HIT Legal Issues: Legal Structure and Tax Status HIT SUMMIT WEST MARCH 7, 2005 Gerry Hinkley Rachel Glitz Davis Wright Tremaine LLP ~ San Francisco http://www.dwt.com/practc/hit/HIT.cfm

Overview and Assumptions Some form of regional organization is needed Minimum geography Broad functionality Top down Bottom up

Top Down Assumptions We will build it, they will come Collaborative effort Dependent on grants No revenue model The right thing to do

Bottom Up Assumptions Provider systems EMRs for competitive reasons Joint activity makes business sense Need to ensure EMRs will be interoperable Risk management Ca-Ching

Identifying RHIO Functions Business Planning and Implementation Forum for stakeholders Standards for interoperability User/participation consensus Chains of trust Baseline standards for security and privacy Connecting to other networks Pointers to information Education Cont…

Identifying RHIO Functions (Cont.) Establishing network functionality Access to information Clinical support Public health Disease management Group purchasing Vendor vetting Pilot projects Sustainability Preparing for change Mergers/Acquisitions

Identifying Funding Sources Dependent on revenue model Grants Venture capital Debt Fees

Stakeholders Providers Payors Government/Public Health Patients IT Vendors

Models Corporation Pass-through entity Governmental Authority

Corporation Attributes Governance Charitable or proprietary Value/Liquidity Risk management Tax status

Tax Exempt Corporation Formation as nonprofit corporation (the easy part) Obtaining and maintaining exempt tax status (the harder part) Why bother? Advantages Disadvantages

501(c)(3) Corporation Must be organized and operated “exclusively” for “charitable purposes” Organizational “test” Operational “test”

“Organizational Test” Must be formed as a nonprofit entity Articles of Incorporation (or other organizing document) must reflect that RHIO: is organized exclusively for a charitable purpose identified under Section 501(c)(3) may not engage, more than insubstantially, in any activities that do not further its exempt purpose does not permit any part of its net earnings to inure to the benefit of a private shareholder or individual

“Operational Test” Must operate “exclusively” for a charitable purpose: Promotion of Health improving the quality of care improving the efficiency of care preventing medical errors/enhancing patient safety benefiting medical research Educational Activities library rulings “CHIN” ruling

Public Charity Status Preferable for 501(c)(3) to qualify as a “public charity” and not a “private foundation” To meet test, RHIO must: be a supporting organization, to another 501(c)(3) or satisfy one of the “support tests” demonstrating that its funds are derived from the public and/or gifts and fees from its exempt activities

501(c)(4) Corporation Must not be organized for profit and must be operated “exclusively” for the “promotion of social welfare” to further the common good and general welfare of the people of the community, as a whole (may overlap with (c)(3) purposes) no part of the net earnings may inure to the benefit of any private shareholder or individual

Advantages of (c)(4) Permitted to lobby and engage in some political activities Not required to meet public support test applicable to (c)(3) Practical alternative for organizations that fail to meet 501(c)(3) requirements

Disadvantages of (c)(4) Contributions by donors are not tax deductible Contributions from (expenditures by) private foundations to a RHIO organized as a (c)(4) are limited by taxable expenditure restrictions: purpose of grant must be exclusively charitable foundation must satisfy “expenditure responsibility” requirements

For Profit Corporation Does not enjoy benefits of tax exempt status Tax Implications for return on equity investment by nonprofits Private Benefit incidental private benefit only Inurement private benefit to “insiders” absolutely prohibited Intermediate Sanctions (excise tax on excess benefit imposed on recipient and RHIO’s manager) UBIT possible if for profit is a nonprofit’s subsidiary

Pass-Through Entity Attributes Governance Charitable or proprietary Value/Liquidity Risk management Tax status

Advantages Partnership or LLC is not a separately taxable entity Avoid burdens of applying for and maintaining exemption Enables each participant to keep its own tax attributes

Disadvantages Creates potential tax risks for exempt partners (or members) could jeopardize exempt status must further exempt purpose may only benefit non-exempt participants “incidentally” could require payment of UBIT

Governmental Authority Attributes Governance Revenue sources Risk management Sunshine laws Tax status

Tax Implications Governmental authority need not apply for recognition of exemption (automatically considered a “public charity”) Beneficial to RHIO contributors: Contributions are tax deductible If contributor is an exempt organization, contributions equate to gift of public funds (no private benefit issue, provided funds are used for public purposes)

Practical Hurdles Must rely on legislature for initiative, funding, organization and operation Potentially takes control away from RHIO users

Entity Selection Drivers Functionality Governance Role for stakeholders Revenue model and funding Tax attributes Long term viability

Process Stakeholder input Top down Think of things to do Bottom up Address identified needs Which organizational model will best accomplish the goals Stakeholder buy-in Implementation – incubator to independence