For years, the IRS has recognized the use of "friendly PCs" as a legitimate means to facilitate the development of integrated healthcare systems and other relationships between physicians and hospitals.  In those states with a strong corporate practice of medicine ban (e.g., California; though over half the states in the union have some form of such a ban), physicians may not practice medicine as employees of a (non-physician-owned) hospital.  Instead, a "friendly PC" may be established, where the physicians practice within a PC having a contractual relationship with the hospital, the hospital may provide or facilitate some funding for the PC, and the hospital retains some say in determining who will be a shareholder in the PC, even though PCs under state law are supposed to be wholly controlled by the professionals practicing together in the PC. 

In a private letter ruling issued in January, and released in April of this year (PLR 2007 16034), the IRS has retreated from its previous issuances approving this sort of arrangement.  In this ruling (which technically has no precedential value), the IRS began by finding that the friendly PC deal under examination was so friendly (i.e., the hospital had undue influence over naming shareholders) that it probably violated state law.  However, since the parties respected the arrangement (even though it was probably unenforceable), the IRS proceeded to analyze the tax issues giving effect to the hospital control over the PC.  The IRS found that the PC’s income was attributable to the tax-exempt hospital.  It then proceeded to find that the PC’s income included income from activities beyond the scope of the hospital’s tax exempt purposes, so that income was taxable (unrelated business income tax, or UBIT).  Yes, the logic is tortured; read the full ruling for the full effect.

Knowledgeable commentators, including (former IRS honcho) T.J. Sullivan, think this result is internally inconsistent as well as inconsistent with prior rulings.  (See BNA Health Law Reporter article.)  While they’d prefer to see the IRS reconsider, they (and we all) would settle for a little more guidance on factors the IRS will consider in reviewing friendly PC deals in the future.

So all you physicians and tax-exempt hospitals thinking about getting a little friendlier — be careful out there.

Hat tip to Michael Cassidy for citing this ruling in his Med Law Blog. 

David Harlow