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With health care reform possibly forthcoming, a U.S. Government Accountability Office review found that the current framework for hospitals to achieve and maintain tax-exempt status is too broad. Learn how this could impact you.

Tax strategies

GAO Recommends Increased Oversight of Hospitals’ Tax-Exempt Status

  • Frank Giardini
  • 12/30/2020

Key insights

  • After issuing a new report, the GAO recommends Congress enact new legislation to clarify the requirements for hospitals to qualify as tax exempt.
  • The “community benefits” necessary for hospitals to qualify as tax exempt are not clearly defined or tracked by the IRS.
  • Potential new legislation could require hospitals to meet additional requirements and provide supporting documentation to acquire or maintain tax-exempt status.

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On September 17, 2020, the U.S. Government Accountability Office (GAO) issued a report to both the U.S. Senate Finance Committee and the House Ways and Means Committee, recommending new tax legislation to provide clearer requirements for hospitals to maintain federal tax-exempt status. The GAO specifically recommended that Congress enact new legislation to amend IRC Section 501(c)(3) to better define how hospitals can qualify as tax exempt, with a focus on the need to provide benefits to the communities they serve. With health care reform possibly on the horizon, this report may play an important role in the tax considerations of tax-exempt hospitals.

Background

The federal government allows hospitals and other charitable organizations to be tax exempt because of the public policy concept that the loss of tax revenue from these organizations is offset by benefits to the general welfare and relief from the federal government’s need to appropriate public funds. The GAO report shared a 2002 Joint Committee on Taxation report that estimated the federal government forfeited a potential $12.6 billion in tax revenue from tax-exempt hospitals. (That amount has undoubtedly increased substantially over the course of the subsequent 18 years.) The GAO further stated that tax-exempt hospitals reported to the federal government that they had provided $76 billion in community benefits in 2016.

In its search to better understand how the IRS tracks tax-exempt hospitals, the GAO ascertained that the IRS did not track these community benefits. In fact, the IRS could not identify any tax-exempt hospitals from fiscal years 2015 – 2019 that were referred to its examination division for review related to insufficient community benefits information. Additionally, the IRS has not revoked any hospital’s tax-exempt status for failing to provide sufficient community benefits at any time in the past ten years.

Thus, the GAO advised Congress to consider enacting new legislation that could hold tax-exempt hospitals accountable by the IRS, concluding that the principal reason for lack of accountability is the existing tax laws, which do not adequately specify “community benefit requirements.”

Current tax law definition of tax-exempt hospitals

Under current federal tax laws, tax-exempt hospitals must meet three sets of requirements in order to obtain and maintain federal tax exemption. These requirements are:

1. Organizational and operational test requirements under IRC Section 501(c)(3)

Under this test, a hospital must be organized and operated as a nonprofit organization with the stated purpose of the promotion of health for the benefit of the community that it serves.

2. Community benefit standards established by Revenue Ruling 69-545

The IRS, in Revenue Ruling 69-545, identified six factors to demonstrate that a hospital provides “community benefit” to its service community:

  • Operates an emergency room open to the public, regardless of ability to pay.
  • Maintains a board of directors composed of members of the community.
  • Maintains an open medical staff policy.
  • Provides care to all patients able to pay, including those covered by Medicare and Medicaid.
  • Uses surplus funds to improve facilities, equipment, and patient care.
  • Uses funds to advance medical training, education, and research.

3. IRC Section 501(r) requirements established by the Affordable Care Act (ACA)

As part of the enactment of the ACA, Congress enacted a new tax law: IRC Section 501(r). Under IRC Section 501(r), a tax-exempt hospital must perform the following action steps — subject to IRS review — on a tri-annual basis:

  • Conduct a community health needs assessment.
  • Maintain a written financial assistance policy.
  • Establish limits on its charges to its patients.
  • Establish limits on its patient billing and collection practices.

The GAO review concluded that the current tax law’s guidance for hospitals seeking to achieve or maintain tax-exempt status consists only of a broad framework of requirements, rather than accountable goals and objectives. Consistent, uniform rules that define “community benefit” and clearly determine how much “community benefit” a hospital needs to generate to maintain its tax-exempt status are not established in the current tax law.

The GAO report’s recommendations to Congress

As part of its review — based on 2016 tax year Form 990, and in particular Form 990 Schedule H — the GAO:

  • Assessed the IRS’s oversight of how tax-exempt hospitals provide community benefits.
  • Assessed the IRS’s enforcement of the IRC Section 501(r) requirements.
  • Interviewed selected stakeholder groups — including tax-exempt and for-profit hospital industry groups, patient advocacy groups, and various research organizations — to obtain their views on the clarity and enforcement of the IRS’s community benefit standards, as well as the IRC Section 501(r) requirements.

In its findings, the GAO informed Congress that current tax law, regulations and rulings are unclear about the community benefit activities in which hospitals should be engaged to justify tax-exempt status under IRC Section 501(c)(3). Further, the GAO reported that it believes the IRS does not have a well-documented process to determine whether tax-exempt hospitals are compliant with the requirements under IRC Section 501(r).

Accordingly, the GAO has recommended that the IRS should:

  • Update Form 990, including Schedule H, to provide additional clarity — for both Congress and the public — about the community benefits a hospital is providing, including community benefit factors.
  • Assess the benefits and costs of requiring tax-exempt hospitals to report community benefit expenses on Schedule H by individual facility rather than by collective organization.
  • Consistently review hospitals’ community benefit activities and establish a well-documented process to identify hospitals at risk of noncompliance with the community benefit standard.
  • Establish specific audit codes for identifying potential noncompliance with the community benefit standard.

Additionally, the GAO recommends Congress amend the Internal Revenue Code to clarify what services and activities need to be considered in order to demonstrate community benefits, as well as the activity levels necessary for a hospital to obtain and maintain its tax-exempt status.

Future considerations

With potential health care reform ahead, the GAO’s recommendations may play an important role going forward. As with the ACA, any new health care legislation is likely to contain a tax component that may clarify the requirements for hospitals’ tax exemption under IRC Section 501(c)(3).

Accordingly, tax-exempt hospitals should review the basis on which they determine “community benefit” for each facility they operate, with special attention paid to how program service accomplishments and activities are documented. More importantly, hospitals also should make sure that they are able to show the value of the benefits they are providing their service communities on both a qualitative and quantitative basis. These proactive steps can help hospitals address and respond to prospective legislative or regulatory changes that could affect their tax-exempt status.   

How we can help

We are here to help hospitals commence this process in earnest, and to prepare for potential upcoming legislative changes. If you have questions or need additional clarity, please contact us.

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