An Iowa County judge has declared that a nonprofit called Care Initiatives is really a "shell" formed to skirt federal limits on tax-exempt bond and that the Internal Revenue Service may revoke the corporation's nonprofit status.

"Care Initiative received notice [on July 8] that its tax-exempt status is currently under investigation by the IRS," Iowa District Court Judge Gene Needles said in his ruling Friday.

IRS officials would not comment on any investigation into Care Initiatives and its compliance with requirements for nonprofits contained in Section 501(c)(3) of the Internal Revenue Code.

But according to Judge Needles, "whether Care Initiatives will retain its 501(c)(3) status is questionable."

The judge found that the non-profit did not meet the code's requirement for independence because it is controlled by private investors, rather than its own board. "No board member or officer has check-signing authority or has ever signed a check or paid a bill," Judge Needles ruled.

Revoking the corporation's non-profit credentials would affect the tax-exempt municipal bond market because Care Initiatives sold $85.95 million of tax-exempt bonds in 1989, under the name Mercy Health Initiatives. The corporation changed its name to Care Initiative after Iowa hospitals under the Catholic Sisters of Mercy objected to the nonprofit's use of the word "mercy."

The bonds were issued through the Iowa Finance Authority and placed with institutional investors by Underwood, Neuhaus & Co. They had no ratings and offered tax-exempt yields ranging from 9.70% in 1999 to 9.95% in 2019.

Henry B. Holmes, a spokesman for the IRS, said that even if Care Initiatives lost 501(c)(3) certification and therefore the ability to issue more tax-exempt debt, its outstanding securities would not necessarily be subject to federal taxes.

"Potentially, they could become taxable," Mr. Holmes said. "Never say never, and never say always, but the potential is certainly there."

In almost all of the cases so far, the IRS has negotiated with the issuer for a direct payment, in order to spare bondholders the distress of seeing what they thought were tax-exempt investments turn taxable. The IRS recently released new regulations that will put nonprofits that want to issue tax-exempt bonds through more stringent tests than ever before. The policy change stems from the Iowa deals and others like it, some of which were attempted in Arkansas by the same bankers.

The litigation that resulted in the Union County Court ruling last week in Iowa began after about 30 counties vowed to collect property taxes from the 41 nursing homes owned by Care Initiatives. The corporation protested in court that, as a federally certified nonprofit, it should not have to pay the taxes.

But even if Care Initiatives maintains its 501(c)(3) status, the corporation would not meet the tests for exemption from property tax laid out in Iowa law, Judge Needles held.

Care Initiatives, he said, was "one of several" nonprofits created by a trio of investors "as vehicles to obtain the tax-exempt bond financing ... necessary to fund the acquisition transactions." He described Care Initiatives as "a 'shell' nonprofit corporation used by [Texas investor] Bruce H. Whitehead and the bond underwriters to obtain the financing necessary to enable them to make millions of dollars of excessive profits."

As it borrowed $86 million at tax-exempt rates to finance the purchase of the 41 homes from the ailing Beverly Enterprises Inc., the nonprofit also funneled $20 million of cash and subordinated notes to several private investors, the judge said.

In addition to Mr. Whitehead, the investors included Terry Colip and Richard Young, who at the time were bankers at the now defunct Underwood Neuhaus, later acquired by Kemper Financial Cos. It was Mr. Colip and Mr. Young, along with Mr. Colip's brother Greg Colip, who originally made up the board of directors of the nonprofit, the judge said.

With the $6.4 million in subordinated notes issued to pay more money to Mr. Whitehead and the Underwood Neuhaus bankers, total debt incurred for the nursing home deal came to $92 million. Mr. Whitehead received $4.297 million of the subordinated debt through a shell company called Ventana Investments. He laid claim to revenues from the nursing homes by taking on the management of them through a third shell operation called the Britwill Co.

In his ruling, the judge said the profits made by the bankers and Mr. Whitehead, about 18% of the total tax-exempt issuance, were too great. "Such excess costs are not normal or reasonable financing costs." he held.

He said the debt load accumulated to finance the nursing home transactions was "unconscionable and has prevented Care Initiatives from having revenues in excess of expenditures in the past and will continue to do so in the foreseeable future."

In addition, Judge Needles said current legal trends led him to believe that Care Initiatives should pay property taxes to Union County, which is home to the corporation's Creston Manor home.

"The current trend is to curb and restrict tax exemptions," he wrote in his opinion. Care Initiatives, he said, "has the burden of proving that the property in question falls within the exemption statute." That statute, contained in the Iowa Code, says that only properties "not leased or under construction with a view to pecuniary profit" can be exempt from taxes.

Creston Manor did not meet that test, in the judge's view, partly because its $67,626 in 1990 profits were "swept into the Care Initiatives system as operated by the Britwill Co. out of its Dallas office," rather than being used for charitable purposes or to improve the nursing home.

Judge Needles's ruling could affect the other counties in Iowa where former Beverly nursing homes are based. The other counties have also sought to collect taxes from the Care Initiatives.

Their cases are under stays until a resolution can be reached in the Union County case, according to Frank W. Pechacek Jr., a lawyer with the Council Bluffs, Iowa, firm of Smith, Peterson, Willson & Beckman. The firm represents Union County, and 16 others of the roughly 30 that are hoping to collect 1990 property taxes from the nonprofit concern. Tax returns for that period are due at the end of the month.

Care Initiatives has until Oct. 14 to appeal the ruling to the Iowa Supreme Court. "I expect we will appeal," said Terry Monson, a lawyer with the Des Moines firm of Ahlers, Cooney, Dorweiler, Haynie, Smith, & Allbee representing the nonprofit.

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