Some healthcare policy analysts were skeptical of the findings.

Oct. 20—As the Trump administration moves to reform the federal tax code, the country’s tax-exempt hospitals are bracing for potential challenges to their not-for-profit (NFP) status, with billions of dollars in federal taxes at stake.

To defend the value of the tax exemption to their not-for-profit member hospitals and patients, the American Hospital Association (AHA) commissioned Ernst & Young to produce a study chronicling the value of NFP hospitals’ community benefits.

The study found that 2,988 tax-exempt U.S. acute-care hospitals spent $67.4 billion in 2013 on community health benefits they provided, compared to $6 billion in estimated tax revenue foregone.

Hospitals are “demonstrating the value they provide and solidifying their commitment to making their communities healthier through strengthened community partnerships...” said Rick Pollack, president and CEO of AHA, said in a release.

The community benefits figure, as reported on IRS 990 forms’ Schedule H, was 11 times greater than the value of the tax revenue forgone for 2013, the most recent year for which information was available for NFP hospital Medicare cost reports.

Hospitals community benefits comprised 11.7 percent of their total expenses, according to an earlier Ernst & Young analysis for AHA.

At the same time, NFP hospitals face increased scrutiny from the IRS and state regulators. Earlier this year for the first time under the Affordable Care Act (ACA), the IRS revoked the tax-exempt status of a rural NFP hospital operated by an unnamed county governmental agency. In that final adverse determination letter released Aug. 4, the IRS said the hospital “failed to comply with the requirements of Internal Revenue Code section 501(r) to conduct a community health needs assessment, adopt an implementation strategy, and make it widely available to the public.”

The IRS cited “egregious failures” by the county-owned hospital, which is both a critical access hospital and a disproportionate share hospital.

In addition, Sen. Chuck Grassley (R-Iowa) threatened more IRS action if NFP hospitals fail to meet their legal commitments “to provide treatment for those who can’t pay or can’t pay enough toward the cost of their own care.”

In a September letter to a news organization, Grassley wrote that “Hospitals should do the right thing when no one’s looking. But in case they don’t, the IRS is required to keep them on track.”

Report Reaction

John C. Goodman, president and CEO of the Goodman Institute for Public Policy Research, was skeptical about the new AHA report’s findings.  Goodman said hospital reporting of costs, bills, and expenses are frequently inaccurate.

“How would anyone know the true value of the community benefits they report?” he said in an interview. “Even the hospitals don’t know what things cost. I view all their numbers with great skepticism.”

Craig Garthwaite, associate professor of strategy and the director of Northwestern University’s Kellogg's Health Enterprise Management Program, also questioned the AHA report. In an interview, Garthwaite challenged the valuation of benefits within the AHA paper.

“By limiting focus to several federal taxes, the study is missing some of the biggest benefits of tax exempt status: state and local property and sales taxes that NFP hospitals don’t pay,” Garthwaite said. “That’s a huge benefit given the size of their physical facilities. They slightly over count the community benefits they provide, while ignoring huge portions of the tax benefits because they accrue to something other than the federal benefit. It’s an attempt to make the disparity as big as possible.”

Michael Fine, a healthcare tax attorney with Wyatt Tarrant & Combs who chairs the American Health Lawyers Association’s Tax and Finance Practice Group, agreed. He noted that state sales and property taxes are more significant financially than the federal income tax benefit.

Fine said in an interview that the EY report employs “a more expansive definition of community benefit” that also includes Medicare underpayments, professional education, and research, which he conceded may spur disagreement from state tax assessors.

He said new IRS Section 501(r) regulations require hospitals to frontload qualifying patients versus claiming them later as bad debt on the back end.

“By implementing 501(r) there is now a clear differentiation between how NFP hospitals are expected to behave. These rules were created, in part, because of some very aggressive debt collection activities by a few hospitals, which gave NFP hospitals a black eye, Fine said. “But the NFP sector has really improved and heeded the call to change these practices.”

Fine said the IRS is now required to review one-third of the nation’s NFP hospitals’ tax compliance annually.

“So we know the IRS is looking, but they’re still lagging behind and are now reviewing 2014 tax returns. Once the IRS catches up with tax years 2015 through 2017, that’s when we will see more IRS activity on Section 501(r) enforcement because the final regulations apply,” Fine said.

State Regulators

James Unland, president of the Health Capital Group, foresees more scrutiny of tax-exempt hospitals coming from state regulators.

Unland said state assessors and attorneys general in California, Illinois, and New Jersey have taken actions. For instance, after a state tax court ruled against Morristown (N.J.) Medical Center in 2015, 35 New Jersey hospitals were sued for property taxes.

“A big case can have a tremendous ripple effect throughout the state,” Unland said.

Many hospitals later settled by making payments in lieu of taxes.

“I think hospitals should be more concerned,” Unland said in an interview. “These things tend to move in waves every 10 years or so and today states feel more confident in challenging hospital tax exemptions at local levels.”

Joel Swider, a tax attorney with the Indianapolis firm Hall Render Killian Heath & Lyman, said other state challenges have come in Connecticut and Montana.

“Hospital should prepare themselves, not only on the application side, but also the appeals side, Swider said. “They need to explain community benefits and go beyond the Form 990 standards. They need to let the public know that they are charitable entities, not just businesses, and combat the view that they are operating the same as for-profit entities.”

He said a legislative bill in Montana that died in February would have revoked the tax exempt status of organizations that compensate staff at rates higher than $250,000. And in February Connecticut Gov. Daniel Malloy, a Democrat, proposed that cities and towns there should be allowed to levy property taxes on not-for-profit hospitals.

“The Connecticut issue remains unresolved, but it essentially is a push by the governor to levy property taxes on not-for-profit hospitals in order to offset budget shortfalls,” Swider said.

 Jeff Carmichael, also with Hall Render, said the IRS takes 501(r) seriously and if hospitals do not, “they may risk losing their tax-exempt status.”

However, in an interview Carmichael cautioned that the IRS revocation of the tax exemption of that government-owned hospital “is not necessarily a sign that the sky is falling. It certainly is a warning to all 501c3 hospitals to have their ducks in a row. But it is a special circumstance.”


Mark Taylor is a freelance writer based in Chicago. 

Publication Date: Friday, October 20, 2017