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Denying tax-exempt status to a laboratory testing company that provides outpatient services at the request of patients and health care providers, including in an underserved rural community, the IRS concluded (PLR 202125020) that the company was created for broader purposes than those specified in IRC Section 501(c)(3) and had not shown it would be operated exclusively for exempt purposes.

Facts

The company's articles of incorporation state that it was formed "to act as a linkage to health care services while providing services," and do not include any language addressing how assets would be disposed of upon dissolution.

The bylaws further describe the company's purpose to "serve as a linkage to care and social support while offering technician services and screenings to the community at large." Carrying out this purpose would "promote preventative health care screening, quality care, and service efficiency by serving as a community resource and liaison to care and providing certified services to assist in creating a more positive health care experience for the community at large."

The application for exemption described the company as:

• Established to provide certain laboratory tests to outpatients at their request or their health care provider's request
• Utilizing certified technicians and students in training to conduct timed tests, glucose tolerance tests and general blood draw procedures
• Conducting tests for strep, flu, HIV and other health conditions
• Conducting DNA tests and urinalysis
• Contracting with third parties to process the lab tests as needed

The company would advertise its services in informational flyers, on radio and through social media. Company representatives also plan to meet with area health care providers to determine "their willingness to refer patients most eligible to receive services." The company envisions patients being referred by healthcare providers with whom it partners. These referring providers will be required to provide signed orders with patient name and information, provider name and information, and tests ordered.

The company will operate primarily in two cities within the same state. One city has a large number of other laboratories, but the company asserts that its facilities provide "a more intimate approach" and "are more conveniently located in communities where travel to area hospitals and/or the universities are sometimes difficult, particularly for low-income and no-income individuals." The other city is moderately rural with a dearth of testing services like those the company offers. Further, the company asserts that it will "bring healthcare innovation to this moderately rural community, offering an opportunity for more laboratory tests to be performed more expeditiously."

The company plans to initially be supported by fees charged for services but intends to apply for federal and state grants for future support. Its fee schedule would follow one established by the US Department of Health and Human Services. Uninsured and under-insured patients could apply for free or reduced-cost testing by completing a financial assessment to determine eligibility. The company asserts that its services will benefit the community because many residents are low income, do not qualify for Medicare or Medicaid, and have not opted for other plans under the Affordable Care Act.

Finally, the company intends to create a training program for certain students earning certificates from local community colleges.

Law and analysis

To meet the requirements under IRC Section 501(c)(3), an organization must be organized and operated exclusively for purposes described in IRC Section 501(c)(3), and no part of the organization's earnings may inure to a private party (Treas. Reg. Section 1.501 (c)(3)-1(a)(l)).

In determining whether the company was organized for IRC Section 501(c)(3) purposes, the IRS noted that the company's articles of incorporation did not limit its purposes to one or more exempt purposes, and concluded that the purposes stated in the articles go beyond those included in IRC Section 501(c)(3). Further, the articles did not include a dissolution clause to ensure the company's assets would be transferred appropriately, for charitable purposes, when it dissolved.

Turning to the operational test, the IRS noted that providing laboratory testing services primarily for fees indicates that the company has "a substantial non-exempt commercial purpose [that] precludes exemption under IRC Section 501." Citing Better Business Bureau v. United States, 326 U.S. 279 (1945), and Schoger Foundation v. Commissioner, 76 T.C. 380 (1981), the IRS noted that although an organization may carry on activities furthering more than one exempt purpose, it will not be considered operated exclusively for exempt purposes "if it has a single non-charitable purpose that is substantial in nature."

The IRS noted that Revenue Ruling 85-110 considered a tax-exempt hospital providing laboratory testing services for nonpatients to be operating a trade or business that did not further its exempt purposes. Further, the exception offered in the revenue ruling for hospitals providing lab testing services to unserved or underserved areas did not apply here because the IRS concluded the company was "not exclusively serving areas that are devoid of other laboratory testing services."

The IRS analogized the company to the organization described in Revenue Ruling 73-127 — a grocery store in an impoverished area that offered food at very low prices, accepted food stamps, and provided training programs. Although the company plans to operate in low-income areas and offer discounted services, its "primary objective is to provide laboratory testing services for a fee, an independent objective not in furtherance of an exempt purpose," the IRS concluded.

The IRS determined that the company's activities are analogous to those at issue in Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687 (1979) aff'd 625 F.2d 804 (8th Cir. 1980), in which the court held that discounted sales of prescription drugs to the elderly and disabled "is not, without more, in furtherance of a charitable purpose." The activities the company intends to carry on "are normally carried on by commercial entities as a trade or business," the IRS emphasized, adding that "not every activity that promotes health supports tax exemption under [IRC] Section 501(c)(3)."

Citing Harding Hospital, Inc. v. United States, 505 F.2d 1068 (6th Cir. 1974), which held an organization seeking tax-exempt status has the burden of showing it meets the statutory requirements, the IRS concluded the company had failed to provide sufficient information to show it operates exclusively for IRC Section 501(c)(3) purposes.

Implications

The IRS has consistently ruled that a tax-exempt hospital's sales of laboratory testing services to patients substantially further tax-exempt charitable purposes, and therefore do not jeopardize exemption or generate unrelated business taxable income (UBTI). The IRS has also ruled, from time to time, that an exempt hospital's lab services provided to nonpatients, such as unrelated health care providers, is related to exempt purposes and does not generate UBTI if those services either (1) are not available or are not adequately available in the hospital's community, or (2) are carried on for educational purposes (e.g., to obtain specimens for training). But it is not clear what constitutes "not available" or "not adequately available," giving the IRS discretion to make judgments regarding relatedness that may not comport with those of the hospital.

In this case, the IRS determined that the laboratory testing company's community was not sufficiently underserved, given that other testing services were present in the community. Accordingly, exempt organizations that offer lab testing services to nonpatients may want to confirm that they are offering those services either in a community in which the services are not otherwise available or as an integrated part of an educational program.

Even if one or both of these criteria are met, the IRS could determine the lab testing services are not substantially related to an exempt purpose. In such instances, the most conservative approach would be for the exempt organization to treat revenue from lab testing services provided to nonpatients as UBTI or to not offer such services to nonpatients. Exempt organizations that provide lab testing services should review the analysis provided in the PLR and, although it cannot be cited as precedent, reassess current lab testing services for nonpatients to determine if they continue to meet the criteria necessary for exemption.

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