The IRS is underway with conducting audits of 35 Section 501(c)(3) tax-exempt hospitals, with a particular focus on “community benefit,” as the IRS announced in June 2024. Targeted hospitals appear to be those who reported low community benefit percentages on their IRS Form 990.
Below are key background points and take-aways for nonprofit hospitals in light of these audits as well as the IRS’ announced prioritized focus on hospitals’ compliance with §501(c)(3) requirements and ongoing scrutiny of nonprofit hospitals by the press, lawmakers, government regulators and the public.
Background – Requirements for §501(c)(3) Hospitals
In addition to the regular requirements for §501(c)(3) tax-exempt status, hospitals are subject to the following requirements (described by the IRS here):
- Community Benefit Standard. The “community benefit” standard, established in 1969 under Rev. Rul. 69-545, generally requires hospitals to:
- Operate an emergency room open to all, regardless of ability to pay.
- Maintain a board of directors drawn from the community (a “community board”).
- Maintain an open medical staff policy.
- Provide hospital care for all patients able to pay, including those covered by public programs such as Medicaid and Medicare.
- Provide free or subsidized care to the indigent.
- Use surplus funds to improve facilities, equipment, and patient care.
- Use surplus funds to advance medical training, education, and research.
- Section 501(r). Internal Revenue Code Section 501(r) was established in 2010 by the Patient Protection and Affordable Care Act (PPACA) as additional requirements for Section 501(c)(3) hospitals. Section 501(r) generally requires hospitals to do the following (as described by the IRS here), with highly detailed and technical requirements under the related Regulations:
- Conduct a community health needs assessment (CHNA) every 3 years and adopt an implementation strategy to meet the identified community health needs.
- Establish a written financial assistance policy (FAP) and a written emergency medical care policy for hospital facilities it operates.
- Limit the amount charged for any emergency or other medically necessary care it provides to an individual eligible for financial assistance under the financial assistance policy to not more that the amounts generally billed to individuals who have insurance covering such care.
- Make reasonable efforts to determine whether an individual is eligible for assistance under the hospital organization’s financial assistance policy before engaging in extraordinary collection actions against that individual.
- IRS Reporting & Public Disclosure. The annual Form 990 information return filed by tax-exempt organizations with the IRS requires detailed reporting by hospitals regarding the requirements above (on Schedule H). Form 990s are often viewed by the press, various government regulators and current and prospective donors and funders.
- IRS Review. PPACA required the IRS to review hospitals’ community benefit activities at least once every 3 years. A 2023 report by the Government Accountability Office found the IRS’ efforts to be lacking.
A hospital’s Section 501(c)(3) tax-exempt status can be revoked for failure to comply with the requirements above. An excise tax penalty of $50,000 is imposed on certain violations of the Section 501(r) Community Health Needs Assessment requirements.
Scrutiny of Nonprofit Hospitals
The IRS’ audit focus on community benefit follows ongoing scrutiny of nonprofit hospitals by U.S. Congress, the press and other government regulators, such as in terms of how much care they provide for the poor, how much benefit they provide to the local community and aggressive collections efforts. In some cases, specific hospitals have been called out in the press. Similar concerns have arisen at the state level in the context of hospitals seeking property tax exemption and states considering or passing legislation to better define community benefit or charity care.
Here are some examples:
- A recent report from the Committee for a Responsible Federal Budget reported that of the country’s 5,129 community general hospitals, 58% are nonprofit organizations that are exempt from most taxation, referencing an estimate that they received approximately $28 billion in tax exemptions in 2020. The report states that “nonprofit hospitals are failing to meet community benefit obligations under all but the broadest (many argue, overly expansive) definitions” and asserts that policymakers should reduce those tax benefits and/or enforce stricter requirements for community benefit.
- A March 2024 report by the Lown Institute scrutinized how much hospitals contribute back to their communities. The report notes: “Out of 1,773 nonprofit hospitals evaluated, 77% spent less on charity care and community investment than the estimated value of their tax breaks — what we call a “fair share” deficit.”
- The American Hospital Association issued sharp critiques of both of the reports above (e.g., see here and here).
- The press has published articles on topics such as Americans struggling with medical debt and justifying the billions in tax breaks that nonprofit hospitals receive.
- The House Ways & Means Committee held a hearing on April 26, 2023 on Tax-Exempt Hospitals and the Community Benefit Standard.
- A bipartisan group of Senators wrote a letter to the IRS and the U.S. Department of the Treasury Inspector General for Tax Administration regarding their concern over the growing amount of medical debt and the role they can play in providing greater transparency and oversight into nonprofit hospitals.
- The White House noted the IRS’ hospital audit effort in June 11, 2024 fact sheet, stating that the audits would “better ensure that nonprofit hospitals provide the community benefits necessary to maintain their non-profit status.”
Observations
- The tax law requirements above do not require a specific amount of financial assistance or community benefits. Accordingly, IRS efforts to enforce the law cannot address some of the underlying points of criticism and public policy concerns.
- While scrutiny has been focused on the amount of financial assistance and community benefit that hospitals provide and their patient collections efforts, the tax law requirements are more focused on establishing a fair process.
Action Items
Given the ongoing scrutiny in the media, by the U.S. Congress, and by other government regulators of the benefits that nonprofit hospitals provide to justify their tax exemption, including on the extent of benefits provided to the community, how much financial assistance they provide to low-income patients and whether they engage in aggressive collections efforts, the following are suggestions to:
- be ready in the event your organization is selected by the IRS in this round of audits,
- reduce your attractiveness to the IRS for a future audit, and
- effectively convey the benefits your hospital offers the community, to help improve relationships with community stakeholders and local governmental bodies on these issues of key importance to communities nationwide – which can be helpful in contexts outside of IRS compliance such as, for example, in seeking government approval for an M&A transaction or property tax exemption.
Proactive Steps to Reduce Risk
- Review the Hospital Website. Review your hospital’s website for technical compliance with §501(r), such as to ensure that the Financial Assistance Policy, plain language summary, application form and list of participating providers and the Community Health Needs Assessment are easily found. Ensure that all website links to and within those documents are working.
- Ensure Community Benefits are Captured. Confirm that your hospital is proactively capturing and publicizing all community benefit and financial assistance efforts within the community on an ongoing basis. Those efforts may occur across a broad spectrum of activities – e.g., efforts to address Social Determinants of Health (SDoH), to attract physicians whose specialty is underserved in the area, to offer community education, to conduct training for healthcare professionals, to conduct scientific research, to hire from local underprivileged communities, and more. For example, ensure that your Form 990 reflects all community benefits reported on community benefit reports required at the state level and helpful activities noted in annual reports.
- Joint Ventures/Transactions & Affiliates. In reviewing for compliance, focus not only on direct hospital operations but on compliance and efforts to serve the community through joint ventures and affiliated entities. When entering into joint ventures and other transactions, ensure that community benefit and financial assistance are addressed and documented effectively.
- Form 990 Disclosures. The specific narratives used on IRS Form 990s is worth focusing on carefully to demonstrate compliance to the IRS and communicate the desired messaging to the public, press and donors.
- Communications Plan. Focus on public messaging – on the hospital website, social media and other outward communications. Clearly conveying the benefits provided to the community can build goodwill and impact relationships with community stakeholders and local governmental bodies.
- Documentation. Focus on creating a strong paper trail of the hospital’s dedication to financial assistance and community benefit – particularly in Board and Committee minutes, which could be scrutinized in an audit.
- Review General §501(c)(3) Compliance. Aside from §501(r) and the community benefit standard, other areas the IRS tends to focus on in audits include:
- Political Activities. Given the current election cycle, it’s a good time to review and remind staff of the political activity prohibition and what that can look like in the workplace, and to adopt a policy (if not already in place).
- §4960 Tax/Excess Compensation. Check for compliance with Internal Revenue Code §4960 excise tax on compensation paid over $1 million paid to a “covered employee” and certain parachute payments. Review current practices for executive compensation generally under the excess benefit transaction rules.
- Worker Classification. The IRS continues to focus on whether workers are properly classified as independent contractors instead of employees. This is a likely area for scrutiny in an audit.
- Schedule Periodic Updates & Training. Review hospital financial assistance and billing and collections policies periodically to ensure that they remain accurate in how they are operationalized, and provide periodic training to ensure compliance and demonstrate good faith.
If selected for an audit:
If your hospital is selected for an audit, advance preparation can make a big difference.
- Conduct a Walk-Through. Make a checklist of the numerous specific requirements and do a walk-through of hospital facilities as if you were a patient, to ensure technical compliance with §501(r), as the IRS could do. For example, check for financial assistance materials in the admitting and emergency room areas. Check for how a patient would encounter opportunities for financial assistance throughout their interactions with the hospital.
- Distinguishing Facts. Identify aspects of your hospital that are unique (e.g., the population served, particular challenges for the local community, etc.), especially in ways that may not be readily apparent to an outside observer. Demonstrate to the IRS how your particular facts should be taken into account in evaluating compliance.
- Staff Preparation. Identify the hospital staff with deep knowledge of the Community Health Needs Assessment and financial assistance process and how they are operationalized. Prepare with them for what to focus on and how to effectively communicate with the IRS.
- Coordination & Messaging. Work closely with legal counsel on reviewing compliance and strategizing about messaging before interfacing with the IRS.
For additional guidance, Sheppard Mullin’s Healthcare Team has a Nonprofit group with deep expertise and valuable insights into the IRS audit process and minimizing risk for tax-exempt organizations.