The IRS has revoked the tax-exempt status of a hospital that did not comply with the requirements for section 501(c)(3). Many hospitals may be at risk for noncompliance.
- The 501(r) requirements of the rule can be especially challenging.
- The IRS expects strict compliance with the specific requirements.
- Losing tax-exempt status could be financially ruinous to a hospital.
The IRS has revoked the tax-exempt status of a hospital for noncompliance with section 501(r) of the Internal Revenue Code, following the lead of state tax courts that have been increasingly harsh when scrutinizing tax-exempt hospitals.
The IRS released a copy of the letter informing the hospital that its tax-exempt status has been revoked. While the identity of the hospital is not included, the letter states that the exemption was revoked because the hospital failed to conduct a community health needs assessment, adopt an implementation strategy, and make it widely available to the public — all aspects of the complex requirements of section 501(r). (Text of the letter can be found at: http://bit.ly/2voCeBG.)
To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must not have any of its earnings inure to any private shareholder or individual. Section 501(r) specifies how organizations demonstrate compliance with that and other components of the 501(c)(3) law, and some hospitals are not giving proper attention to this requirement, says Laura Kalick, JD, LLM, tax consulting director for the Healthcare and Nonprofit and Education Practices with BDO, a consulting firm in Washington, DC.
Kalick is familiar with the case in which the hospital’s tax-exempt status was revoked and says it is a government-owned hospital, which probably played a role in the revocation.
Compliance Rules for Tax Exemption
A hospital must meet the general requirements of 501(c)(3) but also the community benefit standards, and section 501(r), Kalick explains. The 501(r) rules govern how hospitals can bill patients for medically necessary emergency care, and features the following four main components:
• 501(r)(3): Establishes the requirement to conduct a Community Health Needs Assessment (CHNA). Every hospital must conduct a community health needs assessment and file a report every three years. Based on that report, the hospital must create an implementation strategy for meeting the needs of the community, and that report must be publicized on the organization’s website.
• 501(r)(4): Governs financial assistance policies (FAP). The hospital must indicate that anyone potentially eligible for its FAP will not take extraordinary collection actions until it is known whether person qualifies for the assistance.
• 501(r)(5): Sets limits on charges and defines average general billing (AGB) and methodologies for calculating the limitations.
• 501(r)(6): Sets communication requirements, timetables, and restrictions for billing and collections.
The rules took effect for hospitals on the first day of the 2016 fiscal year. Hospitals must be in compliance with all four components to qualify for tax-exempt status, but there is flexibility in how the requirements can be met. Organizations can use different processes and methodologies at different facilities.
“The 501(r) rule applies to any hospital licensed in the state that has 501(c)(3) status, and you have many hospitals that are owned by governmental entities and have dual status. They are exempt from tax because they are governmental entities, but decided they wanted to apply for 501(c)(3) status back probably in the late ‘70s or early ‘80s because they wanted the benefit of having certain benefit plans that were available only to 501(c)(3) organizations,” Kalick says. “Also, it’s a little bit easier to go out and get charitable donations when you have 501(c)(3) status, so hospitals that would have been tax exempt anyway got 501(c)(3) as well.”
Those hospitals complained when the 501(r) rule came out in 2010, arguing they shouldn’t have to comply because they are tax exempt already, but the IRS would not back down and insisted that all 501(c)(3) hospitals must comply.
“The regulations are about 250 pages, very detailed and laying out exactly what you have to do and the consequences of not doing it. There also are rulings and notices that amplify these regulations,” Kalick says. “Then, the IRS trained at least 30 agents initially to go out and start examining 501(c)(3) hospitals to see if they were in compliance with the rules. Because most of the requirements are supposed to be made widely available to the public on the website, the agents can start there and easily see if the hospital has not complied.”
FAP in Multiple Languages
The rule requires the FAP be published on the website in English and any other language used by a portion of the community numbering at least 1,000 people or 5% of the population, whichever is less.
“So, you can go to some hospitals’ websites and the financial assistance plan is translated into 10 or 12 languages. If an IRS agent wants to see if the hospital is in compliance, all they have to do is go to the website and see what’s up there and what’s not,” she says. “It’s very easy. We’ve had a barrage of hospital clients informed that they’re being examined by the IRS for noncompliance. They’re very serious about this.”
The hospital that received the IRS letter was examined that way and did not have the required CHNA, Kalick says. She is familiar with the case and says an IRS agent first determined that the CHNA was not on the website — a violation in itself — and then asked hospital officials if one existed. The officials said no, and they refused to create one because it was too expensive and unnecessary, Kalick says.
“The revocation came about because the IRS said it was an intentional disregarding of the rules. It was not inadvertent, and it was not minor,” Kalick says. “Basically, the hospital said they don’t care because they don’t really need the 501(c)(3) status. If this were not a government hospital but instead was one that depended on their 501(c)(3) status, they would have jumped through hoops to make sure their exemption was saved.”
Losing the tax exemption means all income is subject to taxation, and that could be retroactive to the point of noncompliance, Kalick explains. That could be disastrous to a hospital that is not already tax exempt because it is owned by a government, she says.
“If you have tax-exempt bonds outstanding that are dependent on your status as a 501(c)(3) organization and you lose your tax-exempt status, those bonds will be called. If you have $50 million in bonds outstanding, that becomes a current liability and you have to pay off those bonds,” Kalick says. “That would be disastrous. Property tax exemptions also can be dependent on your 501(c)(3) status, so you could lose property tax exemption at the same time.”
The hospital that received the IRS letter might be fine in the end because it is a government entity with tax-exempt status aside from 501(c)(3), but Kalick says the revocation is a signal that the IRS is serious about compliance. She suspects there are many hospitals complying with the letter of the law, and that could hurt them.
There are hospital administrators who say they don’t have to conduct a CHNA because they’re creating a community report that is in compliance with the rules of the state, and that’s essentially the same thing, Kalick says. They say they’ve been substantively complying.
“That’s not the case. They haven’t been complying and when the IRS notices, it’s going to be serious trouble,” she says. “Others will say they have a policy that doesn’t meet all the rules of 501(r), but they do provide charity care and it’s obvious they should be tax-exempt. No, you have to be in compliance with the rules.”
Watch the Details
Details matter. For instance, the hospital must denote and publish which physicians affiliated with the hospital do not accept the terms of the FAP, charging patients and pursuing debts as they choose rather than following the hospital policy.
If the IRS notifies a hospital that it is being audited, the hospital should immediately assess whether it is in strict compliance with 501(r).
“You have a little bit of lead time sometimes when they give you that notice, so you should take that time to assess what is on your website and make sure every single thing is there,” Kalick says. “The reason you got the notice is because the IRS looked and something wasn’t there, so you have to find it and fix it.”
Kalick also suggests checking other hospital websites and comparing them to one’s own. If they are including information or particular language that you don’t, find out why.
IRS Has High Expectations
The IRS has said that it will not revoke tax exempt status when the noncompliance is minor and not willful, but the example they give is a hospital where the sign in the ED explaining the FAP fell off the wall.
“That’s what they mean by minor and not willful,” Kalick says.
Hospital mergers and acquisitions also are no excuse, she says. A hospital administrator may assume there is no need to comply with the 501(r) rule if his or her facility is about to be acquired by another. The administrator may assume the new organization will fold his or her facility into an existing compliance program. In truth, the acquiring organization will expect the other to have a proper 501(r) compliance program before the acquisition.
“If they find out that you don’t comply with the rule, that poses a tremendous tax liability because you might be held liable for taxes you would have paid going back to some time in the past,” she says. “That would be a nasty surprise to the organization acquiring your hospital, and you don’t want to explain to your bosses why your failure to comply is threatening this deal.”
- Laura Kalick, Tax Consulting Director, Healthcare and Nonprofit and Education Practices, BDO, Washington, DC. Phone: (703) 336-1492. Email: email@example.com.