7.25.24 Cooperative Hospital Service Organizations


  1. This section discusses the qualification for exemption from income for cooperative hospital service organizations described in IRC 501(e).

  2. IRC 501(e) provides an avenue for establishing IRC 501(c)(3) exemption for certain cooperative hospital service organizations that would not otherwise qualify. Such organizations provide certain specified ancillary support services on a cooperative basis to two or more hospitals described in IRC 501(c)(3).

Purpose and Background of IRC 501(e)

  1. IRC 501(e) was enacted in 1968 to allow two or more IRC 501(c)(3) hospitals to increase their efficiency by combining specific administrative support functions within a tax-exempt cooperative service organization. The mere fact that such a service organization is in the business of providing goods or services to IRC 501(c)(3) entities is not sufficient to establish IRC 501(c)(3) exemption for itself. In fact, IRC 502 provides that an organization operated for the primary purpose of carrying on a trade or business shall not be exempt from taxation under IRC 501 on the ground that all of its profits are payable to one or more organizations exempt under IRC 501.

  2. IRC 501(e) provides a narrow route to overcome the provisions of IRC 502 by allowing a hospital service organization to be treated as an 501(c)(3) organization.

Hospital Service Organizations Until 1968

  1. Rev. Rul. 54–305, 1954–2 C.B. 127, denied exemption to a corporation that operated and maintained a purchasing agency for the benefit of its members, who were tax-exempt hospitals and other charitable institutions. The corporation realized substantial profits and distributed only a part to its members. The Service concluded that the corporation was operated for the primary purpose of carrying on a trade or business for profit and was not exempt.

  2. In Hospital Bureau of Standards & Supplies, Inc. v. United States, 158 F. Supp. 560 (Ct.Cl. 1958), a group of unrelated tax-exempt hospitals formed a nonprofit corporation to be a joint purchasing agent and to perform certain product quality research functions on their behalf. The corporation brought suit against the United States to recover income taxes assessed for 1952 and 1953, alleging that it was entitled to a tax exemption under section 101(6) of the 1939 Code, the predecessor of present IRC 501(c)(3). The Service argued that the corporation was a feeder organization, was not serving a charitable purpose, and therefore was not entitled to exemption. The Court of Claims held the feeder provision to be inapplicable because the corporation was not organized and operated for the primary purpose of carrying on a trade or business for profit. It ruled that the corporation was entitled to tax exemption because the activities engaged in were a necessary and indispensable part of the operations of the member hospitals and were therefore charitable.

  3. The Service maintained its position against exemption for hospital service organizations after the Hospital Bureau of Standards case. Congress provided a measure of certainty in the Revenue and Expenditure Control Act of 1968 (Pub. Law 90–364) by enacting IRC 501(e). The statute made IRC 501(c)(3) exemption available for hospital service organization that met specific requirements. The Service continued to oppose exemption for hospital service organizations if the requirements of IRC 501(e) were not met.

Exemption Requirements

  1. IRC 501(e) treats an organization as organized and operated for charitable purposes if it is organized and operated solely to perform on a centralized basis one or more of the services listed in IRC 501(e)(1)(A) for two or more tax-exempt or governmental hospitals.

Specific Services

  1. The services listed in IRC 501(e)(1)(A) are:

    • data processing

    • purchasing (including the purchasing of insurance on a group basis)

    • warehousing

    • billing and collection (including the purchasing of patron accounts receivable on a recourse basis)

    • food

    • clinical

    • industrial engineering

    • laboratory

    • printing

    • communications

    • record center

    • personnel services (including selection, testing, training, and education of personnel)

No Other Services Permitted

  1. Only the specific services listed in IRC 501(e)(1)(A) may be performed by an organization described in IRC 501(e).

    1. In HCSC Laundry v. United States, 450 U.S. 1 (1981), the Supreme Court held that an IRC 501(e) organization may not provide laundry services, a decision based in part upon clear Congressional intent not to include laundry services in IRC 501(e)(1)(A).

    2. In Florida Hospital Trust Fund v. Commissioner, 71 F.3rd 808 (11th Cir., 1996), aff’g 103 T.C. 140 (1994), the court held that an organization could not meet the requirements of IRC 501(e) when it provided a means for hospitals to provide malpractice insurance to each other on a reciprocal basis. The court noted that IRC 501(e)(1)(A) allows only the purchase, not the reciprocal provision of insurance.

Permissible Recipients of Services

  1. IRC 501(e)(1)(B) lists only three types of entities for which services may be performed:

    1. a hospital described in IRC 501(c)(3);

    2. a hospital that is a constituent part of an organization described in IRC 501(c)(3) and which, if organized and operated as a separate entity, would constitute an organization described in IRC 501(c)(3)—this category encompasses, but is not limited to, university and church hospitals; or

    3. a hospital that is 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.

Organization: Cooperative Basis

  1. An IRC 501(e) organization must be organized and operated on a cooperative basis (whether or not under a specific statute on cooperatives).

Distribution Requirements

  1. An IRC 501(e) organization 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.

    1. 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 the amount allocated to it on the books of the organization. For the recordkeeping requirements of an IRC 501(e) organization, see Reg. 1.521–1(a)(1).

    2. 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, based upon the actual cost of the services to the organization.

Retention of Net Earnings

  1. An IRC 501(e) organization may retain an amount for such purposes as retiring indebtedness, expanding the services of the organization, or for any other necessary purpose. However, such funds may not be accumulated beyond the reasonably anticipated needs of the organization. See Reg. 1.537–1(b).

  2. Whether there is an improper accumulation of funds depends upon the particular circumstances of each case. 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.

  3. The term "net earnings" does not include capital contributions to the organization. Such contributions need not satisfy the allocation or payment requirements.

Capital Stock

  1. An organization does not meet the requirements of IRC 501(e) unless all of the organization’s outstanding capital stock, if any, is held solely by its patron-hospitals. No amount may be paid as dividends on the capital stock of the organization. The term "capital stock" includes common stock (whether voting or nonvoting), preferred stock, or any other form evidencing a proprietary interest in the organization.

Business with Nonvoting Patrons

  1. An IRC 501(e) organization may transact business with patron-hospitals that do not have voting rights in 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.

  2. A patron-hospital will be considered to have voting rights in the cooperative hospital service organization if it may vote directly on matters affecting the operation of the organization or may vote in the election of cooperative board members. Patronage refunds must be allocated or paid to all patron-hospitals solely on the basis of the percentage of services performed for patron-hospitals and not upon whether patron hospitals have voting rights.

Other Business Activities

  1. An organization does not meet the requirements of IRC 501(e) if, in addition to performing services for patron-hospitals, the organization performs any service for any other organization.

    1. 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.

    2. The provision of the specified services to entities that are not patron-hospitals is permissible only if such services are de minimis and are mandated by a governmental unit as, for example, a condition for licensing.

Other Income

  1. An IRC 501(e) organization may, in addition to net earnings, receive membership dues and related membership assessment fees, gifts, grants and income from nonpatronage sources such as investment earnings. However, it cannot be exempt if it engages in any business other than that of providing the specified services for the specified patron-hospitals. Thus, an organization described in IRC 501(e) generally cannot have unrelated business taxable income as defined in IRC 512. See Reg. 1.501(e)–1(b)(4) for certain exceptions.

Exclusive Means of Exemption

  1. IRC 501(e) is the exclusive and controlling section under which a cooperative hospital service organization can qualify as a charitable organization. See Reg. 1.501(e)–1(a); HCSC Laundry v. United States, supra. However, IRC 501(e) does not govern organizations where the primary activity is the provision of direct medical care to patients. Such organizations are not hospital service organizations. Organizations created by two or more exempt hospitals that provide medical care to patients may qualify for exemption without regard to the provisions of IRC 501(e), if they otherwise meet the requirements of IRC 501(c)(3).

Foundation Status

  1. A cooperative hospital service organization that meets the requirements of IRC 501(e) is classified as an organization described in IRC 509(a)(1) and IRC 170(b)(1)(A)(iii). See IRM 7.26.3 (concerning certain charities that are not private foundations).

Treated as an IRC 501(c)(3) Organization

  1. The rules applicable to IRC 501(c)(3) organizations are equally applicable to IRC 501(e) organizations. Thus, the notice requirements of IRC 508(a) are applicable to cooperative hospital service organizations: it must apply for exemption on Form 1023 within the same time limitations applicable to IRC 501(c)(3) organizations.

  2. Likewise, an IRC 501(e) organization is subject to the same restrictions with respect to political activity, lobbying, private benefit, and inurement of earnings.

Digests of Published Rulings, Court Cases, and Procedures

  1. Laundry Services—A hospital service organization that performs laundry services for its member hospitals does not meet the requirement of IRC 501(e)(1)(A) and therefore does not qualify for exemption. Rev. Rul. 69–160, 1969–1 C.B. 147.

  2. Laundry Services—Questions and Answers involving exemption under IRC 501(e) when laundry services are provided. Rev. Rul. 69–633, 1969–2 C.B. 121.

  3. Taxation of employee annuities—Contributions by an IRC 501(e) cooperative hospital service organization toward the purchase of an annuity contract for an employee qualifies for the exclusion allowance under IRC 403(b) if all other requirements of that provision are met. Rev. Rul. 72–329, 1972–2 C.B. 226.

  4. Clarification of term "Industrial Engineering" in IRC 501(e)(1)(A)—An organization performing services consisting of installation, maintenance, and repair of biomedical equipment for its member hospitals is an organization described in IRC 501(e). Rev. Rul. 74–443, 1974–2 C.B. 159.

  5. In Florida Hospital Trust Fund v. Commissioner, 71 F.3rd 808 (11th Cir. 1996), aff’g 103 T.C. 140 (1994), the court held that the term "purchasing" , when applied to the obtaining of insurance coverage, does not include self-funding insurance arrangements.

  6. Clarification of term "purchasing" in IRC 501(e)(1)(A)—An organization that otherwise qualifies for IRC 501(e) status that buys hospital equipment for its patron hospitals and holds legal title to that equipment while the hospitals repay the commercial lender for the loan used to purchase the equipment is operated solely to perform the service of "purchasing" within the meaning of IRC 501(e)(1)(A), and, thus, qualifies for exemption under IRC 501(e). Rev. Rul. 80–316, 1980–2 C.B. 172.

  7. Cooperative hospital laundry services are not entitled to exemption through IRC 501(e) because laundry is not specifically listed in the statute. Nor may they otherwise qualify for exemption under IRC 501(c)(3). HCSC Laundry v. United States, 450 U.S. 1; 101 S. Ct. 836 (1981), Ct. D. 2005, 1981–1 C.B. 324, affirming HCSC Laundry v. United States, 624 F.2d 428 (3rd Cir. 1980), and reversing HCSC Laundry v. United States, 473 F. Supp. 250 (E.D. Pa. 1979). Also affirmed on the issue of denial of exemption for cooperative hospital laundry services: Associated Hospital Services, Inc. v. Commissioner, 74 T.C. 213 (1980) and Metropolitan Detroit Area Hospital Services Inc. v. United States, 634 F.2d 330, (6th Cir. 1980), Hospital Central Services Association v. United States, 623 F.2d 611 (7th Cir. 1980).

  8. The holdings of the following cases were implicitly reversed by Northern California Central Services, Inc. v. United States, 591 F.2d 620, 219 Ct. Cl. 60 (Ct. Cl. 1979); Community Hospital Services v. United States, 49 A.F.T.R. 2d, 79–934 (E.D. Mich. 1979); United Hospital Services, Inc. v. United States, 384 F. Supp. 776 (S.D. Ind. 1974).

  9. Cooperative data processing services are permissible under IRC 501(e), but not otherwise under IRC 501(c)(3). See the reversal of Chart, Inc. v. United States, 652 F.2d 195 (D.C. Cir 1981), rev'g 491 F. Supp. 10 (U.S.D.C. 1979). This unpublished appellate decision follows the Supreme Court Decision in HCSC Laundry.