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P, a nationally recognized psychiatric institution, treats mental and nervous diseases. It utilizes a method of treatment known as milieu therapy in which a patient's total environment is controlled on an around-the-clock basis and structured toward rehabilitation. P was originally a corporation for profit. In December 1961, its articles of incorporation were amended to adopt its present name and to qualify under Ohio law as a corporation, not for profit. The shareholders of the predecessor corporation exchanged their stock which was valued at approximately $3,800 per share for notes having a face value of $3,000 per share and bearing interest at the annual rate of four percent. In 1962 the IRS issued a tentative ruling that P was exempt from paying federal income taxes under § 501 (c)(3) of the Code. On December 1, 1965, the IRS indicated that it proposed to revoke the tentative exemption ruling issued in 1962. On November 14, 1968, revoked the tentative ruling of 1962. Before amending its articles of incorporation, P had a contract with a medical partnership composed of seven doctors. This medical partnership performed all the psychiatric treatment on ninety to ninety-five percent of the patients admitted to P. After P's change in status in 1962, the medical partnership was incorporated as the Harding-Evans Medical Associates, Inc. (the Associates). Starting in 1962, P entered into contracts with the Associates. The Associates provided medical supervision in P, teaching and supervision in the residency and other training programs, and medical service to P's indigent patients without a charge or at a reduced rate. P paid the Associates an annual amount of $25,000. This amount was raised to $35,000 as of July 1, 1968. The Associates were to pay P $1,000 per month as a rental for facilities, equipment, and business office services. This rental was increased to $35,000 per year as of January 1, 1965. It subsequently was lowered to $15,000 per year as of July 1, 1968, at the same time that the amount that P paid the Associates for medical supervision was increased from $25,000 to $35,000. Since 1963, individuals not connected with the Associates have constituted a majority of the Board of Trustees of P. The Harding-Evans Foundation (the Foundation) is a tax-exempt organization, the principal activity of which is to provide a residency program in the field of psychiatry for physicians. The Foundation collects charitable funds and expends them on the residency training program at P. The IRS eventually took away P’s tax-exempt status and collected the taxes owed. P sued to recover the $141,730 in taxes and the court held for the IRS. P appealed.

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