The Internal Revenue Service recently prevailed in a major tax court case involving a nonprofit health system that entered into a joint venture with a for-profit business.

Redlands Surgical Services was a nonprofit public benefit corporation and a wholly owned subsidiary of Redlands Health Systems that entered into a joint venture with a for-profit entity. In their opinion, Redlands Surgical Services vs. Commissioner, the United States Tax Court found that Redlands Surgical Center "had ceded effective control over the operations of the partnerships and the surgery center to private parties, conferring impermissible private benefit. [Redlands Surgical Services] is therefore not operated exclusively for exempt purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code."

When structuring joint ventures with for-profit entities, nonprofits should be certain to take care with respect to the examples outlined in Revenue Ruling 98-15. Included in that ruling are examples from the Internal Revenue Service illustrating both "good" joint ventures and "bad" joint ventures.

The lesson learned from the Redlands case points to a number of critical factors that must be present for the joint venture to be considered tax exempt. First and foremost, the exempt organization must retain control over the joint venture through voting rights and the language in the Partnership Agreement. Second, the joint venture must have as its primary motive to benefit the community, rather than to earn a profit. Longterm management contracts with the for-profit partner with options to extend indefinitely would indicate a profit motive for the for-profit partner. Finally, documentation outlining the exempt organization's purpose and agenda should be kept.

The purpose and activities supporting the purpose must be discussed at all board meetings and must outweigh the interest of the for-profit entity. The opinion of the court can be viewed at www.ustaxcourt.gov.