Cutting corporate tax rates would sharply limit the attractiveness to investors of the after-tax yield of tax-exempt hospital bonds, according to one adviser.

Dec. 19—After hospitals raised alarms in recent weeks about a congressional tax overhaul that would end tax-exempt bonds, legislators dropped the provision from a final bill they aim to pass this week.

Despite dropping the elimination of so-called private-activity bonds (PABs), the Tax Cuts and Jobs Act (PDF) still carries some bad financial news for hospitals.

The PAB change was one of many that have occurred recently in the sweeping overhaul of the U.S. tax code, as separate tax bills passed by the Senate and House of Representatives were reconciled by a congressional conference committee to create a common bill for final passage by both chambers. After the Senate passed the bill Dec. 19, the House was expected to clear the bill on Dec. 20 for the president’s signature.

Hospital advocates had pushed back on earlier versions of the tax bill that eliminated PABs, which many small and rural hospitals rely on to provide infrastructure funding.

“Protecting hospitals’ access to tax-exempt private-activity bonds means ensuring access to modern facilities that are better able to provide high quality care in thousands of communities across America,” Rick Pollack, president and CEO of the American Hospital Association, said in a written statement. “A vital source of low-cost capital financing, which helps keep health care more affordable, private-activity bonds are a proven benefit to the public at large and would be preserved under this legislation.”

Moody’s had warned in a Dec. 12 report that elimination of PABs would be a credit-negative for not-for-profit hospitals.

“Tax-exempt entities are really breathing a sigh of relief right now,” said Heather Meade, a principal for Ernst & Young. “A lot of the provisions they were most concerned about did not make it into the conference report.”

One of the largest remaining not-for-profit hospital borrowing impacts in the conference bill would come through reductions in the corporate tax rate from 35 percent to 21 percent, according to Pierre Bogacz, a managing director for HFA Partners.

The change would sharply limit the attractiveness to investors of the after-tax yield of tax-exempt bonds compared with taxable yields, he said. Investors thus would be expected to ask for higher yields on tax-exempt bonds, thereby making tax-exempt borrowing more expensive for hospitals.

The change would affect not only future tax-exempt bonds but also existing ones with “yield maintenance” provisions, a common clause that gives the lender the right to adjust the yield higher.

Because of the corporate-rate change, banks to which hospitals are paying a 3 percent rate likely would increase that by a full percentage point, for example.

“Banks will ask for a higher tax-exempt [bond] yield because that tax exemption is worth less,” Bogacz said in an interview.

Bogacz suggested that hospitals with existing bank placements examine them for yield maintenance provisions and be prepared to address the issue with their bank, because banks are likely to act on it.

Other provisions impacting not-for-profit hospitals include:

  • Creation of a 21 percent excise tax on any compensation over $1 million paid to their five highest-paid employees—with a carve-out for certain medical professionals
  • Implementation of a new 1.4 percent excise tax for endowments (which may affect teaching hospitals connected with endowed universities)
  • A requirement that unrelated business income tax be calculated separately for each business, meaning losses could not cover the taxes on gains from other lines of businesses

“Hospitals may offset the losses in one line of business with gains in another, so that may be a significant change for some,” Meade said.

For-Profit Impacts

For-profit hospitals are expected to largely benefit from the sharp reduction of the corporate tax rate and repeal of the corporate alternative minimum tax.

Complicating issues include the timing of the bill’s signing into law. If Trump signs the bill before the end of 2017, hospitals will need to include an accounting of all changes the new law makes to their organizations in their 2017 financial statements, Meade noted.

“The only way to have any leniency is if the [Securities and Exchange Commission] expressly grants leniency for the hospitals and for companies generally,” Meade said in an interview. “So it’s an open question companies are watching very, very closely right now.”

Another challenge is that few for-profit hospitals have modeled how the various provisions of the bill would impact their organizations. Those organizations may especially want to model the impacts of a new limitation on the use of net operating loss deduction carryforwards, a new limit on the deduction for net interest expense, and employee benefits provisions, according to Meade.

Although the corporate-rate cut increases the chances that for-profit hospitals will come out ahead under tax reform, whether that advantage is overwhelmed by other provisions will need to be assessed on a case-by-case basis, said Rob Friz, U.S. healthcare provider tax leader at ‎PwC.

Advance Refundings Eliminated

The conference tax bill would end the ability of not-for-profit hospitals to undertake a one-time advance refunding of a bond. Hospitals were limited by a 1986 tax overhaul to one such advance refunding, which lowers their overall borrowing costs.

“It’s nice to have, but it is not going to kill anybody’s financial strength by not being able to advance refund,” Bogacz said about the impact on hospitals.

The change could have a bigger impact on state and local governments, which use such bonds to fund projects aimed at some mitigating some of the social determinants of health, such as building housing for homeless populations.

One option for hospitals, according to Bogacz, is to implement a rate lock when performing swaps and then use a current refunding when the bond becomes currently callable.

Individual Mandate Repealed

The tax legislation repeals the tax penalty for the individual health insurance mandate of the Affordable Care Act (ACA) beginning in 2019. According to the Congressional Budget Office (CBO), this repeal provision is projected to reduce the federal deficit by $318 billion over 10 years and increase the number of uninsured by 4 million in 2019 and 13 million by 2027.

“And it would potentially have an impact on state and federal spending on Medicaid, which would impact hospitals,” Friz said.

Additionally, CBO projected that repealing the mandate would increase premiums in the individual market by an average of 10 percent in most years over the coming decade, although most states' individual markets would remain stable.

Hospitals have worried that 13 million in additional uninsured would increase their uncompensated care costs.

“It is unfortunate that the important task of overhauling the tax code will erode health coverage for many,” Pollack said.

Sen. Susan Collins (R-Maine) reportedly agreed to support the tax bill because Republican leaders promised subsequent enactment of individual-market stabilization measures, such as temporary funding for both the ACA's cost-sharing subsidies and state reinsurance programs to subsidize insurers' most expensive claims.

Those measures aim to increase marketplace stability and mitigate the negative impact of eliminating the individual-mandate penalty. However, a Nov. 29 CBO report warned that enacting several stabilization initiatives would do little to lessen increases in the number of uninsured or in premiums if the mandate penalty was eliminated.

Other Provisions

Hospital advocates celebrated the return in the conference bill of the deductibility of qualified medical expenses that exceed 10 percent of an individual's adjusted gross income. An earlier version had eliminated the deduction for the cost of preventive care, treatment, surgeries, and long-term care expenses for chronically ill patients. About 9 million people claimed the deduction in 2015, according to an IRS report.

The conference bill would reduce the medical deduction threshold to 7.5 percent of gross income for the 2017 and 2018 tax years, then return it to the 10 percent threshold that the ACA established in 2010.

Hospital advocates also praised the elimination in the conference bill of an earlier version’s tax on tuition waivers and exemptions.

“The removal of these provisions, and those that would have eliminated the student loan interest deduction and other education-related credits, will help keep medical education and biomedical research training within the reach of all who wish to pursue those paths,” Darrell Kirch, MD, president and CEO of the Association of American Medical Colleges (AAMC), said in a written statement.

Rich Daly is a senior writer/editor in HFMA’s Washington, D.C., office. Follow Rich on Twitter: @rdalyhealthcare

Publication Date: Wednesday, December 20, 2017