United States: Community Benefit Debate Escalates

Over the last two days, two separate, substantive publications addressing community benefit, charity care, and the "Community Benefit" standard of tax-exempt status for hospitals have been released. The first of these publications is the Senate Finance Committee "staff discussion draft" of potential community benefit reforms, initiated following the Committee's September 13, 2006, hearings on Charity Care and Community Benefit. The second publication is the Internal Revenue Service’s "Interim Report on Tax Exempt Hospitals and Community Benefit Project," summarizing data collected as part of its 2006 Community Benefit Compliance Check Questionnaire. While independently prepared, collectively these documents offer useful guidance on legislative and regulatory perspectives on community benefit practices of tax exempt hospitals.

On July 18, 2007, Senator Charles Grassley (ranking Minority Member, Senate Finance Committee) released a "staff discussion draft" of potential community benefit reforms and revisions to the Community Benefit Standard of hospital tax-exempt status. The drafting effort was initiated following the committee's September 13, 2006, hearings on charity care and community benefit.

The discussion draft contains, among other things, a proposal to significantly revise the existing Community Benefit Standard of federal tax-exempt status for hospitals. Specifically, it proposes the following exemption standards:

• establishing a charity care policy and requiring wide distribution of the policy;

• quantitative standards for charity care;

• community benefit-related standards for joint ventures between nonprofit hospitals and for-profit entities;

• revised requirements for board composition, corporate governance and executive compensation (e.g., restricting payments for first class travel, prohibiting payments for spousal travel and country club dues);

• restrictions on conversions to for-profit status;

• additional restrictions on billing and collection practices;

• materially increased transparency and accountability standards; and

• sanctions for noncompliance.

The staff proposals contained in the discussion draft contemplate a tax-exempt hospital universe where some hospitals are exempt under Section 501(c)(3) and other hospitals are exempt under Section 501(c)(4) of the code. The proposals direct the IRS to establish stricter requirements for tax-exempt entities seeking to participate in joint ventures with taxable parties. In the governance area, the staff recommends that no more than 25 percent of a hospital board consist of interested persons and that no more than 25 percent of any committees (other than credentialing and quality care committees), include more than 25 percent physician or management participation.

Of the various proposals, those that can be expected to be particularly controversial are the proposals regarding annual amounts of charity care (a "5 percent test," based on annual patient operating expenses or revenues, whichever is greater), governing board composition, transition rules for hospitals that will be required to "convert" from Section 501(c)(3) to 501(c)(4) status and the continued ability of hospitals to finance activities with tax-exempt bonds. The discussion draft goes to great lengths to state that it is not intended to constitute a legislative proposal. However, the theme of the draft is a dramatic revision of the Community Benefit Standard of tax-exempt status for hospitals, and thus should be closely considered by hospital executive leadership and the board.

A public comment period on the concepts presented in the discussion draft extends until August 24, 2007.

Release of the draft discussion report was timed to coincide with the release by the IRS of its own report on community benefit and other hospital practices as developed from the responses to its Community Benefit Compliance Check Questionnaire, distributed in 2006 to more than 500 nonprofit, tax-exempt hospitals. (Read The Senate Finance Committee staff discussion draft)

On July 19, 2007, the IRS released an interim report on its Hospital Compliance Project initiated to study nonprofit hospitals and community benefit. The new IRS report is a summary of the community benefit data submitted by the 487 tax-exempt hospitals responding to the 2006 Community Benefit Compliance Check Questionnaire. Interestingly, the report does not include any analysis of the community benefit data, nor a discussion of those portions of the Compliance Check Questionnaire addressing executive compensation of tax-exempt hospitals—that is expected at a later date.

The IRS offers three principal observations on the data: first, nearly all responding hospitals reported that they provide various types of community benefit that were the subject of the Compliance Check Questionnaire (e.g., 97 percent reporting that they have a written uncompensated care policy); second, hospitals report similar information in different ways; and third, a wide variation exists in the level of expenditures hospitals report in furtherance of community benefit.

A variation in reporting methods was particularly evident with respect to reporting and measurement of uncompensated care. Specifically, the data shows that (i) hospitals use of a wide range of income and asset criteria to establish eligibility for uncompensated care; (ii) they vary in how they measure and incorporate bad debt expense and shortfalls between actual costs and Medicare and Medicaid reimbursements and (iii) they differ in whether they use charges or costs in their measurements.

The IRS’ next step is to analyze the data to determine the extent to which it provides information concerning the amount of free or discounted care hospitals provide to persons across various demographics, including low-income populations, uninsured persons, and persons covered by Medicare, Medicaid and other government programs.

The IRS acknowledges that it is too early to reach any conclusions regarding the amount of community benefit tax-exempt hospitals actually provide. The IRS will undertake further analysis of the data before speaking to that issue. However, an early manifestation of the types of reforms we might expect from further IRS analysis is separate schedules for information on a hospital's charity care policies, revenue profile, bad debt expense, collection practices and community benefit activities (proposed Schedule H-Hospitals) on the revised Form 990 recently proposed by the IRS.

Significantly, the data in the IRS Report reveals no "smoking gun" or other evidence of abuse or noncompliance with the community benefit standard by nonprofit, tax-exempt hospitals. More importantly, the IRS has more work to do. At this point in the IRS’ Community Benefit Compliance Check process, it would be premature to say that the project has produced results that support the proposals contained in the July 18,2007 Senate Finance Committee staff discussion draft, in whole or in part. This is particularly the case with respect to Senator Grassley’s call for a broad-based revision of the Community Benefit Standard of tax exemption. At most, the IRS report lends some support for the need for greater consistency in defining and calculating community benefit. (Read the IRS interim report)

The combination of the Senate Finance Committee discussion draft and the IRS report are the opening salvos in what can be expected to be a lengthy, complex and contentious debate about the future of tax-exempt status for hospitals. Senior management and their governing boards should unite in a focused and concerted effort to address concerns from both the public, regulators and from elected officials arising from both the discussion draft and the IRS report.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.