By Laura Kalick, JD, LLM in Taxation
Earlier this month, the IRS released a letter revoking the tax-exempt status of a hospital for noncompliance with section 501(r) of the Internal Revenue Code. Why? The hospital failed to conduct a community health needs assessment. Tax-exempt hospitals: read this as a cautionary tale.
On Aug. 4, the IRS released a letter, dated Feb. 14, 2017, revoking the tax-exempt status of a hospital for noncompliance with section 501(r) of the Internal Revenue Code (IRC or Code) (Revocation 201731014). We do not know the identity of the hospital, and to the best of our knowledge, this is the first IRS revocation of a hospital due to noncompliance with IRC 501(r). The details of this revocation are somewhat unique in that the hospital whose status was revoked is a so-called dual status hospital, i.e., the hospital is a government hospital that had applied for 501(c)(3) status for benefits reasons in addition to exemption from income tax.
We’ve previously written about the focus of the 2017 IRS Workplan that included, among other items, emerging issues such as IRC 501(r), and this revocation is a clear confirmation that the IRS is implementing the Workplan, and will likely continue to focus in on these issues.
The letter is a caution to tax-exempt hospitals and all exempt organizations that the IRS is going to enforce rules in instances where there is not complete compliance. Also, universities that have academic medical centers must be particularly mindful of their hospital’s compliance with section 501(r) because noncompliance could jeopardize the exemption of the university itself.
In the ruling, the hospital’s exemption was revoked because it failed to conduct a community health needs assessment (CHNA), adopt an implementation strategy and make it widely available to the public. The IRS found that the failures were not minor, inadvertent or due to reasonable cause. While the hospital can appeal the decision in court, there’s a heavy penalty for noncompliance. If an organization fails to meet the CHNA requirements of section 501(r)(3), section 4959 imposes a $50,000 excise tax for any tax year for which there is such a failure. This particular letter did not mention whether an excise tax was imposed.
BACKGROUND ON SECTION 501(R)
Section 501(r) came into law in 2010 as part of the Patient Protection and Affordable Care Act (P.L. 111- 148), also known as Obamacare. After several years of hearings and many, many comments, the published final regulations were set to take effect for tax years beginning after Dec. 29, 2015. Seven years later, the IRS now has at least 30 trained agents conducting related examinations. Finding evidence of noncompliance is fairly easy because almost all the information must be made widely available by putting it on a website, meaning the agents only need to surf the web to spot potential issues. The trend toward increased scrutiny from the IRS seems to be growing, and we have seen a significant number of hospitals audited on section 501(r) in the past six months.
As we mentioned, the hospital in question was a “dual status” hospital. A dual status hospital is a government hospital that would be exempt from tax because of its relation to the government. Forty or so years ago, many government hospitals applied for section 501(c)(3) status so they could take advantage of offering certain pension plans to their employees that were only available to the employees of section 501(c)(3) organizations, and to make it easier to solicit charitable contributions with the familiar 501(c)(3) status.
The reality is that contributions to governmental entities are tax deductible, and today there are many more pension options for employees of government entities. The IRS letter said that “During the audit, the organization’s administrators made it clear that * * * had neither the will, the financial resources, nor the staff to follow through with the CHNA process required under § 1.501(r)-3 on a triannual basis. Consequently, * * *’s 20XX failure to meet the requirements of § 1.501(r)-3 is considered willful. Especially since the organization expressed on several occasions that they did not need to be exempt under IRC § 501(c)(3) and that this status at times actually got in the way of their ability to be involved in various Medicare reimbursement programs.” While this hospital might not place much value on their tax-exempt status, many other organizations depend on their 501(c)(3) designation.
Section 501(r) provides that a tax-exempt hospital must:
• Conduct a community health needs assessment at least once every three years and adopt an implementation strategy to meet the needs identified through the CHNA;
• Establish a written financial assistance policy (FAP) and a written policy relating to emergency medical care;
• Not use gross charges and limit the amounts charged for emergency or other medically necessary care provided to individuals eligible under the FAP to not more than the amounts generally billed (AGB) to individuals who have insurance covering such care; and
• Make reasonable efforts to determine whether an individual is FAP-eligible before engaging in extraordinary collection actions.
Before the implementation of section 501(r) the requirements for hospital tax exemption were compliance with the general section 501(c)(3) rules, and compliance with the community benefit standard set forth in 1969 in Revenue Ruling 69-545, which required an open medical staff, an open emergency room, and acceptance of patients who had insurance, including Medicare.
Concerns were raised that tax-exempt hospitals were essentially indistinguishable from for-profit hospitals and that there should be stricter requirements—perhaps even a requirement that they provide a certain level of charity care to be considered charitable. Also, there were no prohibitions on tax-exempt hospitals charging uninsured patients gross charges and then taking extraordinary collection actions (ECAs) against individuals who could not pay their bills. The resulting section 501(r) made changes regarding ECAs, but did not impose a required level of charity care. Many believe that since Obamacare has decreased the level of uninsured patients, the distinction between the tax-exempt hospital and the for-profit is now even more blurred.
WHAT TAX-EXEMPT HOSPITALS NEED TO KNOW
Hospitals must comply with a myriad of regulations imposed upon them by different agencies and programs, such as Medicare and federal and state government requirements. While many of these requirements are similar in nature, there are usually some important, but subtle, differences. For example, many states have required that a hospital publish a community benefit report. However, the requirements of these community benefit reports differ from those of the CHNAs, and what is adequate for one may not be adequate for the other. Therefore, if a hospital wants to maintain its section 501(c)(3) status, it is imperative that it complies with all the rules it’s subject to, especially IRS rules.
These rules also include the Financial Assistance Policy (FAP) requirements that are quite specific. For example, a hospital must list those physicians and facilities that will provide services with FAP discounts and those that will not. This list must be updated periodically. The FAP must be on the hospital’s website and must be publicized in a manner to give reasonable notice to patients who may qualify, and contain information about billing and collection, charges to FAP patients, etc.
While this revocation was at the national level, the exemption issue has also been raised by local governments throughout the country as to whether hospitals deserve property tax exemptions. Some hospitals do make payments in lieu of taxes (PILOTS) to compensate for the use of local services such as fire, police and other conveniences, but many do not. And as states examine their fiscal solvency, questions around tax exemptions could grow more common and frequent at that level, as well. According to an analysis of National Conference of State Legislatures data by POLITICO Pro, nine states face a revenue shortfall in their current fiscal year, and 27 states project budget shortfalls in the current or next fiscal year or biennium.
Compliance with section 501(r) is mandatory and complicated. The bottom line is that revocation is not an empty threat and the IRS is serious about enforcement of section 501(r). All exempt organizations should take a close look to determine if they’re compliant, or they risk potential adverse tax consequences.
This article originally appeared in BDO USA, LLP’s “Nonprofit Standard” newsletter (Fall 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com