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An IRS letter revoking a hospital’s tax-exemption provides a stark reminder that compliance with federal charitable hospital rules isn’t optional, health-care tax attorneys told Bloomberg BNA.
“This is a reminder that the IRS is actually out there and looking at whether private nonprofits or dual-status hospitals are complying with the requirements of Section 501(r) of the tax code,” Catherine E. Livingston, a health-care and tax attorney with Jones Day in Washington told Bloomberg BNA. That provision, added to the Internal Revenue Code by the Affordable Care Act, requires tax-exempt hospitals to undertake a series of initiatives to better serve low-income patients and the communities in which they are located.
The revocation appears to be the first by the Internal Revenue Service stemming from a hospital’s failure to meet one or more Section 501(r) requirements, the attorneys said. The private letter ruling revoked the tax-exemption of a dual-status hospital because it willfully failed to comply with section 501(r) of the tax code. The letter was dated Feb. 14 but was released by the IRS Aug. 4.
Dual status hospitals are government-run hospitals that have also obtained tax-exempt status under section 501(c)(3). They qualify for tax exemptions as charitable organizations and also qualify for exemption as governmental organizations.
In the letter the IRS faulted the hospital for its failure to post its Community Health Needs Assessment (CHNA) report or to adopt a plan to address the community health-care needs discussed in the report. Under 501(r) a hospital that qualifies for tax-exempt status under section 501(c)(3) of the tax code has to conduct a CHNA every three years and publicize the report in an easily discovered format, such as on the hospital’s website.
The hospital didn’t contest the IRS determination, instead falling back on its dual status as a partially government-run organization for exemption from federal taxation.
According to the letter, the administrators of the hospital told the IRS the hospital was a “small rural facility” and “had neither the financial wherewithal nor the staffing to devote to the specific requirements of Treasury Regulation § 1.501(r)-3 for conducting a proper Community Health Needs Assessment every three years.”
However, tax attorneys told Bloomberg BNA the letter should serve as a wake-up call for charitable hospitals required to comply with Section 501(r).
“Although premised on some rather unusual facts, the revocation nonetheless serves as a clarion call for hospitals that have been haphazard in their compliance with Section 501(r) over the past few years,” Linda S. Moroney, of Drinker Biddle & Reath LLP in Chicago, told Bloomberg BNA. “This is especially the case with respect to those facets of 501(r) that can be readily assessed based merely on a review of the hospital’s website, including not only whether the hospital has conducted a compliant CHNA, but also whether it has widely publicized its financial assistance policy,” she said.
Sen. Charles E. Grassley (R-Iowa), who played a key role in securing inclusion of Section 501(r) as part of the ACA and has been a vocal advocate for IRS oversight of tax-exempt hospitals, told Bloomberg BNA the letter ruling was a positive sign.
“It’s good to see that the IRS is monitoring compliance and taking enforcement actions where appropriate,” Grassley said in a statement sent to Bloomberg BNA. “For the provisions to have the positive effects Congress intended, hospitals need to know that consequences exist for failing to comply,” he said.
Although the revocation of a hospital’s exemption under Section 501(c)(3) can be a devastating penalty for a tax-exempt health-care organization, the IRS has stated that failure to comply with 501(r) could, in egregious circumstances, lead to revocation.
“Permanent revocation of 501(c)(3) status from a private, nongovernmental hospital could be the most dire of consequences,” Gerald M. Griffith, a tax and health-care attorney with Jones Day in Chicago, told Bloomberg BNA. “This is certainly the case if the hospital has tax-exempt bonds outstanding, because those bonds likely become immediately callable,” he said.
Livingston agreed the potential for revocation serves as a strong motivation for private nonprofit hospitals to comply with all requirements for tax-exempt status, including Section 501(r). “A 501(c)(3) organization has three major concerns when facing the revocation of that status: whether it will be subject to a large income tax bill, how much funding it will lose if charitable foundations and individual donors will no longer make charitable gifts, and what adverse claims will arise if the hospital has tax-exempt debt and defaults as a result of the revocation,” she said.
Griffith, however, said the IRS has to show a willful or egregious disregard of Section 501(r) and its implementing rules in order to revoke tax-exempt status, a very high bar. “In this case the hospital affirmatively stated it did not intend to meet the 501(r) requirements and could not afford to do so,” Griffith said. “Absent that type of statement, if a hospital is making a good faith effort to comply with Section 501(r) requirements, it is quite difficult for the IRS to prove willfulness or that noncompliance was egregious,” he said.
But, short of actual revocation penalties, both Griffith and Livingston warned that failure to completely and openly comply with the CHNA requirements of Section 501(r) could lead to a more invasive audit of the hospital by the IRS. “The key is not just that the assessment be available somewhere online but that it can be found easily on the hospital’s website,” Livingston said. “One of the things the ACA requires is that the IRS review once every three years each nonprofit hospital’s assessment of its community benefit activities,” she said.
“If the IRS cannot find the CHNA during the review, an audit is the next logical step,” Livingston said.
According to Griffith, dual status hospitals should take particular note of the IRS letter. The letter said the hospital claimed its status as a 501(c)(3) exempt entity predated a government takeover of the facility. The hospital served as a Medicare disproportionate share hospital and was a critical care facility such that, when it ran into financial difficulty while under private management, the local government stepped in and took over management of the hospital.
As a result, the hospital said, it didn’t need its 501(c)(3) exemption and didn’t object to having it revoked. However, some governmental hospitals desire to maintain their exemptions in order to be able to make it easier to raise charitable funds from certain donors and foundations. Additionally, a hospital that wants to maintain a 403(b) tax-exempt retirement program for its employees must obtain and maintain 501(c)(3) status.
For these hospitals, failure to comply with Section 501(r) could be disastrous. Dual status hospitals don’t have to file a the Form 990, which serves as the information return for 501(c)(3) organizations with the IRS, because their income is exempt from federal income taxation under another provision of the tax code.
“There may be other dual status hospitals out there that had some false sense of security that because they are not required to file a Form 990 they can fly under the radar,” Griffith said. “This letter reinforces that is not the case.”
To contact the reporter on this story: Matthew Loughran in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Peyton M. Sturges at PSturges@bna.com
The IRS letter is at http://src.bna.com/r41.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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