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Final regulations released by the Internal Revenue Service (IRS) and the Department of the Treasury clarify the relationship between maintaining tax exemption under Internal Revenue Code Section 501(c)(3) and the imposition of excise taxes on "excess benefit transactions" under Code Section 4958. Such final regulations adopt proposed regulations issued in 2005 with minor modifications.

A Code Section 501(c)(3) organization must be organized and operated exclusively for one or more enumerated purposes, including charitable purposes, which include the provision of healthcare services. In addition, among other restrictions, an organization described in Code Section 501(c)(3) cannot have any part of its net earnings inure to the benefit of any private shareholder or individual and cannot be operated for the benefit of private interests. Moreover, Code Section 4958 imposes excise taxes on transactions that provide excess economic benefits to insiders (such as officers, directors and others) of public charities, which include most tax-exempt healthcare organizations.

The final regulations provide guidance on the factors the IRS will consider in determining whether an organization described in Code Section 501(c)(3) that engages in one or more excess benefit transactions should retain its tax-exempt status. Such revocation factors include (1) the size and scope of the organization's activities that further exempt purposes before and after the excess benefit transaction(s); (2) the size and scope of the excess benefit transaction(s) in relation to the size and scope of the organization's regular and ongoing activities; (3) whether the organization has been involved in multiple excess benefit transactions; (4) whether the organization has implemented safeguards that are reasonably calculated to prevent excess benefit transactions; and (5) whether the excess benefit transaction has been corrected or the organization has made good faith efforts to seek correction from the insiders who benefited from the transaction.

An example added to the final regulations illustrates the revocation factors and the emphasis the IRS places on the safeguards to prevent excess benefit transactions. One such example involved an excess benefit transaction that was not significant in comparison to the size and scope of the organization's exempt activities or de minimis. However, the IRS noted that the organization implemented written procedures to prevent the occurrence of excess benefit transactions, followed such procedures and amended them after an excess benefit transaction occurred. Such safeguards were a factor noted by the IRS in determining that the tax-exempt status of the organization in the example should not be revoked. The example in the final regulations underscores the importance of having written procedures to prevent excess benefit transactions and possible revocation of tax-exemption.

Recently, there has been significant turmoil in the tax-exempt auction rate bond market. Under normal circumstances the interest rate on auction rate bonds are re-set through auctions every 7 to 35 days. The interest rate on these bonds is set through a "Dutch auction" process in which successively higher interest rates are accepted in an auction until all of the bonds are sold. The final interest rate, known as the "clearing rate" is generally the rate that applies to all of the bonds for the period. However, if there aren't enough bids to cover all of the bonds offered, then the auction fails and the borrower is required to pay a predetermined rate that is generally well above market rates. Hundreds of auctions have "failed" in recent weeks, which means that not enough buyers showed up to set a clearing rate for the debt. Where auctions have failed, interest rates soared to unprecedented levels, with some borrowers having to pay in excess of 18%.

The Securities and Exchange Commission recently provided relief by allowing conduit borrowers, such as hospitals, a "green light" to purchase their own bonds in an auction under certain circumstances to help avoid auction failures. The SEC's relief will allow many tax-exempt auction bond borrowers to reduce their borrowing costs rapidly. The ability of a conduit borrower to purchase its own bonds, however, is subject to important limitations, both contractual and regulatory.

In order to facilitate liquidity in the tax-exempt bond market, the IRS on March 25, 2008, issued interim guidance in Notice 2008-41 that will apply until regulations are issued that allow a governmental issuer to purchase and hold its own tax-exempt auction rate bonds for not more than 180 days, provided the bond is purchased before October 1, 2008, without causing a retirement or extinguishment of the debt represented by the purchased tax-exempt bonds. In addition, the IRS relaxed certain arbitrage investment restrictions in connection with conduit borrowers' purchase, under adverse market conditions, of the tax-exempt bonds that financed the issuer's loan to the conduit borrowers. Finally, the IRS announced that it will not treat certain waivers of interest rate caps as significant modifications of the tax-exempt bonds for purposes of Reg. §1.1001-3(e)(2). These changes generally apply retroactively to any actions taken with respect to tax-exempt bonds on or after November 1, 2007. Baker Hostetler continues to monitor these complex and very specific temporary changes.

On March 28, 2008, registered nurses at Cypress Fairbanks Medical Center Hospital (Cypress Fairbanks) outside of Houston, Texas voted 119-111 for representation by the California Nurses Association (CNA) in a landmark election conducted by the National Labor Relations Board. Although there were nearly 300 eligible voters, only about 80% of the nurses voted in the election. This is believed to be the first group of healthcare workers in the state of Texas to vote for union representation.

Cypress Fairbanks is owned by Tenet Healthcare Corporation (Tenet) and the organizing drive and election were conducted pursuant to a national neutrality agreement negotiated by Tenet and CNA as part of the settlement of collective bargaining negotiations conducted last year in southern California. Pursuant to the agreement, CNA was provided access to organize employees at certain agreed hospitals across the country. The agreement also provided for "fast track" elections conducted by the National Labor Relations Board with pre-agreed voting units. Significantly, Tenet also agreed not to campaign against union representation as part of the neutrality agreement with CNA.

It appears that key messages for the union were related to patient care and patient staffing.

In a statement announcing the results of the vote, CNA Executive Director Rose Ann DeMoro said the win "changes the face of healthcare in Texas, and will send shockwaves across the country, especially in states where no or only a few RNs are represented. It sends a clarion message to those RNs, a hope that they too can overcome the odds and band together to improve the quality of care at the bedside and change forever the standards for themselves and their colleagues." CNA plans to work quickly with Tenet to negotiate a collective bargaining agreement for the Cypress Fairbanks nursing unit.

It is anticipated that this election will be the first of many organizing attempts by CNA and the Service Employees International Union (SEIU) as both unions are openly competing for the opportunity to represent hospital employees in Texas and in other states across the country. In fact, CNA confirmed that it is attempting to organize other Tenet hospitals in Texas and it has formed "hospital committees" in several cities including El Paso, Dallas, Houston, Austin, Brownsville and San Antonio.