WASHINGTON — A state hospital district and a state university can form a partnership without jeopardizing the tax-exempt status of their bonds, the Internal Revenue Service concluded in a recently issued favorable letter ruling.

According to the IRS, the hospital district and the university entered into a strategic alliance agreement to reduce costs, increase efficiency and improve clinical health care services through the alignment and growth of clinical programs.

At issue was whether the creation of the partnership jeopardized the tax-exempt status of the bonds. The letter ruling did not identify the parties.

Both the district and the university were political subdivisions of the state and could issue and maintain outstanding tax-exempt bonds under the federal tax code. However, the tax code does not permit partnerships to issue tax-exempt bonds. 

The district and university worried that the IRS would contend that, because of the partnership, the bond-financed facilities would be considered used for private business.

The IRS looked through the partnership to the hospital district and the university and concluded that because they were each political subdivisions that could issue tax-exempt bonds, the status of the bonds would remain the same. It took the position that a partnership between two governmental entities was not a separate entity and therefore would not give rise to private use.

“Although we are not expressing an opinion as to whether a partnership has been created, nevertheless, if it were created, we conclude that the purposes would be furthered by treating any such partnership as an aggregate of the separate entities entering into the agreement,” the IRS said in the Jan. 4 letter, which was released earlier last week. “Under the aggregate approach, the persons using the facilities as a result of the agreement are all governmental persons.”

Depending on the circumstances, the IRS has the choice to consider the partnership as a single entity or ignore it and solely look at the entities that created the partnership, sources said.

Tom Vander Molen, a partner in Dorsey & Whitney’s tax and public finance group, said he is not surprised by the IRS’ ruling and thinks the agency found the correct result. Vander Molen said the ruling is consistent with the “governmental partnerships” section of the IRS code, which states that “in the case of a partnership in which each of the partners is a governmental person, the partnership is disregarded as a separate entity and is treated as an aggregate of its partners.”

David Caprera, tax lawyer with Kutak Rock LLP, also said that the IRS’ ruling is correct. However he said he is disappointed that the IRS does not provide guidance for two 501(c)(3) entities in a similar relationship.

“The problem is a bit more difficult because the tax law requires the property financed with 501(c)(3) bonds to be owned by a (c)(3) or governmental unit,” Caprera said.

One tax expert said the letter ruling did not specify the hospital district and university were 501(c)(3) nonprofit organizations so the IRS had no reason to weigh that issue.

The IRS cautioned that the ruling is directed only at the taxpayers that requested it and that it should not be cited or used as precedent. But bonds lawyers sometimes view letter rulings as important, especially in cases where not much guidance has been previously issued by the IRS.

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