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On December 30, 2013, the IRS released a proposed revenue procedure that explains how to correct a “failure to comply” with Section 501(r).

Navigating health reform

IRS Publishes Proposed Guidance for Correcting Failures to Comply With Section 501(r)

  • 1/9/2014

On December 30, 2013, the IRS released a proposed revenue procedure that explains how to correct a “failure to comply” with Section 501(r). A failure to comply can result in a $50,000 penalty and/or loss of tax-exempt status, so it is essential for a tax-exempt hospital to take the appropriate steps to avoid those outcomes and minimize its exposure.

In previously published guidance [Prop. Reg. 1.501(r)-2], the IRS indicated that failures to comply will be excused if they are either:

  1. Minor and inadvertent omissions and errors; or
  2. Neither willful nor egregious and corrected and disclosed.

The primary distinction between these two situations is that the former are insignificant but can be corrected without public notification while the latter can be more significant but must also be publicly disclosed.

“Unfortunately, the distinction between the two situations is subjective and is made by the IRS,” says Kurt Bennion, a Health Care Engagement Director at CliftonLarsonAllen.

A lengthy process

Although compliance with most of Section 501(r) was required as of March 23, 2010, becoming compliant has been a long process for most hospitals. As failures are discovered and corrected, a hospital should evaluate the likelihood that the IRS would consider it a “minor and inadvertent omission or error.”

If hospital leaders do not feel confident the IRS would view the situation favorably, they should consider correcting and disclosing the failure to minimize the risk of noncompliance.

IRS guidance

The IRS’s new guidance says it will excuse a failure if the hospital:

  • Did not fail because of gross negligence, reckless disregard, or willful neglect.
  • Takes steps to correct the failure before being contacted by the IRS about an examination.
  • Corrects the situation of any patients affected by the failure, and restores them (financially or regarding status in a program) to the position they would have been in had the failure not occurred.
  • Makes the correction as promptly as reasonable after discovery.
  • Establishes and/or modifies its practices and procedures to avoid similar failures and to increase the likelihood of identifying and correcting any failures that do occur.
  • Discloses the failure in its Form 990, Schedule H for the year in which the failure is discovered.

Although the required disclosure in Schedule H is lengthy, it simply asks for documentation describing the failure, how and when the failure was discovered, corrections made for affected individuals, and any procedures that were established or revised as a result. Unfortunately, Notice 2014-3 does not indicate how the disclosure process would differ for dual-status hospitals.

Through the correction and disclosure process, the IRS is providing hospitals with a valuable tool to protect their tax-exempt status and charitable assets. Hospitals should make use of this process, as necessary.

On December 30, 2013, the IRS also released Notice 2014-2, which authorizes hospitals to rely on the previously issued proposed regulations to determine compliance with Section 501(r) until final regulations are published.

How we can help

CliftonLarsonAllen has assisted more than 50 hospitals in complying with the requirements of Section 501(r). We can help your hospital by:

  • Reviewing compliance policies and procedures.
  • Recommending modifications to increase compliance.
  • Preparing Form 990 answers and narratives to disclose failures and their corrections.
  • Training employees on compliance requirements and recommended procedures.

Most significantly, when the IRS releases final regulations regarding Section 501(r), every applicable hospital will need to revisit its policies and procedures to ensure compliance with the updated regulations.