with the
overall mission of the group of institutions.
In 1983, the Schools and the affiliated teaching hospitals
responded to the new accreditation standards by entering into a
contract entitled “The Graduate Medical and Dental Education
Consortium of Buffalo” (the Consortium Agreement). The
Consortium Agreement created a membership organization (the
Consortium) comprising the Schools and several affiliated
teaching hospitals.
Through the Consortium Agreement, decision-making related to
the conduct of clinical training programs was centralized, and
the Consortium became the sole sponsoring institution with
ultimate responsibility for all clinical training programs
conducted at any of the hospitals. The Consortium Agreement
states:
The Graduate Medical Dental Education Consortium of
Buffalo * * *, established in 1983, is a membership
organization designed to coordinate and manage the
graduate medical and dental education programs * * *
approved by the Accreditation Council for Graduate
Medical Education (ACGME) and the American Dental
Association (ADA) throughout the affiliated teaching
institutions in Western New York. * * * [The
Consortium] is the sponsoring institution of record for
graduate medical and dental education programs in
Western New York in compliance with the requirements of
the ACGME and ADA. * * * [The Consortium] provides
overall management and assumes final responsibility for
that graduate medical and dental education.
All decisions relating to program operations, resource
allocations, residents' grievances, disciplinary actions, and
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policy development are made by the Consortium. It makes and
implements these decisions through meetings of the Consortium, a
coordinating board that makes recommendations to the Consortium,
and three standing committees. Each of these organizational
units consists of representatives from the Schools and the
affiliated teaching hospitals. Prior to 1991, the Schools and
the member hospitals employed their own residents.
In June of 1991, UMRS and UDRS were incorporated. The
certificates of incorporation, filed in June of 1991 and amended
in April of 1992, state that the corporations were formed to
render those professional services that a doctor (in the case of
UMRS) or a dentist (in the case of UDRS) is authorized to render.
They further state that the corporations may engage in any
activity that a professional service corporation is permitted to
engage in under New York law, subject to the limitation that the
corporations may not engage in any activity that would prevent
them from qualifying under section 501(c)(3) as tax-exempt
organizations. In the event of dissolution, all assets of each
corporation are to be paid to the University or, in the event
that the University loses its tax-exempt status under section
501(c)(3), to a tax-exempt organization qualified under section
501(c)(3) and selected by each petitioner's board of directors.
Under New York law, the shares of professional service
corporations can be issued only to individuals authorized to
practice the profession that the corporation is authorized to
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practice. Although the corporations were each authorized to
issue 200 shares of stock, each corporation issued only 1 share.
The UMRS share is held by Michael F. Noe, M.D., UMRS's president.
The UDRS share is held by Sanford I. Nusbaum, D.D.S., UDRS's
president. Each shareholder is a faculty member of the
University and an employee of one of the affiliated teaching
hospitals. Each serves without compensation from petitioners.
In July of 1991, the Consortium, affiliated teaching
hospitals, UMRS, and UDRS entered into the "Graduate Medical and
Dental Education Consolidation Contract" (the Consolidation
Contract). The Recitals section of the Consolidation Contract
provides as follows:
I. * * * [The Consortium] is the institution of
record for governing graduate medical and dental
education programs in Western New York to comply with
the requirements of the Accreditation Council on
Graduate Medical Education, and * * * [the Consortium]
provides overall management and program control for
that graduate medical and dental education. * * *
[UMRS] AND * * * [UDRS] * * * are professional service
corporations controlled by * * * [the Consortium].
II. To promote the pooling of resources dedicated
to graduate medical and dental education, to improve
hospital and ambulatory care and related health care
for patients in the Western New York area and to
coordinate more closely the academic medical and dental
programs in the Teaching Hospitals, the Teaching
Hospitals and * * * [the Consortium] desire to provide
for the direct employment by * * * [UMRS] of the
medical residents and fellows and the direct employment
by * * * [UDRS] of the dental residents and fellows who
are enrolled in * * * [the University] training
programs conducted at the Teaching Hospitals, with
coordination of the medical and dental education
aspects of this employment by the Administrative
Committee of * * * [the Consortium]. * * * [UMRS] and
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* * * [UDRS] have been established to provide for that
respective direct employment of the medical and dental
residents and fellows.
The Consolidation Contract allocates responsibility among
the Schools, the hospitals, the Consortium, and petitioners. It
provides that, commencing July 1, 1991, all residents enrolled in
academic medical programs administered by the Consortium “shall
become employed by” UMRS, and all residents enrolled in academic
dental programs administered by the Consortium “shall become
employed by” UDRS. It further provides that the affiliated
teaching hospitals would contract with petitioners for the
provision of residents. Petitioners serve only the Schools and
the affiliated teaching hospitals, each of which is a tax-exempt
organization qualified under section 501(c)(3).
Under the Consolidation Contract, the Schools and the
hospitals follow specific procedures with respect to the
allocation of residents. The program directors at each of the
teaching hospitals project their hospital's needs for residents
and communicate that estimate to the Consortium. Applicants for
residency positions submit an application to the Consortium. The
Schools, the Consortium, and the teaching hospitals then select
residents to meet each hospital's needs and communicate that
selection to UMRS (in the case of medical residents) or UDRS (in
the case of dental residents). Thereafter, a certificate of
residency is issued by the Consortium, and the resident is
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assigned to the appropriate hospital. The Consolidation Contract
provides:
The parties recognize that, due to the fact that the
employment of the * * * [residents] is ancillary to the
primary purpose of graduate medical and dental
education, the selection, credentialing, academic
instruction and supervision of the * * * [residents]
is, to a large extent, uniquely within the province of
* * * [the University] and * * * [the Consortium],
subject to the legal obligations of the respective
Teaching Hospitals to supervise professional practice
and other matters within their respective facilities.
Accordingly, it is contemplated that * * * [UMRS] and
* * *[UDRS] would have limited input into the process
selecting the individuals comprising the Housestaff
* * *.
The Consolidation Contract also states that petitioners have
the power to “hire and fire” residents. The affiliated teaching
hospitals, however, supervise the residents and have the right to
refuse to accept the assignment of a particular resident. The
Consortium and the affected teaching hospital have the right to
discipline residents. The Consolidation Contract provides that
petitioners are not legally liable for lawsuits resulting from
such disciplinary actions. The Consolidation Contract further
states that each hospital must provide medical malpractice
insurance for the residents working at its facility and must
indemnify petitioners for all liability arising out of alleged
malpractice on the part of residents.
Once a resident is selected and allocated to a member
hospital, the relevant petitioner assumes responsibility for the
payment of all wages, benefits, and related payroll taxes and
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deductions in connection with the resident's employment. The
Consortium determines the amount of compensation and benefits.
At least 5 days prior to the date UMRS or UDRS makes a payment
for compensation, the relevant school or hospital remits to UMRS
or UDRS funds equal to the amount of the payment. Petitioners do
not engage in fund-raising activities and receive all of their
funding from the Schools and hospitals.
Under the Consolidation Contract, petitioners must provide
the Schools and hospitals with quarterly reports describing all
receipts and disbursements, and the Consortium has the right to
audit petitioners’ books and records. Because petitioners have
no administrative employees, petitioners' administrative
activities (i.e., processing invoices sent to the Schools and
hospitals and salary payments made to residents) are performed by
employees of the Schools. Each petitioner's actual and projected
annual profits, as of May of 1992, were less than one-tenth of 1
percent of gross revenue.
On August 26, 1994, respondent issued final adverse rulings
notifying petitioners that they did not qualify for tax
exemption. The rulings each stated in pertinent part:
You have failed to establish that you will be operated
exclusively for exempt purposes as required by section
501(c)(3) of the Code. Your primary activity is to
provide administrative services to teaching hospitals
affiliated through the Consortium with the State
University of New York at Buffalo residency training
program by paying salaries and fringe benefits of the
residents working in these hospitals. This activity
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does not advance education within the meaning of
section 1.501(c)(3)-1(d)(1) of the Income Tax
Regulations. You also do not qualify under section
501(e) of the Code because you are not operating on a
cooperative basis.
Discussion
I. In General
Section 501(a) provides an exemption from Federal income tax
for organizations described in section 501(c). Section 501(c)
sets forth a list of exempt organizations. The list includes
organizations “organized and operated exclusively for * * *
charitable * * * or educational purposes”. Sec. 501(c)(3).
Section 501(e), entitled “Cooperative Hospital Service
Organizations”, provides that an organization will be treated as
meeting the requirements of section 501(c)(3) if the organization
is: (1) Organized and operated exclusively to provide listed
services solely to two or more hospitals meeting certain
requirements; (2) organized on a cooperative basis and paying net
earnings to members within a specified time period; and (3)
wholly owned by the members if the organization has capital
stock. Sec. 501(e).
Petitioners contend that they are charitable and educational
organizations within the meaning of section 501(c)(3).
Respondent counters that petitioners are neither charitable nor
educational organizations and that they are operated for a
substantial nonexempt purpose. Respondent further argues that
petitioners do not fit within section 501(e), and that, pursuant
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to the Supreme Court's decision in HCSC-Laundry v. United States,
450 U.S. 1 (1981), petitioners cannot qualify under section
501(c)(3).
As a preliminary matter, we note that, in this case, section
501(e) does not preclude an analysis under section 501(c)(3). In
HCSC-Laundry v. United States, supra, the Supreme Court held that
section 501(e) is the exclusive provision for hospital
cooperatives to qualify under section 501(c)(3) and that a
hospital cooperative that does not satisfy section 501(e) cannot
qualify independently under section 501(c)(3). To qualify as a
hospital cooperative under section 501(e), the organization must
provide services “solely for two or more hospitals”. Petitioners
serve schools in addition to hospitals. Thus, they are not
hospital cooperatives, and section 501(e) does not preclude
petitioners from qualifying under section 501(c)(3).
To qualify under section 501(c)(3), petitioners must
establish that they are both “organized and operated” exclusively
for exempt purposes. Sec. 1.501(c)(3)-1(a)(1), Income Tax Regs.
Respondent concedes that petitioners are organized exclusively
for exempt purposes but argues that petitioners are not operated
exclusively for such purposes. An organization will be regarded
as operated exclusively for exempt purposes only if it engages
primarily in activities that accomplish one or more exempt
purposes listed in section 501(c)(3). Sec. 1.501(c)(3)-1(c)(1),
Income Tax Regs. Whether an organization is operated exclusively
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for one or more exempt purposes is a question of fact to be
resolved on the basis of all the evidence in the administrative
record. B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352, 357
(1978); Washington Research Found. v. Commissioner, T.C. Memo.
1985-570. Petitioners have the burden of establishing that the
grounds for denying exemption stated in the final notices of
determination were inadequate. Rule 217(c)(2)(A); Florida Hosp.
Trust Fund v. Commissioner, 103 T.C. 140, 146 (1994), affd. 71
F.3d 808 (11th Cir. 1996).
II. Qualification as “Charitable” Under Section 501(c)(3)
Petitioners argue that they are operated exclusively for
“charitable” purposes. The term charitable is used in section
501(c)(3) in its generally accepted legal sense, which includes
the “advancement of education” and “lessening the burdens of
Government”. Nationalist Movement v. Commissioner, 102 T.C. 558,
576, affd. 37 F.3d 216 (5th Cir. 1994); Sec. 1.501(c)(3)-1(d)(2),
Income Tax Regs.
A. Advancement of Education
Petitioners contend that they advance education in two ways.
We reject both of petitioners' contentions. First, petitioners
argue that they advance education by assisting the Schools in
meeting several requirements imposed by the ACGME accreditation
standards. Petitioners contend that they assist in the provision
of uniform pay and benefits for residents of similar experience
levels, as required by the accreditation standards. The
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Consortium Agreement, however, states that the Consortium, not
petitioners, determines resident compensation levels.
Petitioners contend that they assist in the provision of
professional liability insurance for residents, as required by
the accreditation standards. The Consolidation Contract,
however, states that the member hospitals, not petitioners,
provide such insurance. Petitioners contend that they assist in
the provision of adequate financial support to residents, as
required by the accreditation standards. The Consolidation
Contract, however, states that the Schools and hospitals, not
petitioners, provide all funding of resident salaries and
benefits. Indeed, the Consortium Agreement states that it is the
Consortium, not petitioners, that generally has responsibility
for ensuring compliance with the accreditation standards.
Consequently, we conclude that petitioners provide the Schools
and hospitals minimal, if any, assistance in meeting these
standards.
Second, petitioners argue that they advance education by
working with the Schools and hospitals to manage program-related
activities. Petitioners, however, do not manage any educational
programs. Petitioners emphasize that they have the right to hire
and fire residents. The Schools and hospitals, however, have an
effective veto over petitioners’ hiring decisions because the
Schools and hospitals have the right to refuse to allow a
resident to perform his or her duties. In addition, the
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Consortium handles all resident grievances including matters of
termination of employment. Thus, even if the Consolidation
Contract grants petitioners the right to hire and fire residents,
other provisions of the contract supersede that right by
delegating substantial responsibility to the Consortium and its
members. Further, even if petitioners did have responsibility
for the program, they have no administrative employees, so it is
unclear how they would discharge this responsibility.
Petitioners have not met their burden of establishing that they
advance the education of residents.
B. Lessening the Burdens of Government
Petitioners also argue that they lessen the burdens of
Government. An organization lessens the burdens of Government if
(1) the activities undertaken are those that the Government
considers to be its burden, and (2) those activities actually
lessen such burdens. Columbia Park & Recreation Association v.
Commissioner, 88 T.C. 1, 21 (1987), affd. without published
opinion 838 F.2d 465 (4th Cir. 1988).
Petitioners have not established that the Schools and/or
hospitals constitute governmental agencies. Nor have they
established that the activities they have undertaken are those
that the Government considers its burden. Even if we assume that
petitioners had established these points, their activities do not
lessen any burdens. All of petitioners' financial support comes
from the Schools and hospitals. The cost of paying salaries and
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providing benefits is passed on to the Schools and hospitals and
is the cost that would be incurred if the Schools and hospitals
payed the residents themselves. Further, the administrative
costs of these activities are not assumed by petitioners because
the work is performed by employees of the Schools.
Petitioners argue that Rev. Rul. 85-2, 1985-1 C.B. 178,
supports their contention that they should qualify as exempt
organizations. We disagree. In that revenue ruling, the rules
of a local court required the appointment of guardians ad litem
to represent children in cases involving abuse. An organization
was formed to train volunteer guardians who ultimately replaced
court-hired attorneys. The organization was not fully funded by
the court. Thus, the organization lessened the burdens of
Government. In the present case, petitioners are funded in full
by the Schools and hospitals. Petitioners do not contribute any
funds toward the education of residents. Consequently, the
revenue ruling is not applicable.
III. Qualification as “Educational” under Section 501(c)(3)
Petitioners' final argument is that they qualify as
“educational” organizations. Generally, the term "educational"
as used in section 501(c)(3) relates to (1) the instruction or
training of an individual for the purpose of improving or
developing his capabilities or (2) the instruction of the public
on subjects useful to an individual and beneficial to the
community. Sec. 1.501(c)(3)-1(d)(3), Income Tax Regs.
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Petitioners do not claim to qualify independently as educational
organizations, but contend, under the integral part doctrine,
that they are entitled to share in the Consortium members’ exempt
status. See Hospital Bureau of Standards & Supplies, Inc. v.
United States, 141 Ct. Cl. 91, 158 F. Supp. 560 (1958).
The integral part doctrine is not a codified rule, but is a
judicial doctrine recognized in cases, regulations, and revenue
rulings as a basis for derivative exemption under section
501(c)(3). The cases applying this doctrine have held that where
an organization (1) bears a “close and intimate relationship” to
the operation of one or more tax-exempt organizations, and (2)
provides a "necessary and indispensable" service solely to those
tax-exempt organizations, it will take on the exempt status of
those organizations. See, e.g., Hospital Bureau of Standards &
Supplies, Inc. v. United States, supra at 562; Council for
Bibliographic & Info. Technologies v. Commissioner, T.C. Memo.
1992-364.
The rationale behind the integral part doctrine is that an
organization that takes over an essential task which would
otherwise have to be performed by the organizations served should
be exempt because the members would continue to be exempt if they
performed the task themselves. Cf. Hospital Bureau of Standards
& Supplies, Inc. v. United States, supra at 562-563 (concluding
that an organization that took over an essential task was exempt
under integral part doctrine); Nonprofits' Ins. Alliance v.
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United States, 32 Fed. Cl. 277, 288 (1994) (concluding that an
organization that took over a nonessential task was not exempt
under the integral part doctrine). In cases granting exemption
based on the integral part doctrine, the organization seeking
exemption invariably contributed to the attainment of its
members’ exempt purpose. Nonprofits' Ins. Alliance v. United
States, supra; cf. Northern Cal. Cent. Servs., Inc. v. United
States, 219 Ct. Cl. 60, 591 F.2d 620 (1979) (involving an
independent corporation that provided higher quality laundry
services for member hospitals at lower cost in furtherance of
their exempt purpose); Estate of Thayer v. Commissioner, 24 T.C.
384 (1955) (involving an independently funded trust that
published a newsletter and operated a scholarship program in
furtherance of a university’s exempt purpose).
In the present case, petitioners’ function is merely
incidental to the exempt purpose of the organizations they
serve. Indeed, the Consolidation Contract states that "the
employment of the * * * [residents] is ancillary to the primary
purpose of graduate medical and dental education". (Emphasis
added.) A comparison of the facts in Hospital Bureau and Council
for Bibliographic & Info. Technologies with those in the present
case further establishes this point. In Hospital Bureau and
Council for Bibliographic & Info. Technologies, the organizations
seeking exemption took over functions previously performed by the
organizations they served in order to achieve cost reductions and
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better achieve the organizations’ exempt purpose. Hospital
Bureau of Standards & Supplies v. United States, supra (involving
a corporation that took over the purchasing of hospital supplies
in order to achieve volume discounts for its members); Council
for Bibliographic & Info. Technologies v. Commissioner, supra
(involving a corporation that took over operation and maintenance
of a computerized library research system enabling member
libraries to better perform their exempt functions). In the
present case, petitioners are superfluous corporate shells that
make no cognizable contribution to the education of residents.
Despite petitioners' incorporations, all funds continue to be
provided by the Schools and hospitals, and all program-related
decisions continue to be made through the Consortium. The
Schools and the hospitals continue to supervise and train the
residents and pay their salaries. In addition, the Consortium
continues to make the policy decisions, just as it has since
1983. The only change since the incorporation of petitioners is
that the money used to pay residents is funneled through
petitioners before it reaches the residents. As the
Consolidation Contract states, the Consortium has “overall
management and program control” with respect to the education of
residents. Petitioners are merely "corporations controlled by
* * * [the Consortium]." In substance, petitioners appear to be
appendages rather than integral parts.
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IV. Conclusion
We hold that petitioners have not satisfied their burden of
establishing that respondent's final adverse determinations were
erroneous. Our holding is consistent with the policy underlying
section 501(c)(3). The Supreme Court has stated that Congress,
in enacting section 501(c)(3), sought to “encourage the
development of private institutions that serve a useful public
purpose or supplement or take the place of public institutions of
the same kind.” Bob Jones Univ. v. United States, 461 U.S. 574,
588 (1983). In essence, an organization obtains exemption from
tax under section 501(c)(3) in recognition of its contribution to
the public. Petitioners make no such contribution.
To reflect the foregoing,
Decisions will be entered
for respondent.