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Publications | November 23, 2020
4 minute read

Heightened Oversight of Hospitals’ Tax-Exempt Status

In October, the U.S. Government Accountability Office (GAO) issued a report detailing the requirements for hospitals to obtain and maintain tax-exempt status. To qualify for a tax exemption, hospitals must satisfy certain requirements under Internal Revenue Code (IRC) Section 501(r), which was added pursuant to the Patient Protection and Affordable Care Act (ACA). Additionally, tax-exempt hospitals are required to provide benefits to the communities they serve. The IRS is required to review a tax-exempt hospital’s community-benefit activities once every three years. 

Section 501(r) requires tax-exempt hospitals to maintain a financial assistance policy, conduct a community health needs assessment and set certain constraints on billing and collection practices. 

The GAO report suggests that the IRS can easily verify the requirements under IRC Section 501(r) because those requirements are legal in nature. The community-benefits requirement, however, is more difficult to monitor; the law is not specific about services that qualify as community benefits. Since it is arguably the most important requirement for maintaining tax-exempt status, the GAO report focuses on the community-benefits requirement. 

The report is designed to expose the lack of clarity regarding community benefits and to provide recommendations to Congress and the IRS to improve oversight of the community-benefits requirement. Currently, the IRS reviews six factors to determine a hospital’s compliance with the community-benefits requirement:

  • Operate an emergency room open to all, regardless of ability to pay.
  • Maintain a board of directors drawn from the community.
  • Maintain an open medical staff policy.
  • Provide care to all patients able to pay, including those who do so through Medicare and Medicaid.
  • Use surplus funds to improve facilities, equipment and patient care.
  • Use surplus funds to advance medical training, education and research. 

The GAO report makes it clear that the factors are merely examples, and that “a hospital need not meet all of the factors to qualify for a tax exemption.” The IRS considers all facts and circumstances to determine if the community benefits are sufficient to warrant a tax exemption. Given the flexibility and ambiguity of the factors, the IRS’s oversight of the community-benefits requirement is challenging. In turn, IRS enforcement of the community-benefits requirement has been stifled, resulting in many nonprofit hospitals maintaining tax-exempt status while neglecting to provide benefits to the communities in which they operate.

The lack of specificity regarding what services and activities constitute community benefits leaves tax-exempt hospitals with uncertainty. Replacing the factors with concrete legal requirements would create a scheme that is transparent and easier to follow. 

Tax-exempt hospitals may soon be required to report and demonstrate on their annual information return (Form 990) that the community benefits provided by the hospital are clear and easily identifiable. The IRS may soon develop specific audit codes that help the IRS to identify hospitals at risk for noncompliance with the community-benefits requirement and to ensure that hospitals’ activities are consistently reviewed. 

Hospitals that fall out of compliance face dire consequences. In addition to potentially losing exempt status, the increased oversight by the IRS could lead to a waterfall of devastating implications under the federal Physician Self-Referral Law (Stark law), the federal Anti-Kickback Statute (AKS) and the Federal False Claims Act (FCA). 

For example, to the extent that a hospital is engaging in provider recruitment in areas not designated as health professional shortage areas or medically underserved areas, either generally or with regard to a specific specialty, a community health needs assessment should be utilized. The assessment can be used as a tool to demonstrate that a hospital’s community-benefit activities are being reviewed regularly and can also provide documented evidence of an objective need in compliance with the AKS practitioner recruitment safe harbor. Failure to comply with the AKS is a specific violation of the Stark law recruitment safe harbor, and both can implicate FCA liability. With the IRS potentially increasing its focus on community benefits, tax-exempt hospitals should take preemptive action to ensure compliance with the IRC, Stark law, AKS, FCA and the litany of related regulations. 

For more information about this report or any other matter related to tax-exempt nonprofit hospitals, please contact Alan Rogalski, Jeffrey Segal, Andrew Reside or a member of the Health Law Practice Group.