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Protecting The Hospital Tax Exemption By Complying With Section 501(r) Regulations

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Gary J. McRay and Julie C. LaVille
Foster Swift Health Care Law E-News
February 6, 2015

Final Regulations now provide guidance on how hospitals maintain their tax exemption under Internal Revenue Code Section 501(r). Section 501(r) was added to the Internal Revenue Code (“Code”) by the Patient Protection and Affordable Care Act (“ACA”) in 2010. A hospital loses its tax exemption under Code Section 501(c)(3) if the hospital:

  • Does not meet the community health needs assessment (“CHNA”) requirements of Section 501(r)(3),
  • Does not meet the financial assistance policy (“FAP”) requirements of Section 501(r)(4),
  • Does not comply with Section 501(r)(5), which requires that patient charges for emergency or other medically necessary care under FAP do not exceed the amounts generally billed to individuals who have insurance covering such care, and
  • Fails to meet the billing and collection restrictions of Section 501(r)(6) prohibiting extraordinary collection activities before the hospital has made reasonable efforts to determine whether the patient is eligible for assistance under the financial assistance policy.

The ACA also added Section 4959 which imposed a $50,000 excise tax on a hospital organization that failed to meet the community health needs assessment for any taxable year.

After a series of IRS issued notices and proposed rule-making published in the federal register, the Service has now published, on December 31, 2014, final regulations to provide guidance on the requirements of Section 501(r). The final regulations are imposed on each hospital for its first taxable year beginning after December 29, 2015. Prior to that date a hospital may rely on the 2012 and 2013 proposed regulations. The final regulations apply to all hospital organizations who seek to be recognized as exempt under Section 501(c)(3) including government hospital organizations. Many government organizations do not have to file a Form 990 or include any CHNA related information within Form 990, but these organizations still must make their CHNA reports and FAP reports widely available on a website.

Accountable Care Organizations (“ACOs”) do not have to comply with the Section 501(r) requirements but it is permissible for multiple hospital facilities to have identical FAPs and other policies as long as they clearly indicate that the policies are applicable to each facility. In addition, separate hospitals, if they define their community the same, may conduct a joint CHNA and adopt a joint implementation strategy addressing the health needs identified in the common community.

The failure to satisfy the final regulations implementing Section 501(r) ultimately may cause the revocation of a hospital’s exempt status. The IRS will consider all relevant facts and circumstances involving the failure including:

  • Whether the organization has previously failed to meet the requirements,
  • The size, scope, nature and significance of the failure,
  • If the hospital operates more than one hospital facility, the number, size and significance of the facilities that failed to meet the requirements,
  • The reason for the failure,
  • Whether the organization had prior to the failures established practices or procedures reasonably designed to promote and facilitate overall compliance,
  • Whether the practices or procedures had been routinely followed and the failures occurred through an oversight or mistake in applying them,
  • Whether the organization has implemented safeguards that are reasonably calculated to prevent similar failures,
  • Whether the organization corrected the failures as promptly after discovery as is reasonable, and
  • Whether the hospital implemented safeguards to prevent similar failures prior to the discovery by the IRS.

In general, an omission from a required reporting policy or error in implementation or operational requirements, if the omission or error was minor and either inadvertent or due to reasonable cause, will not be considered a failure to meet the final regulations.

It is possible under the final regulations that a hospital system that operates more than one hospital facility may fail to meet one or more of the requirements of Section 501(r) with respect to one hospital facility yet still keep the tax exemption for the overall organization by paying a corporate hospital facility tax on income derived from the non-compliant hospital facility during the taxable year of non-compliance. In addition, the operation of the non-compliant hospital facility will not be considered an unrelated trade or business described in Section 513 and shall not by itself affect the tax exempt status of bonds issued to finance the non-compliant hospital facility.

We encourage all of our hospital clients to review the final regulations to see if any hospital policies need to be changed or modified in light of the new regulations. We will publish future newsletters that comment on each requirement of Code Section 501(r).