Proposed Federal Legislation Targets Tax-Exempt Hospitals
Today’s blog is provided by Frank Giardini and Kurt Bennion
On September 29, Rep. Victoria Spartz from Indiana introduced a bill to the U.S. House of Representatives that specifically targets hospitals that are tax-exempt under IRC Section 501(c)(3). The “Non-Profit Hospital Tax Exemption Transparency Act” targets tax-exempt hospitals by proposing modifications to IRC Section 501(r). While introduced very late in this legislative session, we want to alert readers that tax-exempt status is again on the radar for some in Congress. Any changes along these lines could significantly increase the compliance burden, require increased expenditures for a tax-exempt hospital to comply with Section 501(r), and ultimately threaten the tax-exempt status of many hospitals across the country.
Proposed Modifications to Section 501(r)
The proposed bill would make some significant changes to Section 501(r). It would require hospitals to meet a new “Expenditure Threshold” (ET) requirement, which would be the cumulative value of the hospital’s federal, state, and local tax exemptions for the tax year. Under this ET requirement, the tax-exempt hospital would be required to annually exceed its “expenditure threshold” through spending on (a) training, education, or research designed to improve patient care, (b) improvements to facilities and equipment, and (c) free or discounted care under its financial assistance policy. Further, some major hospital expenditures would have a limited effect in assisting a hospital to meet the new ET requirement in the following manner:
- Expenditures on facility and equipment improvements would be limited to 50% of the total ET; and
- Facility and equipment improvements cannot include expenditures for the acquisition of a physician practice, hospital, ambulatory surgical center, or any other care delivery organization.
Special Note: The determination of the value of a hospital’s federal, state, and local tax exemption will place an additional tax compliance burden and cost on hospitals annually.
Other modifications to Section 501(r) would include the following:
- Require that a hospital organization’s board of directors be drawn from the community in which the organization is located.
- Require that a hospital treat patients who are covered by public programs, including Medicare and Medicaid, and that the hospital not limit the number of such patients served at the hospital or any clinical sites owned/controlled by the hospital organization.
- Modify the “limitation on charges” under Section 501(r)(5)(A) by requiring that only Medicare rates be used to calculate the “amounts generally billed” (AGB) limit.
Finally, the proposed bill would require more frequent and in-depth IRS reviews of hospitals’ compliance with Section 501(r):
- Require the Treasury Inspector General for Tax Administration (TIGTA) to annually review all hospital organizations’ financial assistance policies for compliance with Section 501(r)(4) and to report their findings to the House Ways and Means Committee.
- Require the Comptroller General of the United States to review the IRS’s efforts to monitor hospitals for 501(r) compliance. The first such review would occur within one year of the bill being signed into law and would be required at least every three years thereafter.
Analysis of the Expenditure Threshold Requirement:
The determination of the value of tax exemption imposes a new and costly administrative burden on hospitals. Hospitals would have to develop and maintain new processes to estimate this value to ensure compliance with Section 501(r) as well as to preserve its tax-exempt status. While the proposed bill does not provide specifics on determining the value of hospital’s tax-exemption, it is fair to assume that the value could be aligned to what the hospital would have paid in federal, state, and local taxes had it been a taxable corporation. This requirement more than likely will force hospitals to develop new processes to adequately estimate the value of tax-exemption, on a real-time basis. Further, due the complexity of this area, tax and other compliance costs will rise related to additional employee time to manage the process as well as the costs associated to external consultants.
Although this proposed requirement may sound like the current community benefit calculations reported in Schedule H of the Form 990, it is much more restrictive in the expenditures it includes. For example, current community benefit reporting includes net Medicaid expenditures, community health improvement expenditures, contributions to other organizations, and subsidized health services, all of which would be limited under this new proposed calculation. It is important to note that although community benefit reporting for hospitals is already required, there is currently no required minimum expenditure amount or percentage that impacts a hospital’s compliance with Section 501(r).
Analysis of the Other Provisions
The requirement related to the governing body’s composition sounds relatively straight-forward, but its simplicity results in unclear expectations. First, how is the hospital’s “community in which such organization is located” determined? Second, does it require that the board be 100% composed of individual who reside within that community? If less than 100% composition is allowed, what is the minimum percentage? Third, does it allow any flexibility in order to include individuals who possess valuable skills and knowledge such as legal, accounting/finance, marketing, operations, and fundraising?
The modification of the AGB limit calculation is also important because of its impact on hospital cash flows. The AGB limit sets an upper limit on the amount a hospital may require an individual to pay if they are eligible for financial assistance. Currently, hospitals are allowed to average commercial insurance rates with Medicare and/or Medicaid rates to calculate the AGB limit. The requirement to only use Medicare rates would generally reduce the upper limit on the amounts a hospital could require an individual to pay once they qualify for financial assistance. Many individuals who qualify for financial assistance are still required to pay some portion of their bill (“partial financial assistance”), but oftentimes those remaining patient liabilities end up in bad debt expense. As a result, the actual impact on hospital cash flows may be minimal, but the proposed change would still reduce hospital flexibility and choices in how to interact with patients and encourage them to fulfill financial obligations.
The final two provisions related to federal oversight of hospital compliance are designed to increase the pressure on hospitals to maintain all policies and procedures in compliance with Section 501(r). Currently, the IRS is required to review every hospital’s compliance with Section 501(r) at least every three years. If federal compliance reviews were to occur annually, the IRS’s burden would be most impacted, although the pressure on hospitals to maintain compliance would also increase the requirement for the Comptroller General review of the IRS appears to simply be an extra measure to ensure the IRS effectively follows its mandate to monitor hospitals for 501(r) compliance.
Next Steps and How We Can Help
Healthcare will always be a hot button issue with Congress. The prospects of additional healthcare reforms as well as the imposition of additional federal regulatory compliance, including tax, have real compliance and financial impacts. Accordingly, an organization should assess the possible impact of these provisions, at a high level. We will strive to keep you abreast of any developments related to this proposed bill.
Our healthcare tax team members would be happy to talk more with you about this proposed legislation and how it may impact your organization specifically. If interested in such a conversation, reach out to your primary contact at CLA or to Kurt Bennion, Healthcare Exempt Tax Director, at kurt.bennion@claconnect.com or (425) 250-6074.
Jennifer Boese is the Director of Health Care Policy at CLA. She is a highly successful public policy, legislative, advocacy and political affairs leader, including working in both the state and federal government as well as the private sector. She brings over 20 years of government relations and public policy knowledge with her to CLA. Well over half of her career has been spent dedicated to health care policy and the health care industry, affording her a deep understanding of the health care market and environment, health care organizations and health care stakeholders. Her role at CLA is to provide thought leadership, policy analysis and strategic insights to health care providers across the continuum related to the industry's ongoing transformation towards value. A key focus of that work is on market innovations and emerging payment models. Her goal is to help CLA clients navigate and thrive in an increasingly dynamic health care environment.
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