IRS Issues Final Regulations for Charitable Hospitals

April 20, 2015

Congressional scrutiny of tax-exempt hospital organizations arose as the distinction between tax-exempt and for-profit hospitals has been diminished by the federal government's provision of Medicare and Medicaid to cover services that tax-exempt hospitals previously provided for free. The overhaul of the healthcare system has brought even more Congressional scrutiny, requiring hospital organizations to be very proactive in ensuring they continue to meet the original requirements for tax exemption, as well as new more rigorous requirements.

The Affordable Care Act ("ACA"), enacted March 23, 2010, added new requirements for Section 501(c)(3) organizations that operate one or more hospital facilities (hospital organizations). On a facility by facility basis, each hospital facility is required to meet the following four general requirements:

  • Conduct a community health needs assessment (CHNA) and adopt an implementation strategy every three years (the CHNA requirements are effective for tax years beginning after March 23, 2012)
  • Make reasonable efforts to determine whether an individual is eligible for assistance under the hospital's financial assistance policy (FAP) before engaging in extraordinary collection actions against the individual
  • Establish written assistance and emergency medical care policies
  • Limit amounts charged for emergency or other medically necessary care to individuals eligible for assistance under the hospital's FAP

The ACA also added new section 4959, which imposes an excise tax for failure to meet the CHNA requirements and added reporting requirements under Section 6033(b) related to sections 501(r) and 4959.

Final regulations under Section 501(r) were issued on December 29, 2014. The final regulations clarify a number of issues relating to compliance with Section 501(r). Importantly, the final regulations provide a delayed effective date—hospitals must comply with the final regulations beginning on the first day of their first tax year beginning after December 29, 2015. For tax years prior to December 29, 2015, a hospital facility may rely on a reasonable, good faith interpretation of 501(r). A few important items clarified in the final regulations are as follows:

  1. The definition of "hospital facility" provides that multiple buildings under one state license constitute a single hospital facility. In addition, operations in a single building under more than one state license constitute multiple hospital facilities.
  2. Section 501(r) does not apply to any activities of a hospital organization that constitute unrelated trade or business activities as described in Section 513. In addition, a hospital facility does not have to meet the requirements of Section 501(r) with respect to taxable corporations that provide care in the hospital facility (e.g., physicians' practices) even if the corporation is wholly or partially owned by the hospital organization.
  3. Section 501(r) applies to a hospital organization that "operates" a hospital facility through a partnership or LLC, subject to certain exceptions.
  4. An error or omission will not be considered a failure to meet Section 501(r) and therefore will not jeopardize a hospital facility's exempt status so long as the error or omission was minor, inadvertent ordue to reasonable cause, and the hospital facility promptly corrects the error or omission. Similarly, the penalty imposed by IRC Section 4959 for failure to complete a community health needs assessment (CHNA) may be avoided if these same requirements are met. Following the issuance of the final regulations, the IRS issued additional guidance regarding correction and disclosure procedures for hospital organizations to follow so that certain failures to meet the requirements of Section 501(r) will be excused. See Rev. Proc. 2015-21.
  5. In many cases, rather than jeopardizing an organization's exempt status, noncompliance will instead give rise to "noncompliant facility income," which is subject to corporate income tax. Importantly, noncompliant facility income is not considered unrelated business taxable income and so should not impact the status of tax-exempt bonds used to finance the hospital facility.
  6. The final regulations provide various modifications to the CHNA requirements, including changing the timing of implementation strategy. The final regulations require adoption on or before the fifteenth day of the fifth month after the end of the taxable year during which hospital facility completed its CHNA, while the proposed regulations require adoption by the end of the taxable year in which the facility completed its CHNA.
  7. Various other clarifications are made to requirements relating to a hospital facility's FAP; emergency medical care policy, billing and collections requirements and limitations on charges.

Despite the delayed effective date of the final regulations, hospital facilities should be proactive in assessing their current policies and making revisions or implementing changes to comply with the final regulations.

To read a more detailed discussion of the changes required under the final regulations, as well as action steps that tax-exempt hospitals should be currently considering and implementing, click under "Resources" below.

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