Under current law, hospitals may be exempted from federal taxes because they promote the health of residents in their communities. Tax exemption is often also considered as a subsidy for the costs the federal or local government would otherwise incur to provide important but costly health services.
In 1988, a chairman's task force of the Healthcare Financial Management Association (HFMA) identified ten attributes of not-for-profit hospitals that merit tax exemption. It found that exempt healthcare organizations are formed to address the specific needs of their communities; therefore, with the exception of the first three attributes (mission, use of financial surpluses, and accountability), the organizational attributes meriting exemption are not standard across all institutions
Major Attributes of Tax-Exempt Healthcare Organizations
Mission to Provide Community Benefit. Mission is a cornerstone of granting tax-exemption. According to federal law, the tax-exempt provider must have a clearly defined mission statement committing the institution to charitable endeavors. Both the institution's historical background and the community's needs are important in determining the mission statement.
Use of Financial Surpluses. No individual may receive any portion of a tax-exempt institution's financial surpluses as a result of ownership. Both federal and state laws require that all financial surpluses must go toward furthering the organization's charitable purpose. Compensation arrangements must be carefully constructed to reflect fair market value for services rendered.
Accountability. The organization's board of trustees must hold itself answerable to its community for maximizing the entity's contribution to the community.
Goodwill. Goodwill is an intangible attribute that characterizes exempt hospitals that have successfully provided care and met their community responsibilities over a long period of time. Such organizations usually have stable ownership and governance structures and regularly receive significant philanthropic and volunteer support.
Types of charity services:
Provision of Charity Care. Free or discounted care is an important component of many hospitals' tax-exempt missions, but is not the only function that hospitals perform to merit tax-exempt status. Organizations that provide charity care must establish and communicate a clear charity care policy based on community needs and input. The policy should include easy-to-understand, written eligibility criteria.
Reduction of Government Burden. Many tax-exempt hospitals provide services that government otherwise would have to provide. Services especially demanded from tax-exempt healthcare providers include high-technology, high-intensity services, emergency care, chronic care, long-term care, and unprofitable services.
Provision of Essential Healthcare Services. Tax-exempt healthcare providers are often the sole providers of healthcare services that are so essential to community health that tax-exempt status is warranted. Examples of essential services include emergency rooms and outpatient clinics serving low-income patients.
Provision of Unprofitable Services. The provision of unprofitable services is commonly a provider's charitable response to a community need. Unprofitable services in this sense lose money because of high costs combined with low volume or inadequate payment rather than inefficient operations. Common examples of unprofitable services include burn, neonatal, and trauma centers and community mental health centers.
Public Education. Teaching institutions are exempt because of their role in the advancement of education and science. Most exempt healthcare providers, however, also provide many educational programs to enhance public health, such as public health education, wellness programs, and the sponsorship of educational activities.
Serving Other Unmet Human Needs. Some exempt hospitals provide important services that are tangential to health care but that are unmet by any other entity in the service area. Examples include senior citizen education and outreach programs, care for "boarder" babies, or "meals on wheels" programs.
Accountability and the Reporting of Community Benefits
HFMA's panel of healthcare accounting experts, the Principles & Practices (P&P) Board, asserts that each healthcare provider should measure and prominently disclose all the attributes that support its tax-exempt status. Such reporting demonstrates the progress that is being made toward meeting the organization's mission and community needs.
HFMA and the P&P Board recognize Community Benefit Reporting: Guidelines and Standard Definitions for the Community Benefit Inventory for Social Accountability-developed by VHA Inc., the Catholic Health Association of the United States, and Lyon Software-as useful guidance.
P&P Board Issue Analysis 05-01: The Relationship of Community Benefit to Hospital Tax-Exempt Status. Order hard copies of this issue analysis.
P&P Board Statement 15, Valuation and Financial Statement Presentation of Charity Service and Bad Debts by Institutional Healthcare Providers
Community Benefit Reporting: Guidelines and Standard Definitions for the Community Benefit Inventory for Social Accountability
Publication Date: Friday, March 24, 2006