The IRS takes the view that political and legislative activities serve to further narrow partisan interests instead of broad public interests, and such activities are therefore not exempt. Any funds or other resources expended on political campaigns and legislative activities are presumed to be nonexempt. As noted above, political activity is action involving the election or appointment of someone to office, or intervention in the electoral process. Legislative activity consists of influencing persons after they have been elected or appointed. State law determines which local offices constitute public office for the purposes of the IRS Regulations, and local election laws will determine whether or not an appointment is in fact an election. (Note that in Washington state, the position of a hospital commissioner is an elected public office).

In contrast to political and legislative activity, 501(c)(3) organizations can engage in some lobbying. IRC Section 4911 defines lobbying as "any attempt to influence any legislation through an attempt to affect the opinions of the general public or any segments thereof; or, any attempt to influence any legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of the legislation." While in general lobbying is prohibited, determining whether an activity is lobbying is will depend upon the facts and circumstances. IRC 4911 excludes from the general prohibition activities which involve information dissemination or communication between an exempt organization and its "members" unless such communications directly incite members to influence legislation, or to cause them to contact nonmembers in order that they might influence legislation. Many communications between an exempt organization and a governmental body are also exempt from a general ban as long as such are confined to nonpartisan information, responses to requests for information by the governmental body, or concern a decision by such a body that might affect the existence or exempt status of the 501(c)(3) organization. Thus, the IRS excludes from its definition of "lobbying" activities which are defined as permissible lobbying under Washington state law.

Practical Consideration

The practical effect of these provisions is that hospital districts that are tax exempt charities are still subject to the more restrictive limits placed upon their activities by the State, and unable to take advantage of the relatively more generous range of activities allowed under the federal regulations.

Grassroots lobbying, defined by IRC 4011(c)(3), involves contacting the general public instead of the legislators themselves. Information sent to constituents which merely refers to and reflects a point of view on specific, relevant legislation is not treated as grassroots lobbying. Under state law, grassroots lobbying by public hospital districts, regardless of federal tax status, is prohibited.

The IRS rules governing the degree of permitted lobbying differ depending upon whether the (c)(3) "elects" to lobby, as specified under IRC 501(h). An exempt organization that makes such an election is subject to an expenditure test. A non-electing exempt organization is limited by a substantial part test.

Practical Consideration

Under state law, a 501(c)(3) hospital district may not be able to engage in lobbying to the extent contemplated by IRC 4911, thus making a 501(h) election less attractive. A 501(c)(3) hospital district contemplating the election of the expenditure test should consult with competent tax counsel, and should otherwise avoid this test unless and until all of the advantages and disadvantages of election are assessed .

These rules apply to a hospital district which does not elect to lobby under 501(h). No "substantial part" of such a 501(c)(3) hospital district's activities may consist of attempting to influence legislation by propaganda or otherwise. A non-electing 501(c)(3) hospital district which engages in substantial legislative activity does not qualify for exemption. Although the IRS does not directly address ballot initiatives, it can be argued that such initiatives, and the activities surrounding them, qualify as lobbying. Therefore, a hospital district would need to be able to show that its involvement in a ballot initiative does not represent a substantial part of its overall activities, as measured by the hospital district's total expenditures.

A non-electing 501(c)(3) hospital district must be able to prove that its lobbying does not represent a substantial part of its activities; an amount between 5-10% of overall budget is generally considered permissible by the IRS. It is important to note, however, that a simple percentage standard is not always determinative of this issue. In some cases the court has considered other factors, such as time expended, or the degree of influence or prestige a particular organization enjoys in the political arena. See, [Christian Echoes National Ministry, Inc. v. U.S., 470 F.2d 849 (10th Cir. 1972), cert. den., 414 U.S. 864 (1973)]

The expenditure test provides a public hospital district who makes the decision to elect to lobby under Section 501(h) a means to determine how much lobbying is allowable by the IRS by application of precise percentages of total expenditures. The test permits lobbying expenditures to consume 20% of an electing hospital district's first $500,000 of total expenditures; 15% of the next $500,000; 10% of the next $500,000; and 5% of remaining expenditures. There is an annual ceiling of $1 million for lobbying outlays. (Grass roots lobbying is allocated an allowance of 25% of total permitted lobbying; public hospital districts, however, cannot engage in grassroots lobbying under state law).

If a hospital district exceeds the allowable amount, it is subject to a 25% excise tax on the excess portion of the outlay. IRC Section 501(h)(1). If a hospital district exceeds the expenditure limit by 150% or more, it may have its tax exemption revoked. IRC Section 504.

Under some circumstances the expenditure test might appear advantageous. It affords some certainty as to how much lobbying can be engaged in without adverse tax consequences. However, this certainty erodes in the case of public hospital districts by the concurrent restrictions on lobbying activities imposed by state law. In addition, the expenditure test compares unfavorably with the "substantial part" test in that it requires more extensive record-keeping and reporting.

In addition to losing its charitable exemption, a non-electing 501(c)(3) hospital district which engages in "excessive" lobbying would also be subject to an annual excise tax in the amount of 5% of the "lobbying expenditures." A separate tax (again, 5% of lobbying expenditures) could also be imposed on each of the officers or directors who knowingly agreed to make such expenditures.

Political activity by a hospital district is constrained by operation of the Washington State Constitution, and by state law. See RCW 42.17 ; see also The Public Hospital District Legal Manual — Special Topics Section: Ballot Propositions and Political Action. Hospital Districts are permitted very limited participation in political campaigns and lobbying.

A hospital district is in effect prohibited from participating in political campaigning, and cannot use public resources to assist in any election campaign, including a campaign to re-elect a district commissioner.

A hospital district cannot allow use of its public facilities by any particular group to further political activities unless it makes such facilities available to all for their unrestricted use. Hospital districts may participate in political activities only if such activities are: (1) open to the general public; (2) explicitly or implicitly authorized by statute, and; (3) part of the usual business of the hospital district. Thus, if certain conditions are met, it is permissible under state law for a hospital district to make its facilities available on a non-discriminatory basis for support of, or opposition to, ballot propositions. If a public hospital district is directly involved in a ballot proposition it is more likely that these conditions will be met.

Formation of a Political Committee by a public hospital district is prohibited; however, a privately formed political committee may engage in activities within a hospital district facility as long as these activities are clearly separate from those of the hospital district. The determinant of "separateness" is whether or not there is any use of public funds or facilities. While a hospital district cannot allow its employees (in their capacity as employees rather than as private citizens) to use public dollars or publicly owned equipment to further political activities, a hospital auxiliary may promote a ballot measure without implicating the hospital district as long as the auxiliary is a completely separate organization. Similarly, a hospital foundation which has organized itself separately from the hospital district, and is not subsidized in any manner by the district, may also safely promote a ballot measure.

Hospital districts are allowed to expend funds for lobbying activities which are limited to providing information or communicating with elected officials, or agency officers or employees regarding official hospital district business; or to advocating the hospital district's position or interests to any elected official, or agency officers or employees. Such expenditures are subject to the reporting requirements of the Public Disclosure Commission.

Hospital districts cannot make gifts or campaign contributions to any elected officials, their staff, or to agency personnel.

Grassroots lobbying by hospital districts is prohibited.

Violation of campaign and lobbying restrictions by hospital district officials will result in monetary penalties being assessed against them.

As mentioned in the first section, IRC Section 501 states that an exempt organization may allow "no part of the net earnings to inure to the benefit of any private shareholder or individual." Simply stated, inurement occurs when a private individual "pockets" the organization's funds, without regard to the accomplishment of the organization's exempt purpose. Private inurement potentially occurs whenever a person receives funds from an exempt organization for insufficient consideration, that is, the transaction is not at arm's length, and the organization "pays" an amount that does not bear a reasonable relationship to a fair market price.

The IRS makes a distinction between inurement, which involves "insiders," and private benefit, which applies to "outsiders." Insiders are persons having a personal and private interest in the activities of an organization, such interest commonly arising from a position of control. Thus, board members, who have the ability to authorize payments by a hospital district, as well as members of their families, are clearly insiders. A business controlled or owned by a board member or his family is also considered an insider for purposes of inurement. Outsiders includes persons such as employees, consultants, contractors, and exempt function beneficiaries. The last category includes physicians who have admitting privileges at a hospital district. While some private benefit which is incidental to the accomplishment of overall public interest or benefit may be permissible, distinguishing incidental benefit from proscribed private benefit will depend upon the particular transaction or activity, and upon the manner by which public benefit is to be derived

When scrutinizing an organization's activities for evidence of inurement, the IRS will examine contracts for supplies and services, loan and lease agreements, and compensation contracts. The exempt organization has the burden of proving that any amounts paid to insiders are reasonable; part of a properly documented transaction; approved by a disinterested person or board committee, or by an independent appraiser; and in conformance with state law regarding fiduciaries or fundraising.

The definition "net earnings" in this context is broad, and includes all assets, held as permanent capital, restricted funds, current or accumulated surpluses, or net profits. Thus, prohibited distributions could be made from salaries or director's fees, rents or royalties, purchase or sale of property, loans or guarantees, and joint ventures or other asset-risking arrangements.

Salaries and compensation must be "reasonable" and "ordinary and necessary" to carry out the exempt purpose. Total compensation must be considered for reasonableness, including salary and fees, pension, any expense allowances, D&O insurance, and compensation to family members.

An organization's compensation structure is more likely to be considered reasonable if it is comparable to that of other similarly sized exempt organizations or their commercial counterparts.

In general, 501(c)(3) hospital districts should adopt conflict of interest policies that evidence good faith in securing independent and impartial approval for payments to insiders. Thus:

• Interested parties should abstain from approving their own compensation.

• A sufficient number of disinterested board members must be available to make such approval valid.

Practical Consideration

A 501(c)(3) hospital district is subject to the mandates of RCW 42.23 , governing ethics violations by public officials. The prohibitions against self interested transactions placed upon commissioners by state law are more narrow than those which the IRS normally imposes upon governing boards of other 501(c)(3) organizations. An example of a conflict of interest policy that is acceptable to both the IRS and the state is one that requires that, if the governing board considers entering into a transaction or arrangement with a corporation, entity or individual in which a commissioner has a remote interest:

• The interested commissioner must disclose the potential conflict to the governing board.

• The Board may ask the interested commissioner to leave the meeting during discussion of the matter that gives rise to the potential conflict.

• The interested commissioner will not vote on the matter that gives rise to the potential conflict.

• The Board must approve the transaction or arrangement by a majority vote of the board members present, not including the vote of the interested member.

• The Board meeting minutes must state which board members were present for the discussion and vote, the content of the discussion, and any roll call of the vote.

Incentive compensation arrangements are subject to enhanced scrutiny by the IRS; Their reasonableness may be evidenced, for example, by compensation amounts which are not dependent upon curtailment of expenses, but upon the accomplishment of the organization's exempt purpose.

Under certain circumstances a 501(c)(3) hospital district may lease or sell property to or from an insider. The property involved must be devoted to exempt functions, and the transaction must satisfy the following criteria:

• The sale price must be purchased by the exempt organization for no more than fair market value; it may be sold by the exempt organization for no less than fair market value.

• The terms of payment must be in favor of the exempt organization.

• The purchase or sale itself should be economically reasonable for the exempt organization.

Private inurement occurs when a 501(c)(3) entity's assets are placed at unreasonable risk of loss in comparison to the assets of private investors joining it in a venture. In most cases, the IRS will not allow a 501(c)(3) entity to participate in a joint venture as the sole general partner in order to prevent the 501(c)(3) from becoming obligated to furthering the private financial interests of their partners. Only when the venture involves the purchase of exempt purpose property (as opposed to investment property) has the IRS allowed a 501(c)(3) to act as a general partner.

A venture which would clearly be permitted by the IRS would be one which:

• Serves an exempt purpose;

• Financed by a "reasonable" amount, and which provides a "reasonable" return to the limited partnership;

• Is formed by an arm's length transaction;

• Does not require the exempt organization to return the invested capital;

• Does not permit investors to gain control over the exempt organization's operations; and

• Does not allow officers or directors of the 501(c)(3) to be investors.

A 501(c)(3) hospital district's venture which falls within the scope of the IRS approval may still be subject to scrutiny by the State Auditor, but because it avoids inurement it would likely also avoid characterization as a prohibited gift of public funds or lending credit.

Acquisition of a physician practice will always trigger an examination of the transaction for private inurement. No part of the tax exempt hospital's earnings may inure to any private persons, defined to include those persons with personal and private interest in the activities of the hospital. Physicians on the staff of a hospital are often considered by the IRS to be "insiders" for tax purposes when their financial transactions with the hospital are reviewed. This creates a rebuttable presumption of inurement that hospitals must overcome. Although the IRS is willing to overlook incidental private benefit that inevitably accrues to a physician in any hospital-physician relationship, it is critical that the hospital district make clear that any such private benefit in an acquisition transaction is incidental to the overwhelming public benefit of the hospital-physician relationship that is formed.

In 1992, the IRS issued General Counsel Memorandum 39862 which disapproved of three joint ventures between hospitals and physicians. The IRS disapproved these transactions on several grounds. First, the IRS concluded that the physicians were not sharing enough of the venture's risk. In each case, the hospital set up a partnership with several medical staff members, and served as the only general partner, while physicians were limited partners. The hospital then sold the net revenue stream from one or more of its outpatient departments to the partnership while maintaining direct ownership of the department. Thus, the hospital bore all responsibility for the losses of the joint venture, while the physicians risked only their initial investment. More importantly, the IRS found that the direct benefits flowing to the investor physicians were anything but incidental, and were in fact the primary reason for setting up the joint ventures in the first place. There were no corresponding public benefits such as expansion of health care resources, creation of a new provider, improvement in treatment modalities, or reductions in costs of care. The IRS stated that the only public benefit asserted — the enhanced financial well-being of the hospital — bore only a tenuous relationship to the hospital's charitable purpose of providing health care to the community.

Practical Consideration

In light of GCM 39862 and other recently published IRS rulings, a 501(c)(3) hospital district might consider the following suggestions when structuring the purchase of a physician's practice, or a joint venture with a physician:

• Obtain an independent appraisal of the physician's practice and make sure that all negotiations are at arms' length;

• Make sure that any ongoing compensation paid to the physician after the practice acquisition is reasonable and reflects a competitive rate for the services to be rendered by the physician;

• Limit physician representation on the governing board of a tax exempt clinic or foundation to a 20 per cent safe harbor; physicians can comprise up to 49 per cent of the board of entities operational within a community controlled hospital system or integrated delivery network, as long as all organizations in the network adopt rigorous conflict of interest policies with respect to transactions with interested persons;

• IRS exempt organization continue professional education textbook for fiscal year 1997;

• Document the community benefit that will result from the proposed joint venture. Benefit to the hospital district alone will be insufficient. Examples of public benefits that might result from a joint venture include: lower prices; availability of new services; better locations for providing services; availability of new equipment; and

• If a joint venture is set up as a partnership, it probably should be set up as a general partnership rather than a limited partnership to ensure that physicians share equal, if not greater, risk than the hospital district.

Physician recruitment practices of tax-exempt hospitals, and their potential for private inurement, have elicited restrictions on such practices from the IRS. The Service has issued guidance to tax-exempt hospitals on the matter of physician recruitment in the form of a proposed revenue ruling, Announcement 95-25. The proposed ruling sets forth five scenarios. In each situation, a non-profit hospital uses a different arm's length negotiated recruitment package to attract a physician to its non-employee medical staff. In four of the five situations, the hospital provides incentives to the physician in such a manner that does not cause the hospital to violate the organizational and operational tests. In other words, these hospitals do not:

• Engage in substantial activities which do not further the hospital's exempt purposes or that do not bear a reasonable relationship to those purposes;

• Engage in activities which result in inurement of the hospital's net earnings to a private individual; such inurement may result if the incentive package is structured as a device to distribute the net earnings of the hospital;

• Engage in substantial activities that cause the hospital to be operated for the benefit of a private interest (rather than public interest) so that it has a substantial non-exempt purpose; and

• Engage in substantial unlawful activities, which is inconsistent with the pursuit of charitable purposes.

Thus, four of the hospitals structured their incentive agreements so that the transactions further charitable purposes; avoid inurement; avoid the hospitals serving public rather than private interests; and, are lawful. The fact pattern involving the fifth hospital, however, indicates that it had engaged in unlawful physician recruitment practices that resulted in criminal conviction. By knowingly and wilfully conducting substantial activities inconsistent with charitable purposes (i.e., criminal violation of Medicare and Medicaid anti-kickback statute), the fifth hospital (and its physician recruitment program) does not qualify for exemption under Section 501(c)(3).

Certain elements of the fact patterns presented in Announcement 95-25 suggest new IRS positions. Specifically:

• The examples include three-year limits on the incentives but the ruling does not suggest that there is an inherent cap.

• Recruitment in the same city as the hospital is permissible.

• Hospitals may pay physicians to take on charity care and Medicaid patients.

• Income guarantees are expressly recognized as permissible.

• Reasonable compensation is examined in terms of the physician's specialty without regard to the locality, recognizing that hospitals are competing in a national market.

• Reasonable compensation is examined in light of whether there are charitable, community-oriented reasons for the physician's entire package.

Practical Consideration

The individual scenarios described in Announcement 95-25 should be reviewed by tax-exempt hospital districts for guidance in complying with the 501(c)(3) prohibitions against private inurement. The significance for tax-exempt hospital districts of the distinctions made by the IRS between permissible and impermissible recruitment practices, is that these restrictions may be narrower than what might be allowed under state law alone.

On July 30, 1996, the Taxpayer Bill of Rights 2 was signed into law. Embedded in this Act are provisions which have significant impact on Section 501(c)(3) public charities and 501(c)(4) private foundations. The intermediate sanction provisions would impose excise taxes on "disqualified persons" and organization managers who knowingly engage in excess benefit transactions. These transactions could take the form of unreasonable compensation for services or non-fair-market-value transactions for goods or other property. Note that the excise tax is not applied to the exempt organization itself. The Act makes clear that the ultimate penalty of revocation of tax exempt status remains intact. Where an excess benefit transaction calls into question the basic charitable, tax exempt nature of the organization, revocation remains available, with or without the imposition of intermediate sanctions. The sanctions are in effect for all transactions entered into on or after September 14, 1995.

Practical Consideration

These new provisions merit careful and serious consideration by 501(c)(3) hospital districts. The personal incomes of commissioners, administrators, and physicians are now subject to excise taxes if these individuals knowingly engage in prohibited transactions.

In light of these new provisions, it may be wise for 501(c)(3) hospital districts to review and/or adjust their board review processes for transactions with "insiders" to take advantage of certain protections under the act, which will be discussed further on in this section. While this section sets forth the basic framework of this new Act, the impact upon any individual hospital district should be explored with help of competent tax counsel.

The Act defines an "excess benefit transaction" to include any transaction in which an economic benefit is provided by a Section 501(c)(3) organization directly or indirectly to or for the use of any disqualified person if the value of the economic benefit provided exceeds the value of the consideration (including performance of services received for providing such benefit). The excess benefit itself is the amount of the impermissible inurement.

Such transactions may arise from the following types of arrangements:

• A Non Fair Market Value Transaction: transactions in which the disqualified person engages in a non-fair market value transaction with an exempt organization;

• An Unreasonable Compensation Transaction: transactions in which a disqualified person receives unreasonable compensation from an exempt organization; or,

• A Revenue Sharing Transaction: transaction (to the extent provided in forthcoming regulations) in which a disqualified person receives payment based on the exempt organization's income (a transaction that violates the present-law prohibition against private inurement).

Unreasonable compensation transactions may arise in the context of an "insider" physician agreement involving compensation by a hospital district/employer at a rate above reasonable standards, or a consulting agreement involving insiders by which the hospital district agrees to pay the insider/consultant an unreasonably high rate of compensation.

Revenue sharing transactions will be more specifically defined by the Treasury Department in subsequently issued guidelines. An example of such might include an arrangement in which the exempt organization compensates an insider on the basis of an unlimited percentage of its gross or net revenue, or in which it contributes or promises its future revenue share to a private individual or entity.

The Act defines a "disqualified person" as one who was, at any time during the five year period ending on the date of the excess benefit transaction, in a position to exercise substantial influence over the exempt organization's affairs; also included are certain family members and "35% controlled entities" of a disqualified person.

Whereas physicians are treated as "insiders" for purposes of private inurement, they are not automatically considered to be "disqualified persons" for purposes of this Act. However, they will be considered as such if, as is likely to be the case, they are perceived to exercise substantial influence over the organization's affairs.

The payment of personal expenses and benefits to or for the benefit of disqualified persons, and other non-fair market value transactions, will be treated as compensation for purposes of the Act only if it is clear that the hospital district intended and made the payments as compensation for services. Two factors in particular will be important in determining whether such transactions are truly compensatory:

• Whether the hospital district's board approved the transfer as compensation in accordance with its standard practices; and

• Whether the transfer was reported (except in the case of non-taxable fringe benefits) as compensation on any required forms and tax returns.

A board of commissioners which approves a compensation arrangement with a disqualified person is entitled to a rebuttable presumption of reasonableness if it:

• Is composed of individuals unrelated to, and not subject to the control of, the disqualified person(s) involved in the arrangement;

• Obtains and relies upon appropriate data as to comparability for functionally comparable positions, e.g., independent compensation surveys or actual written offers from similar institutions competing for the services of the same disqualified person(s); and

• Adequately documents the basis for its determination.

To take advantage of the rebuttable presumption of reasonableness, any amount claimed to be compensation must be treated as compensation from the first moment it is considered or paid. The approval of a compensation agreement by a state or local legislative regulatory body is not conclusive for reasonableness.

The Act provides for a two-tier scheme of taxation. The initial tier operates as follows:

• A disqualified person who is determined to have benefited from an excess benefit transaction will be subject to a first tier tax of 25% of the amount of the excess benefit.

• An organizational manager who participates in an excess benefit transaction, knowing that is such, is subject to a first tier tax of 10% of the excess benefit (subject to a maximum penalty of $10,000).

The second tier operates as follows:

• The disqualified person is subject to a penalty tax equal to 200% of the amount of excess benefit if there has been no correction of the excess benefit within a specified amount of time. "Correction" may involve "undoing" the excess benefit to the extent possible, and may require repayment of some or all of the improperly transferred amount.

• There is joint and several liability for the payment of the tax.

The availability of intermediate sanctions poses many new issues for 501(c)(3) hospital districts. Among the most obvious are: individual liability for directors, administrators and other decision makers knowingly violating the Act; implementation of policies and procedures which satisfy the criteria for the rebuttable presumption of reasonableness (including conflict of interest policies); retroactive application of the Act.

Practical Consideration

A 501(c)(3) hospital district would be prudent to review, with competent tax counsel, its organizational transactions dating from September 14, 1995. The review would focus on transactions resulting in excess benefit.

Public hospital districts may take the position that unrelated business income tax (IRC 513) is not an issue for them. However, because a definitive ruling on this issue has not been made, any hospital district that does so should be prepared to argue this position to the IRS. The IRS has not foreclosed the possibility of a hospital district that earns unrelated business income, and is thus subject to unrelated business income tax (UBIT). See, e.g., PLR 9436052; PLR 8307074; PLR 8239159; PLR 8140005.

The Service has acknowledged that an entity's income may be excludable under IRC Section 115 (which exempts income derived from the exercise of an essential governmental function, accruing to a state or political subdivision thereof), and that such an entity is not required to file an informational return (Form 990). Nonetheless, in private letter rulings the Service has repeatedly left open the question of whether unrelated business income earned by such an entity is subject to UBIT.

The Doctrine of Intergovernmental Immunity offers Constitutional protection for an organization that is an "integral part" of a state or political subdivision against federal taxation which unduly burdens a state in the performance of its essential government functions. This protection extends to the other direction as well, preventing states and local governments from imposing taxes on federally owned property (unless authorized by Congress to do so). Public hospital districts, as integral parts of a state or political subdivision, could assert the Doctrine against a finding of unrelated business income by the IRS. Whether this assertion would ultimately prevail against the IRS is unclear.

Gross income derives from an unrelated trade or business if the conduct or business that produces the income is not "substantially related" to the exempt purpose of a charitable organization. Treas. Reg. 1.513-1 (d)(1). Trade or business is substantially related to the exempt purpose only where its conduct has a "substantial" causal relationship to the achievement of the tax exempt purpose. Treas. Reg. 1.513-1 (d)(2). Thus, a substantially related trade or business must contribute importantly to the accomplishment of the exempt purpose. Conversely, income from the sale of goods or performance of services does not derive from related trade or business, if the production of such goods or services does not contribute importantly to the accomplishment of a tax-exempt purpose. Whether the activities which produce gross income contribute importantly to any purpose for which an organization is granted tax exemption will depend upon the facts and circumstances involved.

Income realized directly or indirectly from patients is considered related income. Well known examples of businesses operated by tax-exempt hospitals which are necessary in relation to their tax-exempt function include gift shops; cafeterias operated primarily for employees and medical staff; parking lots for patients and visitors; and, condominiums constructed by a hospital for use as short-term living quarters by its patients. To the extent it would be possible for a hospital district to operate a business primarily for the use of the general public, which did not generate income directly or indirectly from patients, and thus did not contribute substantially to the achievement of its charitable purpose, the income so derived might be targeted by the IRS for taxation.

As noted earlier in this section, the IRS might possibly assert a finding of unrelated business income against a 501(c)(3) hospital district, if the business activity in question can be characterized as unrelated to the hospital district's charitable purpose. Recall from a previous section (I.A.: Qualifying for Section 501(c)(3) Status) that, in order to qualify for Section 501(c)(3) exempt status, a hospital district must limit the scope of its activities to something less than that which is granted under state law. While the business activity at issue may be authorized by RCW 70.44 , it might also possibly exceed the scope of related trade or business activities permitted within the meaning of the IRS rules.

Employees other than a hospital district administrator/superintendent are eligible for gratuities, incentives and bonuses in the form of an incentive program, which has been established by board resolution with clear criteria for achievement in advance of any such award. Hospital district administrators are municipal officers, whose compensation in the form of bonuses is limited by Article XI, Section 8, and by Article XXX, Section 1 of the Washington State Constitution. Retrospectively awarded bonuses are precluded, but prospective salary increases or bonuses for services rendered in accordance with established criteria are not prohibited.

Hospital districts are subject to the "gift of public funds" limitation, plus the same prohibitions that affect other hospitals with regard to federal anti-kickback regulations. A hospital district cannot reimburse a physician for travel expenses, meals, or entertainment unless it is contractually obligated to do so in exchange for services, or unless a physician is a candidate for a medical staff position.

Under state law, (RCW 42.23 ) no elected or appointed officers of a hospital district may have a direct or indirect beneficial interest in a public contract, nor can he or she receive compensation from any person as a result of such a contract with certain transactions exempted. There are statutory exceptions to this prohibition, which are categtorized under the law as "remote interests," that is, relationships that do not trigger a presumption of conflict. These "remote interests" are listed under Section 42.23.040 .

A contract executed by a hospital district in violation of the statute is deemed void. An officer who enters such a contract is subject to criminal and civil liability, as well as forfeiture of office. RCW 42.23.050

Washington law specifically permits hospital districts to enter into joint ventures with physicians. RCW 70.44.240 . Hospital districts are authorized to enter into joint ventures with private entities for the provision of healthcare services. The form of the joint venture can vary, but the formation of a separate corporation is prohibited by Article VII, Section 8 of the Washington State Constitution, which forbids municipalities from forming a for-profit corporation which issues stock, thus leading to the direct or indirect ownership of shares of stock in a private enterprise. There is a constitutional exception to this prohibition only for the purposes of a retirement plan, or deferred compensation fund. Article XXIX, Section 1 (amend. 49).