Howard A. Levenson

Many tax-exempt hospitals could do a better job accounting for the community benefit they deliver, and thereby show that they are truly worthy of tax exemption.

At a Glance

  • The IRS's Revenue Ruling 69-545, issued in 1969, remains the standard for determining whether the amount of community benefit a not-for-profit hospital delivers justifies its tax-exempt status.
  • The revised IRS Form 990 will give hospitals an opportunity to demonstrate that they are providing sufficient community benefit.
  • With increased public attention, hospitals need to ensure they are publicly documenting the benefit they provide their communities in order to reduce the risk that lawmakers could change the law or the IRS could revise the community benefit standard .

Hospitals' elevated public stature left some surprised when, in recent years, Congress began asking questions about whether not-for-profit hospitals deliver enough "community benefit" to justify their tax exemptions.

It is uncertain to what end Congress will pursue its inquiry, but the further we move into 2008, this much is clear: Continued governmental scrutiny of hospitals' tax-exempt status is not going away anytime soon. Washington is exhibiting a heightened sensitivity for budget scrutiny, and with funds for discretionary programs scarce, Congress is spending money on a pay-as-you-go basis. With precious little tax revenue available, the House and Senate tax-writing committees are vigorously watching tax dollar use. That is why tax-exempt hospitals-all tax-exempt organizations, for that matter-must be prepared to justify their tax status.

The federal government bases a hospital's tax-exempt status on whether it meets the "community benefit standard" articulated by Revenue Ruling 69-545, issued by the IRS in 1969.a Chief among the revenue ruling's requirements are that hospitals must:

  • Accept and treat Medicare and Medicaid patients
  • Open their emergency departments (EDs) to all people, regardless of their ability to pay
  • Have an open medical staff that allows credentialed physicians to practice at their facilities
  • Operate under a community board's control

How Did We Get Here?

In 2005, Congress began shining a light on the topic and began to probe whether tax-exempt hospitals and health systems were benefiting their communities enough to earn tax exemption. Soon after, the media picked up the story and made it national news.

Several lawsuits challenging tax exemption for hospitals that employed aggressive collections tactics against uninsured patients brought unfavorable media attention, and the Senate Finance Committee called hearings on the matter. Some committee members started urging the IRS to better enforce the current community benefit standard, which justifies the tax exemption.

At the same time, committee members encouraged the IRS to consider whether the community benefit standard, which has not been changed since 1969, needed a revision. In testimony before the Senate Finance Committee, one not-for-profit hospital industry association, the Catholic Health Association (CHA), articulated its approach to quantifying community benefit. Many not-for-profit hospitals already comply with the CHA's standard, and it is the one for which influential committee members expressed a preference.

The American Hospital Association (AHA) promotes an alternative standard, which aligns with the CHA's standard on all but two grounds. Unlike the CHA, the AHA believes community benefit quantification should include both bad debt (i.e., unrealized revenues from patients who fail to pay their medical expenses) and Medicare cost shortfalls (i.e., the gap between Medicare program costs and reimbursements).

Testing the bounds of what might be considered community benefit, the IRS sent three-part questionnaires to more than 500 randomly selected, tax-exempt hospitals. The questionnaires asked the hospitals to provide general organizational information, operations information, and executive compensation information. The IRS said the data hospitals returned would form the basis of a revised Form 990, the annual information return for tax-exempt organizations (see

Around the same time the IRS sent its questionnaires, the AHA commissioned a study of AHA members' responses to the IRS questionnaire.b The review of the nearly 120 questionnaires disclosed that the AHA member hospitals participating in the project appeared to meet the existing community benefit standard.

By contrast, the IRS's own 2007 Hospital Compliance Project Interim Report did not conclude whether reporting hospitals were meeting the current community benefit standard.c The information the IRS reviewed, however, did appear consistent with the information reviewed by the AHA study to reach its conclusion, taking into account the different sampling sizes.

In the spring of 2007, the IRS issued a draft redesigned Form 990, which the agency last overhauled in 1979. Piecemeal changes made to the form in the nearly 30 ensuing years did not, according to the IRS, sufficiently keep pace with changes in the tax-exempt community or the law.

The Form 990 redesign seeks to accomplish three things:

  • Provide a more realistic picture of an organization's operations and a better basis for comparison among organizations, thereby enhancing the filing organizations' transparency
  • Promote compliance with an accurate reflection of an organization's assets and its use of those assets
  • Minimize filing burdens and avoid unwarranted recordkeeping and reporting through the use of plain language

The revised Form 990's Schedule H addendum attempts to provide tax-exempt hospitals with a method for quantifying their community benefit based on the CHA standard, while also offering them the opportunity to describe, in words, other ways in which they benefit their communities. Although portions of the revised form will be phased into use over the next two years, the form is scheduled to be in effect for tax years beginning in 2008.

An Uncertain Regulatory Landscape

When the current congressional session began in 2006, the House and Senate adopted a "pay-as-you-go" rule for public programs known as "PAYGO." Congress has since frequently adopted PAYGO when government's high budgetary expenditures demand it. The rule basically requires any new increase in federal spending to be offset by a decrease in federal dollars elsewhere to pay for the new program. In response to the uncertainty that this rule creates, organizations must go to extraordinary lengths to convince Congress that their organization deserves government financing or tax-preferred treatment.

Congress and the IRS will continue their scrutiny of tax-exempt organizations and may continue to consider legislating a quantifiable community benefit standard, including, at some point, a revised charity care definition. It is therefore worth reiterating that tax-exempt hospitals-all tax-exempt organizations, for that matter-must be prepared to justify their tax status.

A Blurred Distinction

Much of the uncertainty has been created by change that has occurred since the IRS issued its 1969 revenue ruling. The 1969 revenue ruling had, itself, substantially overhauled a 1956 revenue ruling that contained a general charity care requirement. The 1969 ruling replaced the general charity care requirement with two more specific requirements: First, it required that EDs be open to everybody, regardless of a person's ability to pay, and second, it required that all with the ability to pay, including Medicare and Medicaid patients, be treated as well.

Medicare and Medicaid were relatively new programs in 1969, and the federal government likely had concerns some hospitals would not participate in them. But history has shown us most for-profit hospitals do participate in Medicare and Medicaid. Beyond those programs, the 1986 Emergency Medical Treatment and Active Labor Act (EMTALA) ensures public access to emergency medical services regardless of one's ability to pay.

Although the EMTALA rules appear to limit hospitals' medical care provision obligations to the point of patient stabilization, the IRS's 1969 revenue ruling may have a broader scope, as far as indigent care is concerned. Nevertheless, there can be little doubt that EMTALA's passage, along with taxable hospitals' voluntary Medicare and Medicaid patient treatment, somewhat blurred the line between tax-exempt and taxable hospitals.

The Need for a Clarified Distinction

Although tax-exempt hospitals are different from taxable hospitals in many distinct ways, the former hospitals have not always done a good job articulating those distinctions in the public domain through the annual filing of their Forms 990, which are publicly accessible documents.

Based on what's currently transpiring at the federal level, the government does not seem ready to change the community benefit standard that not-for-profit hospitals use to obtain or keep their tax-exempt status. The Form 990 revision, however, does give an indication about the government's mood. These forms will now disclose in the public domain what hospitals are doing to meet their community benefit obligations.

Although the federal government has not yet issued a standard that articulates a minimum charity care or community benefit requirement, putting hospitals' data on publicly accessible forms will increase people's examination of them. As hospitals draw public attention, the organizations that appear to be neglecting their community benefit obligation will be subject to criticism not only from the public, but also from lawmakers who are in the position to change the law.

The Problem of the Uninsured

Providing health care to people who have no health insurance is a factor that significantly complicates the community benefit issue. Health care for the uninsured is an issue that leading Senate Finance Committee members strongly advocate, and it is a vastly greater issue than charity care itself.

Most tax-exempt hospitals maintain charity care policies targeted to low-income individuals whose income falls below three to five times the federal poverty guidelines for the community in which they live. Uninsured individuals who fall within Medicaid or Medicare guidelines or within a hospital's charity care guidelines will qualify for free or discounted health care at virtually all tax-exempt hospitals. But a critical segment of the uninsured population still remains unaccounted for. This segment, the largest segment of the uninsured, in fact, is a group often called the "working uninsured."

Most of the working uninsured would fail to satisfy a hospital's charity care guidelines, at least upon their initial need for hospital services. At some point, an employed but uninsured individual could drop into an income or asset bracket in which he or she would qualify for charity care under a hospital's guidelines. But such a change could not always be expected to occur, and in most cases, such individuals will neither qualify for charity care nor fall within the Medicaid guidelines either. Some individuals may fall within Medicare guidelines, but few of the working uninsured will be old enough to meet these guidelines.

What Are Tax-Exempt Hospitals Doing?

No reasonable person could expect tax-exempt hospitals alone to solve the issue of the uninsured. The problem calls for a broader solution that, in all likelihood, will require government involvement. Some states have already enacted laws to provide coverage for uninsured children, regardless of where they obtain treatment. The provision of health care to the uninsured and the provision of health care to charity care and indigent patients are separate, distinct issues, and they must be treated as such.

So what, then, are tax-exempt hospitals to do while the government decides whether it will modify the community benefit standard to include a charity care requirement?

Valuing community benefit delivered versus tax exemption. A number of proactive, tax-exempt hospitals have undertaken efforts to calculate the value of their tax-exempt status. Hospitals that pursue this tack compare the value of such status with the amount of charity care and other associated benefit they give back to their community. This approach gives a hospital a quantifiable metric that suggests whether it is providing enough benefit or needs to provide more.

It is important to recognize that appraising the value of a hospital's tax-exempt status is more difficult than simply applying state and federal government income tax rates to the financial statement's audited revenues. First, if a hospital's status changed to taxable, a lot of the financial statement's numbers would need to be adjusted to arrive at taxable income. Second, the largest tax benefit to most tax-exempt health systems arises from the exemption from state and local property and sales tax. For example, in calculating the value of the income tax exemption, gifts and grants tax-exempt hospitals count as revenue would in all likelihood disappear if the hospital were to become a taxable entity.

In addition, the favorable interest rate a hospital might pay using tax-exempt bond financing would also disappear, and those loans would have to be refinanced with higher-rate taxable debt. The status change would increase the hospital's interest expense and increase its interest deduction vis-à-vis its current financial statement.

Last, but not least, the newly taxable hospital would have to determine its state and local property tax and sales tax rates because sales and property tax breaks would no longer be available. These additional taxes would, in turn, be deductible for federal income tax purposes.

Employing better public relations. A number of hospitals also have undertaken efforts to do a better job communicating to the public the hospital's community benefit. The revised Form 990 allows space, through an addendum, for filers to put into words the extent to which they earn their preferred tax status through good works in the communities they serve. Here, a seasoned tax adviser who understands tax-exempt hospitals' industry best practices can prove to be an indispensable strategic ally.

Beyond communicating good works to the IRS, tax-exempt hospitals could do a better job communicating their charity care policies to incoming patients so that more individuals who qualify for charity care actually claim it. There are myriad reasons individuals do not claim charity care to which they are eligible, and often when those individuals receive care, the costs are written off as "bad debt."

Tax-exempt hospitals that can grow their charity care rolls while shrinking their bad debt rolls increase their community benefit. Such a move is in alignment with the CHA's guidelines, which some influential lawmakers seem to favor. Still, better charity care policy communication may not, at the end of the day, appreciably increase the number of patients who claim it.

A Fair Assessment

The determination of which tax-exempt hospitals are providing adequate community benefit should not be predicated upon a hospital's geographic location. Charity care is dispensed disproportionately among hospitals located in inner cities and suburbs, and as one would expect, inner-city hospitals see more charity care patients than do hospitals in the suburbs. This fact should not preclude suburban residents from having access to tax-exempt hospitals in their communities as long as these hospitals offer a reasonable charity care policy that is made available to all those in need who present themselves to that hospital.

Truth be told, community benefit is difficult to value. There is no one-size-fits-all solution. It is best to remain vigilant while awaiting further government moves. Anticipate community scrutiny and embrace it. Do not shy away from it. Recognize the scrutiny as an opportunity to communicate-to demonstrate-how the hospital helps the community it serves, then make sure to tell that story to all of the hospital's stakeholder groups.

Howard A. Levenson, CPA, is national director, exempt organization tax services, in Ernst & Young LLP's Washington, D.C., office, and a member of HFMA's Virginia Chapter.

The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP.

a. To read Revenue Ruling 69-545, go to, search on "69-545," scroll down and click on "Revenue Rulings Archive - 69," and then scroll down to the ruling.

b. Ernst & Young LLP, Community Benefit Information from Non-Profit Hospitals: Lessons Learned from the 2006 IRS Compliance Check Questionnaire, Chicago: American Hospital Association, Nov. 27, 2006

c. To read the IRS report, go to and search on "Hospital Compliance Project."

Publication Date: Saturday, March 01, 2008

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