Proposed Tax-Exempt Bond Changes Could Thwart Hospital Funding

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By Matthew Loughran

Nonprofit hospitals could see a key funding stream evaporate if the House Republican tax bill becomes law, according to health-care tax attorneys who spoke to Bloomberg Law.

Private activity bonds, which governmental authorities issue to help private organizations pay for facilities and capital improvements, are currently exempt from taxation in certain circumstances, including when the proceeds of the bonds go to support qualified 501(c)(3) organizations, like nonprofit hospitals. The Tax Cuts and Jobs Act ( H.R. 1) eliminates the tax exemption for the bonds altogether, which could increase the borrowing costs for hospitals and, in turn, force them to raise rates for patient care, attorneys who counsel health-care organizations said.

“This tax bill is an assault on health-care providers across the country,” Matthias Edrich, a tax attorney with Kutak Rock LLP in Denver told Bloomberg Law. “In some communities governmental entities don’t provide health-care services, so the proceeds of private activity bonds are particularly important to service those communities,” he said.

Robert Capizzi, a health-care tax attorney for Chapman & Cutler in Chicago, agreed the provisions would have an outsized effect on nonprofit hospitals, which comprise about 60 percent of all hospitals. “If enacted into law, the tax bill would be a devastating blow to 501(c)(3) health-care organizations,” he told Bloomberg Law. “Effective Jan. 1, 2018, 501(c)(3) organizations would no longer be able to use tax-exempt financing to pay for any of their capital expenditures,” he added.

Change Could Raise Health-Care Costs

Edrich, who advises hospitals and other health-care providers on tax-exempt bond issues, warned that elimination of private activity bonds could sharply increase the costs of health care for some communities. “The cost of prohibiting private activity bonds will be borne by those who are served by these entities in the form of higher costs for health care, schooling, housing, senior living and more,” Edrich said. “Unfortunately, those who are served by these entities are most often those who are least able to afford to pay the increased costs of such services.”

Edrich explained that the increase in prices is a result of the way that the investing public chooses which bonds to buy. “There is a misconception in Congress that private activity bonds are bonds that are issued by businesses for corporate purposes that don’t affect the average taxpayer,” he said.

Currently, state and local governments issue private activity bonds to the public at tax-exempt interest rates and loan the proceeds of the bond sale to the nonprofit community service organizations to finance capital improvements.

According to Edrich, the interest rate that the bond purchaser receives is the same interest rate the bond issuer charges to the nonprofit for the loan of the bond proceeds. If the interest that the bond holder receives from his or her purchase isn’t tax deductible, the purchaser is going to demand a higher interest rate from the bond issuer, who will then demand the same higher interest rate from the nonprofit entity.

“If the cost of borrowing increases to the borrower, because private activity bonds are no longer available, the borrower must increase its fees for services,” Edrich said.

Advance Refundings Also at Risk

Also concerning to some health-care tax attorneys is the fact that the bill contains restrictions on advance refundings of tax-exempt bonds. In an advance refunding, an issuer issues bonds to generate capital to refinance prior bonds. The prior bonds are paid off and discharged at a later time once the redemption provisions of the prior bonds that allow for such a discharge are met.

An advance refunding allows a bond issuer to refinance a prior bond to achieve debt service savings even though the prior bond might not be callable until a later date. “This is really critical because it can reduce the debt costs for a hospital substantially,” Edrich said. An advance refunding may also be used to restructure the organization’s financing documents to allow greater flexibility for future financing needs.

“Over the long term, advance refunding reduces interest costs,” Edrich said. But, he acknowledged, “it may cause two tax-exempt bonds to be outstanding for the same project at the same time for a limited period until the prior bond can be redeemed pursuant to its terms.”

Edrich warned the speed with which the Republican tax plan has been introduced has left many in the industry scrambling. “This is causing additional uncertainty and jeopardizing the financial health of a lot of nonprofit institutions,” he said.

Capizzi noted even bonds that have already been issued could be affected by the bill. “The bill does not even include any transition rules that would permit the current refunding of tax-exempt 501(c)(3) bonds issued before January 1, 2018,” he said.

Industry Groups Speak Out

It’s unclear whether the provisions will survive the current markup by the House Ways & Means Committee, because they haven’t gone unnoticed by industry groups or Democrats in Congress. “As the House and Senate consider this bill, I think there will be a major lobby within the bond industry to maintain the tax exemption for bonds issued for 501(c)(3) health-care organizations,” Capizzi predicted.

That lobbying began in earnest shortly after the provisions were announced last week when a group called Municipal Bonds for America—which includes groups like the American Hospital Association, the Association of American Medical Colleges, and the National Association of Health and Educational Facilities Finance Authorities—sent a letter to the leaders of both parties in the House and the Senate urging them to oppose the provisions that would remove the tax exemption for private activity bonds and prohibit advance refundings.

The American Hospital Association sent a separate letter to members of the House Ways & Means Committee, which is marking up the bill this week, painting a dire picture of health care should the bond provisions be included in the final bill.

“The financial unraveling of a hospital has the potential to impact a community more profoundly than the unplanned closure of nearly any other institution,” the letter said. “Patients will suffer as hospitals struggle to survive. Prices will rise, equipment will wear down without being replaced, and physicians will leave,” it continued.

Provisions May Not Survive

The House Ways & Means Committee’s summary of the bill says the provisions are geared toward providing taxpayers with greater accountability. “Taxpayers will not be forced to subsidize private activity bonds that directly benefit private individuals and entities rather than hardworking American families,” the summary, prepared by committee chairman Rep. Kevin Brady (R-Texas), said.

“These reforms preserve important sources of financing for public works projects. They also protect taxpayers from having to subsidize bonds that directly benefit special interest entities and initiatives—like wineries, golf courses, and office buildings for investment bankers, as they have been used in the past,” the summary added.

But that summary misunderstands the purpose of private activity bonds, Edrich said. “What is not clear to a lot of people in Congress and to a lot of average citizens is that all types of nonprofit organizations use private activity bonds, including hospitals, colleges, charter schools, public schools, low income housing operators, and assisted living facilities,” he said.

Edrich said many Americans have seen the benefits of tax-exempt bonds in their communities without even knowing it. “If you have gone to a nonprofit hospital for care, have a family member in an assisted living facility or gone for mental health care, chances are the facility that you used was financed through private activity bonds,” Edrich said.

According to a staffer in Rep. Bill Pascrell’s (D-N.J.) office, the congressman is considering offering an amendment to remove the provisions from the tax reform bill later this week. Pascrell, who serves on the House Ways & Means Committee, which is marking up the bill, introduced another bill in June ( H.R. 3009) that would expand the volume cap on private activity bonds for water and wastewater projects.

“It is no secret that I have spent the past decade spearheading bipartisan legislation to expand the use of private activity bonds,” Pascrell told Bloomberg Law in an email. “With our infrastructure crumbling nationwide, that the Republican tax bill now seeks to eliminate this critical tool to construct housing, expand ports, build hospitals and upgrade our water systems is a misguided decision, harmful to job creation and economic development.”

—With assistance from Alex Ruoff in Washington, D.C.

To contact the reporter on this story: Matthew Loughran in Washington at

To contact the editor responsible for this story: Peyton M. Sturges at

For More Information

The text of H.R. 1 is at committee summary of the bill is at Municipal Bonds for America letter is at American Hospital Association letter is at

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