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Nonprofits Form Profit-Making Firms to Funnel Cash : Hospitals Find Way to Ease Squeeze

April 08, 1985|From the Washington Post

WASHINGTON — Nonprofit hospitals, squeezed by the ever-rising cost of health care and changes in the Medicare system, have begun taking a new look at a good old American way of staying in business: profit.

It's not exactly their own profits, however, because nonprofit hospitals are restricted in what they can earn by the tax laws. Rather, it's the profits of subsidiary or affiliated businesses that the nonprofits form. Any money these subsidiaries make can then be funneled back to the nonprofit through arrangements such as a lease on hospital-owned land, donations of services or joint ventures.

One hospital in Chicago, for example, leases space in its lobby for a McDonald's franchise.

A nonprofit hospital in Clearwater, Fla., has a subsidiary for-profit company that runs a printing operation, a laundry and a durable medical goods supply company. It provides services for the hospital at cost and to anyone else at profit-producing rates.

Several nonprofit hospitals have developed for-profit hotels adjacent to their facilities to provide rooms to patients who don't need full-service hospital beds or to people visiting patients.

Technical Dynamics, a for-profit subsidiary of the Fairfax (Va.) Hospital Assn., repairs sophisticated medical equipment for 40 hospitals along the East Coast and is turning a nice profit even though it has been in business only a short time. It is expected to pay off its development costs soon and begin donating its profits to the hospital association.

"We're a nonprofit corporation, so we can't make too much money without jeopardizing our nonprofit tax status," says Donald S. Harris, senior vice president of the Fairfax Hospital Assn., Technical Dynamics' parent company. "Technical Dynamics could either make a donation in-kind or give us a gift to help cover the cost of providing health care for indigent people."

Fairfax Hospital Assn. also has moved into several joint ventures with its own doctors, for-profit ventures set up with hopes that they will funnel back profits, Harris says. The services provided by the joint ventures include weight reduction counseling and in vitro fertilization, both moneymaking services generally not covered by medical insurance.

"Hospitals are looking for new sources of capital finance because the market for tax-exempt revenue financing is drying up," says Paul F. Danello, a Washington tax attorney with Memel, Jacobs, Pierno & Gersh, who has helped nonprofit hospitals set up for-profit subsidiaries.

"Hospitals are rethinking whether they are just in the business of providing only in-patient acute care or in the health business, which means treating people before and after they are sick, home care, skilled nursing care. Hospitals have begun to look into different lines of business and they need for-profit subsidiaries to finance and operate those businesses."

The way it is usually done, says Danello, is that the nonprofit hospital board creates a new corporate structure with a new tax-exempt parent corporation that controls the nonprofit as a subsidiary along with several affiliated for-profit subsidiaries. The for-profits pay taxes but also provide services at cost to the nonprofit hospital. By law, said Danello, they are not allowed to charge the nonprofit more than what the services cost.

Under this structure, nonprofit hospitals can spin off much of their ancillary services--such as billing, laundry, janitorial and food services--into for-profits subsidiaries. The for-profits can then expand their business and work more efficiently; in short, behave like real companies. Danello said that in most cases the for-profits find they can compete in the marketplace, particularly if they provide services they have some experience with. Another way a nonprofit can find new revenue for capital improvements is to go into a joint venture with members of its own staff. Sometimes known as MeSH organizations (Medical Staff Hospital), the joint ventures are structured so that several doctors invest their own money, raise more capital and build whatever the nonprofit needs, such as a new outpatient surgical center, more doctors offices or a hotel. The new building is often developed on land leased by the hospital to the joint venture.

The doctors then receive tax benefits from their investment, and the nonprofit can receive dividends or rent through the lease on the land, or even other forms of revenue through different channels.

"A lawyer will tell you that, once you've seen one joint venture you've seen one joint venture, because most of these are set up differently depending on what the nonprofit needs, what the doctors need and how the tax laws can be used," said Gregory Graze, director of community affairs for Parkland Memorial Hospital in Dallas, a public hospital that is negotiating a deal with the University of Texas to build a new nonprofit hospital and teaching center that will generate lease revenues for the public hospital.

"Hospitals are under intense pressure to cut costs and eliminate services that are not making money for them, and the safety net of services for the indigent is being stretched to the limit. Hospitals are turning to alternatives like these to remain economically viable."

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