By Cameron R. Monti
For nearly a decade, the federal government has closely scrutinized hospitals that hold 501(c)(3) not-for-profit status and enjoy exemption from income, property, and sales tax. Yet many of those same hospitals that enjoy exemption from tax have difficulty demonstrating a clearly established charitable purpose or practices for which they are organized, or substantiating the clear charitable benefits provided to their surrounding community in which they operate.
An organization, such as a hospital, may qualify for exemption from federal income tax if it is organized and operated exclusively for either religious, charitable, scientific, testing for public safety, literary, educational, fostering national or international amateur sports competition, or the prevention of cruelty to children or animals. Most hospitals qualify for not-for-profit status under the “charitable” election. In addition, the “community benefit standard” is the legal standard applied when determining whether or not a non-for-profit hospital is, or should be, exempt from federal income tax.
The standard is comprised of five factors: (1) operation of an emergency room open to all members of the community without regard to ability to pay; (2) a governance board composed of community members; (3) the use of surplus revenue for facilities improvement, patient care, and medical training, education, and research; (4) the provision of inpatient hospital care for all persons in the community able to pay, including those covered by Medicare and Medicaid; and (5) an open medical staff with privileges available to all qualifying physicians.
At the state and local level, some hospitals have had their property-tax exemptions challenged or revoked on the basis that the community benefits they provide are inadequate. A 2013 study published in the New England Journal of Medicine found that, on a national basis, hospitals devoted, on average, 7.5 percent of their operating expenditures to community benefits. However, those not-for-profit hospitals on the lower end of the spectrum only devoted approximately 1% of their operating expenditures.
To qualify for tax-exemption a hospital must, in effect, show that it provides charitable benefits to a class of people that is broad enough to benefit a community, and the hospital must be operated in furtherance of a public rather than a private interest. Despite this, however, many critics who have been suspect of not-for-profit hospitals’ genuine charitable purpose have led to closer scrutiny by the IRS and Congress over the past decade.
A February 2009 Executive Summary of an IRS study of more than 500 not-for-profit hospitals found that the average and median total compensation amounts reported as paid to the top management official by respondents to the questionnaire were $490,000 and $377,000, respectively. Other related studies have supported that some not-for-profit hospitals provided very limited charitable benefits to its community. As a result, over the past five or six years, the federal government has continued to adopt rules and regulations to encourage compliance by hospitals that operate as nonprofit organizations, in an effort to ensure they are earning the right to their tax exempt benefits.
For example, Section 9007 of the Patient Protection and Affordable Care Act (PPACA) imposes implementation and reporting requirements pursuant to IRC § 501(r) on nonprofit hospitals to: (a) establish financial assistance and emergency medical care policies including policies that specify eligibility criteria, qualifications for assistance, and medical debt collection practices against non-paying patients; (b) implement limits to costs leveled to patients for necessary emergency medical treatment who are eligible for assistance under the hospital’s financial assistance policy prior to pursuing aggressive collection actions against patients; (c) make reasonable efforts to assess whether a patient may be eligible for assistance under the hospital’s financial assistance policy and provide a patient a minimum of 120-days before a hospital can pursue “extraordinary collection action” such as reporting unpaid medical debts to credit report bureaus or referring a debt to a collection agency; and (d) conduct a “community health needs assessment” and adopt a strategy to implement the assessment policies at every three years.
Not-for-profit hospitals that fail or refuse to implement or comply with the rules and regulations, or fail to satisfy the reporting requirements may be subject to an excise tax penalty of $50,000 under IRC § 4959. The Treasury Regulations mandate that a hospital liable for the excise tax must file IRS Form 4720 by the 15th day of the fifth month after the end of the organization’s taxable year during which the liability under section 4959 was incurred.
The federal government’s efforts to foster accountability can also be found in IRS Form 990, the federal tax return for not-for-profit hospitals. Form 990 has been an ever-evolving tax return since 2009, beginning with changes made by the Internal Revenue Service within Form 990 in an effort to encourage reporting, accountability, and transparency from tax-exempt hospitals to ensure they are following the requirements of the PPACA and are conducting themselves as the not-for-profit organizations for which they are characterized. Schedule H of IRS Form 990 pertains specifically to hospitals. The revised Schedule H requires hospitals to report their expenditures for activities and services that the IRS has classified as community benefits.
In 1969, the IRS effectively eliminated the prior 1956 standard that a not-for-profit hospital must provide charity health care “…to the extent of [their] financial capability.” Since that time, however, there continues to be opponents that question whether the genuine level of charitable and community benefits that 501(c)(3) hospitals provide is great enough to justify the tax benefits enjoyed by their exemption and not-for-profit status.
(Monti, of Howard & Howard, concentrates his practice in taxation, business and employment law. He can be reached at cmonti@howardandhoward.com.)
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