No Paper Tiger: IRS Revokes Non-Profit Hospital’s Tax-Exempt Status for Failure to Comply with Section 501(r)November 2017
For the first time, a hospital organization that held exempt status under Section 501(c)(3) of the Internal Revenue Code has seen it revoked by the IRS for failure to comply with the requirements of Section 501(r). See Private Letter Ruling 201731014 (Aug. 4, 2017). The revocation was based on the failure of the hospital organization (the "Organization") to adopt an implementation strategy for its community health needs assessment (CHNA) and make its CHNA widely available to the public. The ruling is a reminder of the need for exempt hospital organizations to ensure that they are fully complying with the requirements under Section 501(r). It also provides insight into the types of failure to comply with Section 501(r) that will be considered egregious and willful and that therefore are likely to result in loss of exempt status.
Background on Section 501(r)
To qualify as exempt under Section 501(c)(3), a hospital organization that operates one or more hospital facilities must satisfy the following requirements imposed by Section 501(r) and the Treasury regulations under that section.
- The organization must conduct a CHNA every three years.
- The governing body of a hospital facility is required to adopt an implementation strategy to meet the community health needs identified through the CHNA, on or before the 15th day of the fifth month following the end of the tax year in which the hospital facility conducted the CHNA.
- The CHNA must be made widely available to the public.
- The organization must establish a written financial assistance policy (FAP) for each hospital facility it operates.
- The organization must adopt certain limits on charges for emergency or other medically necessary care provided to individuals eligible under its FAP.
- The organization cannot engage in “extraordinary collection actions” against any individual to collect payment for care, until the hospital facility has taken “reasonable efforts” to determine whether the individual is eligible for financial assistance under its FAP.
If a hospital organization fails to satisfy these requirements, the IRS may revoke its exempt status under Section 501(c)(3).
Revocation is not automatic. Rather, in determining whether to continue to recognize the status of the hospital organization, the IRS considers all of the relevant facts and circumstances. The Treasury regulations also provide rules under which certain omissions and errors will not be considered as failures to satisfy the requirements of Section 501(r). In addition, the Treasury regulations provide that if the hospital facility's failure to meet one or more of the requirements under Section 501(r) is neither willful nor egregious, it will be excused if the hospital facility corrects and makes disclosure in accordance with IRS guidance.
The Organization that had its exempt status under Section 501(c)(3) revoked was a “dual status” organization, meaning that it was exempt both under Section 501(c)(3) and also because it qualified as a governmental unit or agency.
The IRS determined that the Organization’s exempt status under Section 501(c)(3) should be revoked because the Organization failed to adopt an implementation strategy for its CHNA and failed to make its CHNA widely available to the public. With respect to the failure to adopt an implementation strategy, the Organization apparently prepared an implementation strategy report and acted on some of the report's recommendations, but the Organization never formally adopted and implemented the report. With respect to the failure to make its CHNA widely available to the public, the Organization had a paper copy available upon request but did not publish the CHNA on its website.
The IRS concluded that the Organization’s failures to comply with Section 501(r) were not minor but were both egregious and willful and that its exempt status under Section 501(c)(3) should be revoked. Its conclusion that the failures were willful was based, at least in part, on statements by the Organization.
Analysis of the Ruling
The ruling is important for at least three reasons. First, it is a reminder of the need for hospital organizations to comply fully with Section 501(r). The IRS is currently auditing many hospital organizations for Section 501(r) compliance and has now shown that it is willing to revoke exempt status in appropriate circumstances.
Second, the ruling sheds light on the types of failure that will be considered egregious. Failure to complete and formally adopt an implementation plan and failure to post the CHNA on the hospital organization’s website are egregious failures and therefore are not excused under the standards in the Treasury regulations. This is the case even if a plan is prepared and some elements of the plan are implemented.
Third, the ruling sheds light on when failure will be considered willful. The IRS made this determination based on several statements by the Organization’s management. During the audit, the Organization told the IRS that it did not really need Section 501(c)(3) status because it was a dual status organization. Although many hospital organizations will not be dual status organizations, the statement was interpreted by the IRS as an indication that the Organization was disregarding the requirements of Section 501(r) because it did not care about exempt status under Section 501(c)(3), and therefore was acting wilfully.
The ruling states that the Organization also said that it did not have the will, the financial resources, or the staff to follow through with the CHNA process required under Section 501(r) every three years. Saying that it did not have the “will” to comply with Section 501(r) amounted to an admission that the failure was wilful. However, an organization's claim that lack of staff or resources prevented full Section 501(r) compliance is also likely to be interpreted as willful failure, because it is essentially an admission that an organization knows what it should be doing but is not doing it because of resource constraints. Auditors may take a sympathetic view toward organizations that genuinely are trying to comply but that experience failures due to recourse constraints; but it is hard to imagine an auditor's viewing such resource constraints as reasonable cause.
Nonprofit hospitals must take care to meet all relevant requirements in order to preserve their tax-exempt status. Compliance with the Section 501(r) rules is among them, including such things as having the board of directors formally adopt plans and putting in place meaningful implementation strategies. Through this ruling, the IRS has made clear that almost meeting the requirements is not enough.