1.501(e)-1. Cooperative hospital service organizations
(a) General rule. --Section 501(e) is the exclusive and controlling
section under which a cooperative hospital service organization
can qualify as a charitable organization. A cooperative hospital
service organization which meets the requirements of section
501(e) and this section shall be treated as an organization
described in section 501(c)(3), exempt from taxation under section
501(a), and referred to in section 170(b)(1)(A)(iii) (relating
to percentage limitations on charitable contributions). In order
to qualify for tax exempt status, a cooperative hospital service
organization must --
(1) Be organized and operated on a cooperative
basis,
(2) Perform, on a centralized basis, only one
or more specifically enumerated services which, if performed
directly by a tax exempt hospital, would constitute activities
in the exercise or performance of the purpose or function constituting
the basis for its exemption, and
(3) Perform such service or services solely
for two or more patron-hospitals as described in paragraph (d)
of this section.
(b) Organized and operated on a cooperative
basis
(1) In general. --In order to meet the requirements
of section 501(e), the organization must be organized and operated
on a cooperative basis (whether or not under a specific statute
on cooperatives) and must allocate or pay all of its net earnings
within 81/2 months after the close of the taxable year to its
patron-hospitals on the basis of the percentage of its services
performed for each patron. To "allocate" its net earnings
to its patron-hospitals, the organization must make appropriate
bookkeeping entries and provide timely written notice to each
patron-hospital disclosing to the patron-hospital the amount
allocated to it on the books of the organization. For the recordkeeping
requirements of a section 501(e) organization, see §1.521-1(a)(1).
(2) Percentage of services defined. --The percentage
of services performed for each patron-hospital may be determined
on the basis of either the value or the quantity of the services
provided by the organization to the patron-hospital, provided
such basis is realistic in terms of the actual cost of the services
to the organization.
(3) Retention of net earnings. --Exemption will
not be denied a cooperative hospital service organization solely
because the organization, instead of paying all net earnings
to its patron-hospitals, retains an amount for such purposes
as retiring indebtedness, expanding the services of the organization,
or for any other necessary purpose and allocates such amounts
to its patrons. However, such funds may not be accumulated beyond
the reasonably anticipated needs of the organization. See §1.537-1(b).
Whether there is an improper accumulation of funds depends upon
the particular circumstances of each case. Moreover, where an
organization retains net earnings for necessary purposes, the
organization's records must show each patron's rights and interests
in the funds retained. For purposes of this paragraph, the term
"net earnings" does not include capital contributions
to the organization and such contributions need not satisfy
the allocation or payment requirements.
(4) Nonpatronage and other income. --An organization
described in section 501(e) may, in addition to net earnings,
receive membership dues and related membership assessment fees,
gifts, grants and income from nonpatronage sources such as investment
of retained earnings. However, such an organization cannot be
exempt if it engages in any business other than that of providing
the specified services, described in paragraph (c), for the
specified patron-hospitals, described in paragraph (d). Thus,
an organization described in section 501(e) generally cannot
have unrelated business taxable income as defined in section
512, although it may earn certain interest, annuities, royalties,
and rents which are excluded from unrelated business taxable
income because of the modifications contained in sections 512(b)(1),
(2) or (3). An organization described in section 501(e) may,
however, have debt-financed income which is treated as unrelated
business taxable income solely because of the applicability
of section 514. In addition, exempt status under section 501(e)
will not be affected where rent from personal property leased
with real property is treated as unrelated business taxable
income under section 512(b)(3)(A)(ii) solely because the rent
attributable to the personal property is more than incidental
or under section 512(b)(3)(B)(i) solely because the rent attributable
to the personal property exceeds 50 percent of the total rent
received or accrued under the lease. Exemption will not be affected
solely because the determination of the amount of rent depends
in whole or in part on the income or profits derived from the
property leased. See, section 512(b)(3)(B)(ii). An organization
described in section 501(e) may also derive nonpatronage income
from sources that are incidental to the conduct of its exempt
purposes or functions. For example, income derived from the
operation of a cafeteria or vending machines primarily for the
convenience of its employees or the disposition of by-products
in substantially the same state they were in on completion of
the exempt function (e.g., the sale of silver waste produced
in the processing of x-ray film) will not be considered unrelated
business taxable income. See, section 513(a)(2) and §1.513-1(d)(4)(ii).
The nonpatronage and other income permitted under this subparagraph
(4) must be allocated or paid as provided in subparagraph (1)
or retained as provided in subparagraph (3).
(5) Stock ownership
(i) Capital stock of organization. --An organization
does not meet the requirements of section 501(e) unless all
of the organization's outstanding capital stock, if there is
such stock, is held solely by its patron-hospitals. However,
no amount may be paid as dividends on the capital stock of the
organization. For purposes of the preceding sentence, the term
"capital stock" includes common stock (whether voting
or nonvoting), preferred stock, or any other form evidencing
a proprietary interest in the organization.
(ii) Stock ownership as a condition for obtaining
credit. --If by statutory requirement a cooperative hospital
service organization must be a shareholder in a United States
or state chartered corporation as a condition for obtaining
credit from that corporate-lender, the ownership of shares and
the payment of dividends thereon will not for such reason be
a basis for the denial of exemption to the organization. See,
e.g., National Consumer Cooperative Bank, 12 USC §3001
et seq.
(c) Scope of services
(1) Permissible services. --An organization
meets the requirements of section 501(e) only if the organization
performs, on a centralized basis, one or more of the following
services and only such services: data processing, purchasing
(including the purchasing and dispensing of drugs and pharmaceuticals
to patron-hospitals), warehousing, billing and collection, food,
clinical (including radiology), industrial engineering (including
the installation, maintenance and repair of biomedical and similar
equipment), laboratory, printing, communications, record center,
and personnel (including recruitment, selection, testing, training,
education and placement of personnel) services. An organization
is not described in section 501(e) if, in addition to or instead
of one or more of these specified services, the organization
performs any other service (other than services referred to
under paragraph (b)(4) that are incidental to the conduct of
exempt purposes or functions).
(2) Illustration. --The provisions of this subparagraph
may be illustrated by the following example.
Example. An organization performs industrial
engineering services on a cooperative basis solely for patron-hospitals
each of which is an organization described in section 501(c)(3)
and exempt from taxation under section 501(a). However, in addition
to this service, the organization operates laundry services
for its patron-hospitals. This cooperative organization does
not meet the requirements of this paragraph because it performs
laundry services not specified in this paragraph.
(d) Patron-hospitals
(1) Defined. --Section 501(e) only applies if
the organization performs its services solely for two or more
patron-hospitals each of which is --
(i) An organization described in section 501(c)(3)
which is exempt from taxation under section 501(a),
(ii) A constituent part of an organization described
in section 501(c)(3) which is exempt from taxation under section
501(a) and which, if organized and operated as a separate entity,
would constitute an organization described in section 501(c)(3),
or
(iii) Owned and operated by the United States,
a State, the District of Columbia, or a possession of the United
States, or a political subdivision or an agency or instrumentality
of any of the foregoing.
(2) Business with nonvoting patron-hospitals.
--Exemption will not be denied a cooperative hospital service
organization solely because the organization (whether organized
on a stock or membership basis) transacts business with patron-hospitals
which do not have voting rights in the organization and therefore
do not participate in the decisions affecting the operation
of the organization. Where the organization has both patron-hospitals
with voting rights and patron-hospitals without such rights,
the organization must provide at least 50 percent of its services
to patron-hospitals with voting rights in the organization.
Thus, the percentage of services provided to nonvoting patrons
may not exceed the percentage of such services provided to voting
patrons. A patron-hospital will be deemed to have voting rights
in the cooperative hospital service organization if the patron-hospital
may vote directly on matters affecting the operation of the
organization or if the patron-hospital may vote in the election
of cooperative board members. Notwithstanding that an organization
may have both voting and nonvoting patron-hospitals, patronage
refunds must nevertheless be allocated or paid to all patron-hospitals
solely on the basis specified in paragraph (b) of this section.
(3) Services to other organizations. --An organization
does not meet the requirements of section 501(e) if, in addition
to performing services for patron-hospitals (entities described
in subdivisions (i), (ii) or (iii) of subparagraph (1)), the
organization performs any service for any other organization.
For example, a cooperative hospital service organization is
not exempt if it performs services for convalescent homes for
children or the aged, vocational training facilities for the
handicapped, educational institutions which do not provide hospital
care in their facilities, and proprietary hospitals. However,
the provision of the specified services between or among cooperative
hospital service organizations meeting the requirements of section
501(e) and this section is permissible. Also permissible is
the provision of the specified services to entities which are
not patron-hospitals, but only if such services are de minimis
and are mandated by a governmental unit as, for example, a condition
for licensing.
(e) Effective dates. --An organization, other
than an organization performing clinical services, may meet
the requirements of section 501(e) and be a tax exempt organization
for taxable years ending after June 28, 1968. An organization
performing clinical services may meet the requirements of section
501(e) and be a tax exempt organization for taxable years ending
after December 31, 1976. However, pursuant to the authority
contained in section 7805(b) of the Internal Revenue Code, these
regulations shall not become effective with respect to an organization
which has received a ruling or determination letter from the
Internal Revenue Service recognizing its exemption under section
501(e) until January 2, 1987. [Reg. §1.501(e)-1.]
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