IRS clarifies physician recruiting rules for charitable hospitals

Wide range of techniques are acceptable

In its final ruling on physician recruiting by tax-exempt hospitals, the Internal Revenue Service (IRS) has taken a generally positive stand on activities that are "reasonable" and "arm’s length" transactions.

Revenue Ruling 97-21, issued May 5, is likely to ease the minds of physician recruiters at charitable hospitals who were left confused in the wake of the Hermann Hospital Physician Recruitment Guidelines issued a few years ago.

"It is the only revenue ruling out there where the [IRS] says recruiting can be in furtherance of a hospital’s charitable purposes," says Robert C. Louthian, JD, an attorney in the Washington, DC, office of law firm McDermott, Will & Emery. "It does provide certainty with recruiting practices."

The new IRS ruling uses five hypothetical situations to illustrate behavior considered acceptable for maintaining tax-exempt status. They are as follows:

Situation one.

Hospital A is in a rural area that has been designated by the U.S. Public Health Service as a Health Professional Shortage Area for primary care physicians. Hospital A recruits an OB/GYN physician to become a non-employee member of its staff. The recruitment package is contained in a written agreement approved by the hospital’s board of directors or its designees.

Hospital A pays a signing bonus as well as the physician’s malpractice insurance for a limited period of time. In addition, Hospital A provides the physician with office space at a below-market rent for a limited number of years in a building owned by the hospital. Under the agreement, the hospital guarantees the physician’s mortgage on a residence in the county and provides practice start-up financial assistance. The package is properly documented and bears commercially reasonable terms.

Situation two.

Hospital B is located in an economically depressed inner city area. Based on a community needs assessment, Hospital B determines that there is a shortage of pediatricians in its service area and that Medicaid patients are having difficulty getting access to physician services. The hospital recruits a pediatrician from outside its service area to maintain a full-time pediatrics practice in its service area, become a non-employee member of its medical staff, and treat a reasonable number of Medicaid patients.

The recruitment package, contained in a written agreement negotiated at arm’s length is approved by the hospital board or its designees. There are no other recruiting incentives offered other than those contained in the written agreement.

As part of the agreement, the pediatrician is reimbursed for moving expenses. In addition, the hospital reimburses the physician for professional liability tail coverage and guarantees the physician’s private practice income for a limited number of years. This guarantee is properly documented and bears commercially reasonable terms. The amount guaranteed falls within the range indicated in regional or national surveys of net income earned by physicians practicing in the same specialty.

Situation three.

Hospital C is located in an economically depressed inner city area. A community needs assessment shows that indigent patients are having difficulty gaining access to medical care because of a shortage of obstetricians in the hospital’s service area willing to treat Medicaid and charity cases.

Hospital C recruits a physician currently on its own medical staff to provide these services.

A written agreement, in accordance with guidelines for physician recruiting established by the hospital board of directors, is signed between Hospital C and the physician. The agreement was approved by the officer designated by the hospital’s board to enter into contracts with hospital medical staff. Hospital C does not offer any recruiting incentives other than those contained in the written agreement.

In the contract, the hospital agrees to reimburse the physician for the cost of one year’s malpractice insurance. In return, the physician agrees to treat a reasonable number of Medicaid and charity care patients that year.

Situation four.

Hospital D, located in a medium to large metropolitan area requires four radiologists to ensure adequate coverage and high quality of care in its radiology department. Two of its radiologists are leaving the hospital. Hospital D conducts a search and finds a qualified radiologist. The candidate currently practices in and is on the medical staff of a hospital in the same city where Hospital D is located. The candidate provides services for patients receiving care at that hospital but does not refer patients there or to any other hospital in the city.

Hospital D offers the physician a recruitment package contained in a written agreement, negotiated at arm’s length, and approved by its board of directors. No other incentives are offered outside of the written agreement.

Under the agreement, Hospital D guarantees the physician’s private practice income for the first few years the physician is a medical staff member and provides coverage for its radiology department. The private practice agreement is properly documented and bears commercially reasonable terms. The guaranteed amount falls within the range reflected in regional or national surveys regarding net income earned by physicians in the same specialty.

Situation five.

Hospital F is located in a medium to large metropolitan area. It has been found guilty in a court of law of knowingly and willfully violating the Medicare and Medicaid Anti-kickback Statute for providing recruitment incentives that constituted payments for referrals. The activities resulting in the violations were substantial.

In the first four situations, hospitals have not violated the IRS’ tax exempt requirements. The common denominators in those situations are:

1. Objective evidence documents a need for a physician in a particular specialty.

2. The recruitment package was documented by a written agreement that comprised all of the incentives offered to the physician.

3. The agreement was negotiated at arm’s length.

4. The agreement was approved by the hospital’s board of directors, its designees, or complied with written recruiting guidelines approved by the hospital’s board of directors.

5. The compensation paid to the physicians was within a range considered reasonable for that speciality.

6. Any financial assistance in the form of a loan or other extension of credit was adequately documented and bore commercially reasonable terms.

These examples show that the key elements are "a community need for a physician and [hospital] board involvement, Louthian says. "[The IRS] wants to make sure somebody is held accountable. They want to make sure the hospital is aware of what’s going on."

In the fifth situation, the hospital did not meet the requirements of tax-exempt status because it was found by a court to have violated the law.

Another significant part of the new ruling is the variety of recruitment techniques allowed, Louthian observes. "The variety of types of incentives that are discussed in situations one to four is welcome news."

[Editor’s note: A copy of Revenue Ruling 97-21 may be obtained from the Internal Revenue Service by calling (202) 622-5000. It is also listed on the IRS Web site at http://www.irs.ustreas.gov].