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Tax-Exempt Status: From Charitable Care to Community Benefit

Nonprofit hospitals are in a new era of compliance, with reporting obligations now inextricably tied to an organization’s tax-exempt status. Two recent notices from the IRS attempt to provide more clarity for hospital leadership. 

Internal Revenue Code (IRC) Sec. 501(r), which sets forth requirements nonprofit hospitals must meet in order to maintain federal tax-exemption under IRC Sec. 501(c)(3), was created with passage of the Affordable Care Act (ACA) in 2010. More than half of all hospitals in the United States are nonprofit. Thus, IRC 501(r) will have a significant impact on the manner in which health care will be provided in the local community and across the country.

Charitable Care, Community Benefit

In 1956, the IRS standard for tax exemption required hospitals to provide charity care to the extent of their financial ability. “Community benefit” was first articulated by the IRS in 1969. While charity care remained an important component, hospitals were required to expand efforts and promote health to a class of persons broad enough to benefit the community. The standard remained essentially unchanged until 2009 when the IRS introduced a new Schedule H to supplement financial data collected from all tax-exempt organizations. Enactment of the ACA presented another opportunity to expand and clarify federal community benefit requirements, establishing criteria related to the assessment of community health needs; financial assistance policies; and hospital charges, billing and collection practices.

501(r) provides that a hospital organization will not be afforded tax-exempt treatment under 501(c)(3) unless the hospital meets requirements of 501(r)(3) through (r)(6):

  • 501(r)(3) requires a hospital organization to conduct a community health needs assessment (CHNA) every three years and implement a strategy to meet those needs.
  • 501(r)(4) requires a hospital organization to establish a financial assistance policy (FAP) and a policy related to emergency medical care.
  • 501(r)(5) limits amounts charged for emergency or other medically necessary care that is provided to individuals under the hospital’s FAP to not more than the amounts generally billed to insured individuals.
  • 501(r)(6) requires reasonable efforts to be made to determine whether an individual is FAP-eligible before engaging in extraordinary collection actions.

There is considerable guidance from tax and legal professionals regarding the nuances and best practices for complying with the requirements of 501(r), including the dynamic nature of the CHNA process and the need for its conclusions and responses to be thoroughly documented.

Notices, Proposed Regulations and Procedures

Implementation of 501(r) has not been without challenges and the IRS has attempted to resolve a wide variety of issues through notices and publication of proposed and temporary regulations. It is in the absence of statutory guidance that proposed regulations offer organizations the best instruction on compliance. Most recently (i.e., on Dec. 30, 2013), two more notices provided guidelines for affected organizations. Notice 2014-2 confirmed that tax-exempt hospital organizations may rely on proposed regulations under 501(r) before final regulations are published. Notice 2014-3 provided correction and disclosure procedures for certain failures to meet the requirements under 501(r).

With the issuance of Notice 2014-2, nonprofit hospitals are provided a clear methodology for compliance with 501(r) based on the proposed regulations dated June 26, 2012 and April 5, 2013. For the earlier guidance, information was provided on the requirements for charitable hospitals relating to financial assistance and emergency medical care policies, charges for emergency or medically necessary care provided to individuals eligible for financial assistance, and billing and collections. CHNA requirements were covered in April 2013 along with a discussion on the related excise tax and reporting requirements for charitable hospitals as well as consequences for failure to satisfy 501(r). The 2013 proposed regulations also specified that failure would be excused (i.e., no loss of tax-exempt status), if a hospital corrected and disclosed errors and omissions promptly after discovery. 

Most tax-exempt hospitals were required to meet the CHNA requirement set forth in 501(r)(3) by the end of 2013. As for those organizations that made a good faith effort to comply by the deadline, issuance of Notice 2014-2 on Dec. 30 might be considered anything but timely. Fortunately, Notice 2014-3 includes a proposed revenue procedure allowing nonprofit hospitals to maintain favorable tax treatment when failure is neither willful nor egregious. 

A Road Map for Hospitals

The proposed correction and disclosure procedures of Notice 2014-3 provide a road map for organizations seeking to excuse one or more failures as long as action begins before the hospital is contacted by the IRS concerning an examination. Correction includes the following four principles:

  • Attempt to restore affected persons to the position they would have occupied had the failure not occurred.
  • Take action reasonable and appropriate to the failure.
  • Make the correction as quickly as possible after discovery.
  • Establish or modify policies and procedures to prevent similar failures from recurring.

Disclosure on Schedule H of Form 990 for the tax year in which the failure is discovered requires:

  • A description of the failure, including its type, location, date, number of occurrences, number of persons affected and dollars involved, along with the cause of the failure and practice and procedures in place prior to the occurrence.
  • A description of the discovery, including how it was made and timing.
  • A description of the correction made, including the method and date of corrections and whether affected persons were restored.
  • A description of the practices and procedures, if any, that were established or modified or an explanation as to why no changes were needed.

The IRS states that correction and disclosure does not create a presumption that failure was not willful or egregious. However, correction and disclosure in accordance with the proposed revenue procedure will be considered as a factor and may serve as an indication that failure was not egregious or willful.  

It is important to note that minor and inadvertent omissions and errors due to reasonable cause will not be considered a failure to meet a requirement of 501(r), if corrective action is taken promptly after discovery. By contrast, a failure to meet the CHNA requirements of 501(r)(3) subsequently excused as a result of appropriate correction and disclosure actions may still result in the imposition of an excise tax.

501(r): A Shift in Emphasis 

The IRS continues to focus on activities and policies of nonprofit hospitals while capturing information to ensure compliance with the ACA.  However, many of the provisions of 501(r) were effective for tax years beginning after the date of enactment.  As such, and without final rules and regulations, the challenge for affected organizations has been to avoid failure. A recent notice confirms certain proposed regulations can be relied upon for compliance pending the publication of final regulations or other applicable guidance. Another new notice proposes procedures to correct and disclose failures to comply with the requirements of 501(r).

Policy analysts predict less demand by uninsured patients for free and discounted hospital care as the ACA is implemented.  The anticipated result is greater resources at nonprofit hospitals to focus on community benefits.  The entire industry is shifting from managing illness to promoting wellness.  Nonprofit hospitals, in return for retaining favorable tax treatment, are expected to contribute by creating and expanding public and community health initiatives throughout the communities they serve. 501(r) appears to be the tool by which the shift from an emphasis on charitable care to community benefit will be accomplished.

Gerald M. SwiackiGerald M. Swiacki is a senior vice president with Lancaster Pollard. He manages the Southeast region and is based in the firm’s Atlanta office. He may be reached at gswiacki@lancasterpollard.com

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