Lisa Simonson Maiuro
Helen Schneider
Nicole Bellows

How can you maintain your organization's tax-exempt status? One way is to participate in the debate over how to measure charity care and community benefits.


At a Glance 

The recent decision by the Illinois Department of Revenue to revoke the tax-exempt status of Provena Covenant Medical Center is just one indication of a larger trend in which states are increasingly questioning the exchange of social contributions by not-for-profit hospitals for favorable tax treatment. As yet, there is no consensus on how charity care or community benefits should be measured. Results of a study examining different states' specifications of charity care indicate that alternate definitions of charitable contributions have a material effect on the total dollars recognized as charitable contributions. Such differences could have a bearing on any state's decision regarding whether a hospital should be allowed to retain its tax-exempt status. 


The service you do for others is the rent you pay for the time you spend on earth. 

-Muhammad Ali

In February 2004, the Illinois Department of Revenue revoked the tax-exempt status of Provena Covenant Medical Center, a Catholic-affiliated not-for-profit hospital in Urbana, because local tax authorities determined that it was not a charitable institution - a decision that the February 19 Wall Street Journal described as an "unusual move that is sending shock waves across the hospital industry." Not-for-profits across the country may be wondering, "Am I next?"

Not-for-profit hospitals have been under increased scrutiny as local and state governments have become more concerned about holding these hospitals accountable to their communities for their tax-exempt benefits. With states facing severe budget deficits and the uninsured population totaling more than 43.6 million nationwide in 2002 (according to the U.S. Census Bureau), state policymakers have begun to debate more than ever the question "Are we getting enough in return for the tax exemptions granted to not-for-profit hospitals?" Not-for-profits that wish to preserve their tax-exempt status should make a strong effort to play an active role in this policy debate, because the definition of "community benefit" that policymakers use as a basis for answering this question could influence their decisions about whether hospitals are meeting their obligation to retain tax exemption.

More than 20 states have community-benefit reporting requirements designed to tackle the question of whether not-for-profit hospitals are worthy of tax exemption. Yet even in these states, the requirements vary in nature and scope, and determining whether a given not-for-profit hospital's tax exemption is "safe" may be impossible because the methods for economic valuation tend to be unclear and the criteria for providing adequate charity care are often not defined.

To understand the ramifications of these differences and ambiguities, the authors conducted a multivariate study of the effect of market conditions on the provision of charity care over a three-year period (1998-2000). Data for the study were obtained from the California Office of Statewide Health Planning and Development (OSHPD) Annual Disclosure Reports. The California data were used to examine and quantify the potentially variable nature of charity care reporting by addressing the following questions:

  • What are the alternate ways that charity care may be defined given the flexibility available to hospitals in reporting this measure?
  • To what degree do these alternate definitions differ?
  • What policy changes may be considered to make not-for-profit hospitals more accountable?

The findings described here are excerpted from the larger study. Although the research is based on California data, the general findings are applicable to hospitals across the country.

Charity Care: What Are the Legal Requirements?

In accordance with the "community benefit standard" established by the IRS in 1969, federal tax law requires not-for-profit healthcare organizations to provide services in a way that benefits their community in return for federal tax exemption. The IRS's current position on charitable obligations is reflected in a revised and updated ruling issued by the agency in 1983. The ruling states, "the promotion of health . . . is deemed beneficial to the community as a whole," and on the basis of this premise, it sets forth a number of criteria for tax exemption. These criteria include the requirements that care be provided to all uninsured patients, including government-sponsored patients, and that a full-time emergency department be maintained in which no one requiring emergency care can be denied treatment (although this condition may be waived).

However, the IRS did not clearly define community benefits expected of not-for-profit hospitals. This imprecision has prompted researchers to investigate the commitment of not-for-profit hospitals to their communities and states. (See, for example, Reinhardt, Uwe E., "Economics of For-Profit and Not-for-Profit Hospitals," Health Affairs, Nov.-Dec. 2000, pp. 178-185; and Nicholson, Sean; Pauly, Mark V.; Burns, Lawton R.; Baumritter, Agnieshka; and Ash, David A., "Measuring Community Benefits Provided by For-Profit and Nonprofit Hospitals," Health Affairs, Nov.-Dec. 2000, pp. 168-177.)

In 1985, the Utah Supreme Court ruled in Utah County v. Intermountain Health Care that two not-for-profit hospitals did not qualify for property tax exemption based on a six-part test established by that court. The court's criteria focused narrowly on charity care rather than the federal view that recognized community health promotion, in addition to uncompensated care, as an important tax-exempt function.

The 1985 decision prompted numerous tax challenges against not-for-profit healthcare organizations, with the result that many states began to develop standards for tax exemption involving requirements ranging from voluntary process-oriented reporting to more prescriptive, mandatory reporting. By 2001, 21 states had enacted legislation to address hospital charity care through state community benefit planning and reporting laws.

Yet the reporting requirements under these laws still differ from state to state, as do the definitions of charity care.

For example, California's community benefit legislation (SB697) does not require a specified level of community benefits, does not clarify what qualifies as a charitable contribution to the community, and does not provide accounting guidelines for assigning a value to these benefits.

By contrast, the Rhode Island Hospital Conversions Act gives authority to require that all hospitals meet certain standards as a condition of licensure. Specifically, the act stipulates that hospitals must meet the statewide community needs for the provision of charitable care, and must also meet standards for assurance of the continuance of uncompensated care and community benefits.

As promulgated in the regulations implementing the Rhode Island law, the charity care standard for hospital licensure is the hospital's five-year historical charity care percentage average. The second community benefits standard, which addresses uncompensated care, is defined in the regulations to include free care, bad debt, and Medicaid shortfalls. Like the charity care standard, this criterion is also based on each hospital's five-year historical uncompensated care percentage average.

Analyzing Charity Care: Three Progressively Inclusive Measures

To ensure that the question of whether a hospital merits tax exemption is always resolved fairly and consistently, state enforcement agencies must agree on a definition of charity care and community benefit that is broad enough to sufficiently account for the hospital's charitable activities. To assess definitions of different breadth, we measured and analyzed three definitions of charity care:

  • Pure charity care - the portion of care for which patients are unable to pay and are not billed by the hospital
  • Uncompensated care - charity care plus bad debt, where bad debt is intended to capture care delivered to patients who were presumed able to pay, but from whom the hospital has been unable to collect
  • Total charity care - the costs of pure charity care, bad debt, and Medicare and Medi-Cal (California Medicaid program) contractual shortfalls

Although broad, these three definitions do not capture all of the activities of not-for-profit hospitals that could be described as contributing to the community benefit (see "What Constitutes Charity Care?" below). It also is important to note that "pure charity care," as reported in California and many other states, is not entirely "pure." Currently, California provides limited guidance on what constitutes charity care. While many services booked as charity care are provided to patients with important health needs, accounting for other services may be debatable. For example, some hospitals include as charity care health fairs in affluent communities where the need for such care may not be as great as in geographic areas with financially vulnerable populations.

Definition of Charity Care: What's the Effect

Our study showed that the definition of charity care is crucial to the debate about a hospital's obligations. The study findings disclosed a 26-fold difference in average hospital costs, depending on how charity care is defined. That is, in 2000, the charity care contributions of California's hospitals overall ranged from $437.2 million for "pure charity care" to $11.7 billion for "total charity care" including bad debt and government shortfalls. On a per hospital basis in 2000, average hospital charity care contributions ranged from $1.5 million for "pure charity care" to $34.07 million for "total charity care." "Uncompensated care," the most commonly used measure of hospital charitable contributions, accounted for 8.84 percent, on average, of "total charity care" costs.

In addition, all three measures of charity care increased over the time period studied. However, the rate of increase varied widely across definitions, with "pure charity care" showing the highest rate of increase, on average. From 1998 to 2000, the average supply of "pure charity care" increased by 30 percent, or by 19 percent as a proportion of total expenses. Average "uncompensated care" and "total charity care" both grew about 22 percent, or by 8 and 6 percent, respectively, as a proportion of total costs.

The choice of measures used to define charity costs also has a bearing on the answer to the question "Which hospitals provide the most charity care?" In 2000, only about two-thirds of the hospitals in the top quartile (25 percent) of "pure charity care" providers also were in the top quartile for "uncompensated care," and less than two-thirds (58 percent) of these hospitals were in the top quartile for "total charity care."

Policy Recommendations and Implications

The data from this research indicate that the level of a hospital's charity care contribution improves drastically if charity care measures include shortfalls from Medicare and Medicaid contractual adjustments. Thus, the extent to which not-for-profit hospitals "measure up" in their efforts to justify tax exemption is reflected by the costs included in the measure.

Although government and not-for-profit hospitals tend to remain high providers of charity care, there remains significant variation among hospitals' charitable contributions. And a few industry experts have recently observed that tax-exempt status of some not-for-profits may not be justified. (See, for example, Morrisey, Michael A.; Wedig, Gerald J.; and Hassan, Mahmud, "Do Nonprofit Hospitals Pay Their Way?" Health Affairs, Winter 1996, pp. 132-144.) Not-for-profit hospitals should not take such observations lightly, given the increased focus of state and federal agencies on developing legislation to define charity care and examine hospitals' charitable contributions.

Legislative efforts are likely to produce the following changes in states where the criteria for hospitals is unclear or vague:

  • More specific criteria about what may qualify as a charitable activity (e.g., services qualify if they are provided by a licensed healthcare professional, or if they are medical diagnostic or therapeutic procedures for which a medical record is generated or maintained)
  • Explicit accounting procedures for economic valuation
  • Clearer reporting on progress toward specific health or community goals in addition to reporting of total expenditures
  • Greater standardization for the reporting format that will allow for comparisons among hospitals and across years

What Hospital Leaders Can Do

Currently, few states have minimum hospital standards for charity care, and there are great challenges to imposing such standards. The stakes have grown higher, however, and recent events suggest that the movement toward developing minimum standards is fast gaining momentum. As policymakers seek more specific standards for holding not-for-profit hospitals accountable to their communities in exchange for tax-exempt status, the leaders of these organizations should become informed, educated, and active in the discussion.

Admittedly, legislation is often driven by political expediency rather than a rational understanding of the issues. Nonetheless, it is important for hospital executives to understand the research that can drive policy discussions. Gaining this understanding requires more than just skimming the results; it involves a critical assessment of the data and the measures used to reach conclusions.

Hospitals may want to consider convening a work group or panel to discuss the issues, possibly in collaboration with a trade organization or professional association, or through funding from a foundation.

However, such a group - while acknowledging the hospitals' specific financial interests-would need to rise to the challenge of being fair and objective to reinforce the credibility of the results and enhance the chances that those results might be influential in the policy debate.


Lisa Simonson Maiuro, PhD, is employed by Medstat, Sacramento, Calif., and a member of HFMA's Northern California Chapter.

Helen Schneider, PhD, is an AHRQ postdoctoral scholar and a researcher, Nicholas C. Petris Center on Health Care Markets and Consumer Welfare, University of California, Berkeley.

Nicole Bellows is a doctoral student in health services and policy analysis, University of California, Berkeley, School of Public Health, and a graduate student researcher, Center for Health and Public Policy Studies, Berkeley.

Publication Date: Wednesday, September 01, 2004

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