P&P Board Examines The Relationship Of Community Benefit To Hospital Tax-Exempt Status

April 20, 2005

Challenges to tax-exempt status are a perennial issue for nonprofit institutional healthcare providers, but have taken on new urgency as lawsuits and Congressional hearings scrutinize the roles, obligations, and oversight of not-for-profit entities. These challenges have raised confusion in the healthcare community and among the public about the purpose of, and conditions for, tax exemption for healthcare providers. 

On May 2, 2005, HFMA's Principles and Practices (P&P) Board will release a new issue analysis to provide some clarity to the healthcare industry on the charitable attributes that merit tax-exempt status and address how to effectively communicate those attributes to stakeholders. The monograph consolidates IRS positions to date on the role of community benefit in determining tax-exempt status, describes the wide array of charitable community benefits, and recommends practices on how to quantify and communicate those benefits. 

Attributes of Tax-Exempt Healthcare Providers

Tax-exempt healthcare organizations are formed to address the specific needs of their communities; therefore, the exempt organization's attributes that merit tax-exemption are not standard across all institutions. In 1991, an HFMA Chairman's Task Force released a report identifying the major attributes of tax-exempt organizations. The P&P Board built on these attributes in light of the current environment. The attributes are:

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.

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-tech, 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, of course, are exempt because of their role in the advancement of education and science. Most tax-exempt healthcare providers, however, also provide a range of educational programs to enhance public health. Examples of such programs include public health education, wellness programs, and the sponsorship of educational activities.

Serving Other Unmet Human Needs. Some tax-exempt hospitals provide important services that are tangential to health care but that are unmet by any other entity in the service area. Examples of these activities include senior citizen education and outreach programs, care for "boarder" babies, or the operation of a "meals on wheels" program. 

Goodwill. Goodwill is an intangible attribute characteristic of successful tax-exempt hospitals continuing their mission of providing care and meeting their community responsibility over a long period of time. Such organizations usually have stable ownership and governance structures and regularly receive significant philanthropic and volunteer support.

Communicating Community Benefit

Except for certain states, such as California where annual reporting is required, there are no appropriate standards for community benefit documentation and communication. The P&P Board recognizes 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 for this process. 

The issue of how to report community benefits and charity care is in flux as the current spate of tax-exemption challenges works its way through the legal system. One emerging practice is to mark charity care or community benefit footnotes as unaudited. This topic is currently under review by the AICPA. Another emerging practice is to disclose the information through 990 filings, particularly for Medicare and community benefits.

The P&P Board believes healthcare providers should identify, measure, and prominently disclose all the attributes of their organizations that warrant tax-exempt status. Many critics of tax-exemption focus on only one attribute, ignoring the cumulative effect of activities that make tax-exemption appropriate. Therefore, it is important that government officials, the media, community leaders, and the public understand all the reasons why an organization qualifies for tax-exemption and the progress that is being made toward achieving its mission. 

SOURCE:

 P&P Board Issue Analysis 05-01: The Relationship of Community Benefit to Hospital Tax-Exempt Status, available from HFMA's On-Line Store May 2, 2005

Additional Resources

• Community Benefit Reporting: Guidelines and Standard Definitions for the Community Benefit Inventory (from the CHA web site)
• P&P Board Statement 15, Valuation and Financial Statement Presentation of Charity Service and Bad Debts by Institutional Healthcare Providers 
  1.  Good Actors in a Bad Movie, August 2004 hfm (Available to HFMA members only. Not a member? Join today!) 
  2. Endangered Species? Not-for-Profit Hospitals Face Tax-Exemption Challenge, September 2004 hfm (Available to HFMA members only. Not a member? Join today!)
• Tax Exempt Status of Not-for-Profit Hospitals: Best Practices for Compliance (March 2005 Audio Webcast)
• New Challenges to Hospitals' Tax Exempt Status as Relates to Charity Care (May 2004 Audio Webcast)
• Services to the Community -- Justification of Tax-Exempt Status (CFO Forum members only. Not a member? Join the CFO Forum today!)
• Uninsured Patients: Comprehensive Listing of HFMA Products and Services

If you have questions or comments about HFMA Wants You to Know, contact editor Laura Noble.

HFMA Wants You to Know ISSN: 1540-0697. Volume IV, Issue 8. Copyright 2005, Healthcare Financial Management Association. All rights reserved.