Hospital’s Tax-Exempt Status Revoked for Lack of Community Health Needs Assessment

The IRS reviewed 692 hospitals for 501(r) compliance in FY16, and of those, 166 were referred for further examination.

In an unprecedented action, the IRS has revoked a not-for-profit hospital’s federal tax exemption for failure to comply with the requirements of Internal Revenue Code section 501(r), which requires exempt hospitals to comply with the following:

• Conduct a community health needs assessment (CHNA) and make it widely available to the public.
• Adopt a written financial assistance policy (FAP) that includes plain language, eligibility criteria, and the process for applying for financial assistance, among other areas.
• Adopt a written policy requiring emergency care regardless of FAP eligibility.
• Limit the amounts they charge FAP-eligible patients to not more than the “amounts generally billed” to insured patients for the same services.
• Prohibit the use of gross charges in making amounts generally billed calculations.
• Refrain from engaging in extraordinary collection actions (ECAs) before determining FAP eligibility.

In its recent ruling on tax exemption, the IRS stated that the unnamed rural hospital had failed to conduct a proper CHNA and make it widely available to the public. The hospital’s tax-exempt status under section 501(c)(3) was therefore revoked retroactively to Jan. 1 of a specified (but undisclosed) year.

The case is somewhat unusual in that in addition to its charity status, this disproportionate share, critical access hospital also qualifies for tax-exemption as a government entity. For that reason, its CEO told the IRS that they did not need or want their section 501(c)(3) exemption. It was also stated that they did not have the financial wherewithal or staffing to conduct a proper CHNA and that their exempt status actually hindered them in some of their “reimbursement or payment arrangements.” (What those “arrangements” are was not described in the ruling.)

Although the facts of the case seem unique, there are important lessons to be learned according to Laura Kalick, tax director for the BDO Center for Healthcare Excellence & Innovation, Washington, D.C. The first of these is that the IRS is serious about enforcing 501(r). “I understand that there are at least 30 IRS agents surfing the internet looking for community health needs assessments on hospital websites,” she said recently. “Having your CHNA on your website is the simplest and safest way to ensure that it is widely available to the public. Failure to do so is not a minor infraction.”

The IRS reviewed 692 hospitals for 501(r) compliance in FY16, and of those, 166 were referred for further examination, according to a Bloomberg BNA report.

Kalick says that another tripping point concerns the financial assistance policy. States may have their own requirements for providing financial assistance, but following state criteria does not ensure compliance with 501(r). “Among other things, the federal requirements about ‘amounts generally billed’ and how those amounts are to be determined can be major pitfalls,” she says.

These concerns are echoed by Jonathan Wiik, principal, healthcare strategy at TransUnion Healthcare, Greenwood Village, Col. He confirms Kalick’s point about IRS agents surfing the web, and he adds that it’s important to remember that 501(r) can apply to any patient that owes money, not just uninsured and charity patients.

“Most hospitals do charity well, but consistently determining and documenting eligibility under their FAP is often a problem,” Wiik says. He recommends using third-party data to determine which patients are likely to be eligible. “Use of third-party data facilitates a consistent, unbiased, efficient method for identifying patients who may be eligible. By leveraging third-party data to assist in qualifying a subset of individuals who otherwise would not participate in an interview to determine their eligibility, one can minimize collection expenses, optimize charity determinations, and improve cash flow.”

Wiik notes that 501(r) requires documentation of screening efforts on all potential FAP recipients for eligibility before sending them to collections or employing extraordinary collection actions.

And Tami Knobbe, senior vice president of nThrive, suggests that part of the ECA process should involve detailed conversations with bad-debt agencies. “This should include simple things like ensuring that credit reporting is done no sooner than 240 days from placement (versus the date of billing). Having these discussions in advance adds another layer of protection,” she says.

Section 501(r) compliance is important not only for tax exemption but also for good patient relations and even hospital overall market value. For example, if organizations were to become involved in merger talks, up-to-date and detailed 501(r) policies would be an asset. “All hospitals should dot the i’s and cross the t’s on all their 501(r) materials,” Kalick says.

She adds that once the IRS starts auditing hospitals for compliance with 501(r), agents are likely to inquire into other issue areas as well. “I’ve seen them look at a wide range of topics like employment taxes, Form 990, transactions with disqualified persons (Schedule L), and others.”

Wiik agrees, pointing out that the aftershocks of an audit can spread beyond federal taxation issues. He cites the late 2015 case of Morristown Medical Center, which agreed to pay $26 million in back property taxes because a state judge ruled that it should not be exempt. “The judge said that not-for-profit hospitals would be legal fictions if all hospitals operated the way that one did,” Wiik says. “Because all local governments are looking for additional sources of income, it’s important to make sure that you comply fully with all federal exemption criteria, including section 501(r).”

Kalick, Wiik, and Knobbe emphasize the need to document thoroughly every aspect of 501(r) compliance and ensure that all aspects of it are written in plain language. As stated in HFMA’s Patient Friendly Billing® project, the needs of patients and families come first, so “the average reader should easily understand the language and format of financial communications.”

In summary, they offer these recommendations:

• Create a 501(r) team consisting of risk, compliance, finance, and revenue cycle personnel.
• Update FAPs and application processes.
• Update signage, statements, flyers, and websites.
• Review methods for determining amounts generally billed.
• Ensure that referring physician practices are aligned with those of the hospital.
• Identify gaps and make changes where necessary.
• Ensure that the board of directors is kept apprised of all related policies.
• Document, document, document!

Most organizations do this, but where they fall short is in documentation and using third-party data to validate. Wiik adds, “It is critical to leverage any reliable information you can—whether it be self-reported by a patient or discovered independently through third-party sources—to establish a patient’s eligibility for financial assistance. Documentation of these accounts and stratification into bad debt, charity, and payment segments ensures that earned revenue is paid, collections are optimized, and patients are engaged.”

The key to success is engaging patients early in the process and documenting their status. The other elements of 501(r) are clear, and organizations must understand and follow the rules.

Remember: the IRS is watching!

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J. Stuart Showalter, JD, MFS, is a contributing editor for HFMA.

Interviewed for this article:

Laura Kalick, JD, LLM, is tax director for The BDO Center for Healthcare Excellence & Innovation and BDO’s Nonprofit & Education practice, Washington, D.C., and a member of HFMA’s Maryland Chapter.

Jonathan G. Wiik, MSHA, MBA, is principal, healthcare strategy, Transunion Healthcare, Greenwood Village, Col., and a member of HFMA’s Colorado Chapter.

Tami Knobbe is senior vice president, nThrive, Downers Grove, Ill., and a member of HFMA’s Greater St. Louis Chapter.

Discussion Starters

Forum members: What do you think? Please share your thoughts in the comments section below.

• What challenges have you encountered in compliance with the 501(r) rules and how have you solved them? 

• Are most not-for-profit hospitals equipped to comply with the 501(r) requirements? If not, what specific resources or solutions might make compliance easier?