HIT Legal Issues: Legal Structure and Tax Status

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HIT Legal Issues Legal Structure and Tax Status

• HIT SUMMIT WEST MARCH 7, 2005
• Gerry Hinkley Rachel Glitz
• Davis Wright Tremaine LLP San Francisco
• http//www.dwt.com/practc/hit/HIT.cfm

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Overview and Assumptions

• Some form of regional organization is needed
• Minimum geography
• Broad functionality
• Top down
• Bottom up

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Top Down Assumptions

• We will build it, they will come
• Collaborative effort
• Dependent on grants
• No revenue model
• The right thing to do

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Bottom Up Assumptions

• Provider systems
• EMRs for competitive reasons
• Joint activity makes business sense
• Need to ensure EMRs will be interoperable
• Risk management
• Ca-Ching

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Identifying RHIO Functions

• Business Planning and Implementation
• Forum for stakeholders
• Standards for interoperability
• User/participation consensus
• Chains of trust
• Baseline standards for security and privacy
• Connecting to other networks
• Pointers to information
• Education
• Cont

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Identifying RHIO Functions (Cont.)

• Establishing network functionality
• Access to information
• Clinical support
• Public health
• Disease management
• Group purchasing
• Vendor vetting
• Pilot projects
• Sustainability
• Preparing for change
• Mergers/Acquisitions

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Identifying Funding Sources

• Dependent on revenue model
• Grants
• Venture capital
• Debt
• Fees

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Stakeholders

• Providers
• Payors
• Government/Public Health
• Patients
• IT Vendors

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Models

• Corporation
• Pass-through entity
• Governmental Authority

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Corporation

• Attributes
• Governance
• Charitable or proprietary
• Value/Liquidity
• Risk management
• Tax status

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Tax Exempt Corporation

• Formation as nonprofit corporation (the easy
  part)
• Obtaining and maintaining exempt tax status (the
  harder part)
• Why bother?
• Advantages
• Disadvantages

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501(c)(3) Corporation

• Must be organized and operated exclusively for
  charitable purposes
• Organizational test
• Operational test

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Organizational Test

• Must be formed as a nonprofit entity
• Articles of Incorporation (or other organizing
  document) must reflect that RHIO
• is organized exclusively for a charitable purpose
  identified under Section 501(c)(3)
• may not engage, more than insubstantially, in any
  activities that do not further its exempt purpose
• does not permit any part of its net earnings to
  inure to the benefit of a private shareholder or
  individual

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Operational Test

• Must operate exclusively for a charitable
  purpose
• Promotion of Health
• improving the quality of care
• improving the efficiency of care
• preventing medical errors/enhancing patient
  safety
• benefiting medical research
• Educational Activities
• library rulings
• CHIN ruling

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Public Charity Status

• Preferable for 501(c)(3) to qualify as a public
  charity and not a private foundation
• To meet test, RHIO must
• be a supporting organization, to another
  501(c)(3) or
• satisfy one of the support tests demonstrating
  that its funds are derived from the public and/or
  gifts and fees from its exempt activities

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501(c)(4) Corporation

• Must not be organized for profit and must be
  operated exclusively for the promotion of
  social welfare
• to further the common good and general welfare of
  the people of the community, as a whole (may
  overlap with (c)(3) purposes)
• no part of the net earnings may inure to the
  benefit of any private shareholder or individual

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Advantages of (c)(4)

• Permitted to lobby and engage in some political
  activities
• Not required to meet public support test
  applicable to (c)(3)
• Practical alternative for organizations that fail
  to meet 501(c)(3) requirements

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Disadvantages of (c)(4)

• Contributions by donors are not tax deductible
• Contributions from (expenditures by) private
  foundations to a RHIO organized as a (c)(4) are
  limited by taxable expenditure restrictions
• purpose of grant must be exclusively charitable
• foundation must satisfy expenditure
  responsibility requirements

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For Profit Corporation

• Does not enjoy benefits of tax exempt status
• Tax Implications for return on equity investment
  by nonprofits
• Private Benefit
• incidental private benefit only
• Inurement
• private benefit to insiders absolutely
  prohibited
• Intermediate Sanctions (excise tax on excess
  benefit imposed on recipient and RHIOs manager)
• UBIT
• possible if for profit is a nonprofits
  subsidiary

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Pass-Through Entity

• Attributes
• Governance
• Charitable or proprietary
• Value/Liquidity
• Risk management
• Tax status

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Advantages

• Partnership or LLC is not a separately taxable
  entity
• Avoid burdens of applying for and maintaining
  exemption
• Enables each participant to keep its own tax
  attributes

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Disadvantages

• Creates potential tax risks for exempt partners
  (or members)
• could jeopardize exempt status
• must further exempt purpose
• may only benefit non-exempt participants
  incidentally
• could require payment of UBIT

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Governmental Authority

• Attributes
• Governance
• Revenue sources
• Risk management
• Sunshine laws
• Tax status

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Tax Implications

• Governmental authority need not apply for
  recognition of exemption (automatically
  considered a public charity)
• Beneficial to RHIO contributors
• Contributions are tax deductible
• If contributor is an exempt organization,
  contributions equate to gift of public funds (no
  private benefit issue, provided funds are used
  for public purposes)

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Practical Hurdles

• Must rely on legislature for initiative, funding,
  organization and operation
• Potentially takes control away from RHIO users

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Entity Selection Drivers

• Functionality
• Governance
• Role for stakeholders
• Revenue model and funding
• Tax attributes
• Long term viability

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Process

• Stakeholder input
• Top down
• Think of things to do
• Bottom up
• Address identified needs
• Which organizational model will best accomplish
  the goals
• Stakeholder buy-in
• Implementation incubator to independence