August 23, 2006
Not-for-profit hospitals are finding they're under increasing pressure to justify their tax-exempt status. Beyond the highly-publicized question of whether they provide sufficient charitable care to fulfill their obligation under tax exemption, the IRS and members of Congress have voiced concerns that the line has become increasingly blurred between organizations operating as true altruistic public charities and not-for-profit health systems thriving under quasi-corporate leadership and structure disguised as entities serving the public good.
An article in the June 2006 hfm suggests some often-overlooked areas to check to make sure your organization's compliance with the tax-exempt requirements remains above reproach.
Potential Trouble Spots
Clinical research. Healthcare organizations often conduct (or are directly affiliated with clinical research institutions that conduct) a variety of research activities. Each research protocol should be evaluated to ensure that the results of the research benefit society at large rather than a specific individual or entity. An example of public benefit would be if a corporation funds a study of drug interactions for a drug family, such as antibiotics (rather than a product manufactured exclusively by one pharmaceutical company).
Partnerships with educational institutions. Healthcare financial managers should evaluate all relationships between the hospital organization and educational institutions, particularly for-profit trade schools. For example, if a hospital routinely pays tuition or offers scholarships for students to complete a two-year radiology program, the hospital's Section 501(c)(3) tax-exempt status may be at risk because the privately owned radiology school receives economic benefits from the hospital organization.
Board composition. Private inurement may result if decisions are made at the board level that directly benefit a physician serving in a governance capacity. To avoid a potential conflict of interest, members of the medical staff actively practicing at facilities owned and operated by the hospital should be prohibited from serving on the organization's board or board committees.
Political activities. Despite hospitals' financial vulnerabilities to changes in government programs such as Medicare and Medicaid, participating in political activities, particularly lobbying and campaign contributions, may place tax-exempt status at risk. A simple matter of the display of a political sign on hospital grounds or campaign pins worn by employees could be suspect. Clear organizational policies should be established and enforced prohibiting such activities by all hospital employees and medical staff.
Operating an affiliated business. Many health systems own and operate affiliated businesses that support the primary mission of the organization. Examples include schools, collection agencies, joint ventures, and even hotels to house traveling nurses and the family members of patients. Healthcare financial managers should assess the overall size and scope of the business units and subsidiaries in which the organization has ownership or substantial controlling interests to ensure the majority percentage of the total organization is not deemed to be businesses outside the purpose for which the tax-exempt status was established.
Red Flags for Private Inurement
Transactions that benefit individuals in excess of fair market value may jeopardize an organization's tax-exempt status under Section 501(c)(3). One or two isolated incidents may result only in intermediate sanctions, but the IRS may take stronger action against the organization's exempt status if there is a pattern of offenses, the size of excess benefit transaction is extreme, the institution lacks measures to prevent future occurrences, or if the institution fails to take corrective actions. Some areas to watch include:
Physician benefits. Carefully scrutinize the economic favors given to physicians, especially in markets where pressure is intense to attract physicians. Such favors include inflated fees for clinical services rendered, excessive payments for administrative medical director services, waived rent for office space owned by the hospital system, or lavish gifts for continued patient referrals.
Executive compensation. A market salary study should be performed to ensure the compensation packages, including salaries, bonuses, and fringe benefits, are reasonable and justifiable. Perks such as housing and automobile allowances, paid memberships to country clubs, and exorbitant expense accounts should be identified and curtailed. Paid travel expenses, especially spousal travel above reasonable and customary amounts, may also be viewed by the IRS as a form of excessive benefit. The organization should ensure these perks are included as income on the individual's W-2 statement.
Reduce Your Organization's Risk Exposure
The IRS, as well as federal and state legislators, regulators, and attorneys general, are sending a clear message to the not-for-profit business community about their concerns that tax-exempt status privileges are being abused. Healthcare financial managers should step back and realistically assess the components of their business organizations, business objectives, and governance structure to ensure that, from a macro perspective, the organization's activities meet the spirit of the fundamental purpose behind the tax-exempt status. That, combined with a detailed evaluation of specific transactions and events to verify compliance with the individual requirements of the tax-exempt regulations, will help you reduce your organization's risk of losing its exempt status.
SOURCE: Condensed from Is your Hospital's Tax-Exempt Status at Risk?, by John S. Ricaud, director of internal audit, Piedmont Healthcare, Atlanta, June 2006, hfm.
Additional Resources
--------------------------------------------------------------------------------
If you have questions or comments about HFMA Wants You to Know, contact editor Maxine Harrison.
HFMA Wants You to Know ISSN: 1540-0697. Volume V, Issue 18. Copyright 2006, Healthcare Financial Management Association. All rights reserved.