The Internal Revenue Service has denied tax-exempt status for two organizations Lancaster General Health formed to run two of its newest facilities, Lancaster Rehabilitation Hospital and Physicians' Surgery Center.

Lancaster General is challenging the determination, handed down by the IRS in May.

If the IRS ruling is upheld, according to two nonprofit experts, the health care system could be on the hook for taxes.

The entities are Lancaster General Rehabilitation Services, which runs the rehabilitation hospital, and Lancaster General Ambulatory Surgical Services Inc., which runs the surgery center.

Lancaster General Health created them in 2006 and owns a 50 percent stake in each. A for-profit company owns the other half of the rehabilitation hospital and surgeons own half of the surgery center. They're located in the medical corridor between Rohrerstown Road and Good Drive in East Hempfield Township at the Suburban Health Pavilion.

In 2008, Lancaster General Health asked the IRS to recognize the two as as charitable organizations.

But in financial statements filed earlier this year, LGH said the IRS had determined, in May, that neither entity meets the charitable organization criteria because "each entity has insufficient control over its respective joint venture organization to ensure that such organization is operated in a charitable manner."

The financial statements were filed as LGH sought to issue bonds to help finance construction of the Ann B. Barshinger Cancer Center in East Hempfield Township.

Lancaster General declined to comment on what it would mean if its charitable status bid is denied.

"It's a matter pending before the IRS. It's on hold. It would be difficult to say what it means until the IRS makes a ruling," spokesman John Lines said Wednesday.

However, Nicholas Cafardi, dean emeritus and law professor at Duquesne University's law school and author of "Understanding Nonprofit and Tax Exempt Organizations," said it appears the arrangement doesn't meet IRS criteria for a nonprofit.

The ownership arrangement doesn't give the health care system the required control over the organizations, he said.

"Certainly, 50-50 on its face does not do that," he said Friday. "If they don't have control, that really ends the discussion."

That's unless there's something in the bylaws of the organizations that speaks to control, which he said was unlikely.

"Obviously, the IRS has analyzed all those documents," he said.

Lauren Mack, a Chicago attorney with the law firm Polsinelli Shughart who specializes in nonprofit and health care tax law, said the IRS sets a high bar, but challenges can be successful.

"It could be possible to structure a 50-50 joint venture that the IRS would approve, but the devil is in the details," said Mack, who is not representing LGH.

And if the arrangement doesn't meet the criteria for federal income tax exemption under IRS rules, Cafardi said it would also likely fail to meet criteria for property tax exemption under state law.

Robert Krimmel, East Hempfield's manager, said he was unaware of the IRS ruling and couldn't say what local tax impact, if any, there might be.

According to the bond documents, since their creation through March 31, Lancaster General Rehabilitation Services and Lancaster General Ambulatory Surgical Services have had income of about $23 million.

Lancaster General Health had total revenues of $954 million in the fiscal year that ended June 30.

Lines also declined to speculate what the financial impact could be if the health care system's challenge is unsuccessful.

"The challenge for us is there are so many variables it is literally difficult to say what it would mean financially," he said.

The IRS also declined comment.

"That would be a violation of disclosure regulations of tax information," said David Stewart, an IRS spokesman.

He also couldn't say how long it may take for the IRS to respond to the challenge.

dnephin@lnpnews.com