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Tax Exempt Hospitals Still Mired In Red Tape: IRS Issues Final Regulations Implementing Code Section 501(r)


Doing business is permanently more complex for tax exempt hospitals, now that the IRS has issued Final Regulations on Internal Revenue Code (IRC) Section 501(r).

These regulations replace temporary regulations issued in 2012 to implement IRC Section 501(r) enacted as part of the Affordable Care Act. This section creates additional requirements tax exempt hospital organizations must meet to continue to enjoy the privilege of their tax exempt status, embodying concepts long championed by Senator Chuck Grassley (R-Iowa).

The regulations apply to “hospital organizations” — organizations recognized in IRC § 501(c)(3) which operate one or more hospital facilities, i.e. a facility that is required by a state to be licensed or registered as a hospital. (The term “hospital” is used throughout this update.)

These regulations are the last piece needed to complete the 501(r) rules for nonprofit hospitals. Many of the requirements of the Statute itself and the rules which preceded this latest publication have already taken effect. Hospitals subject to these regulations can continue to rely on both the 2012 and 2013 proposed regulations until their first taxable year beginning after December 29, 2015. The endorsement of these rules by the Consumer Financial Protection Bureau suggests that they may also someday come to be viewed as a guide for for-profit hospitals.

Community Health Needs Assessment — § 501(r)(3)

General Requirements

Section 501(r)(3) requires tax-exempt hospitals to conduct a community health needs assessment (CHNA) every three (3) taxable years and adopt an implementation strategy to meet the community health needs identified in the CHNA.

In order to complete a CHNA a hospital must: (1) define the community it serves; (2) assess the health needs of that community; (3) solicit and take into account input received from persons who represent the broad interests of that community; (4) create a written report (CHNA report) and have it adopted by an authorized body of the hospital; and (5) make the CHNA report available to the public.

Assessing Community Need

The Final Regulations afford hospitals considerable flexibility in defining the communities they serve, provided medically underserved, low-income, or minority populations are not excluded. To assess the health needs of a community, a hospital must identify significant health needs of its community, prioritize them, and identify resources available to address them. A hospital must solicit input about the health needs of a community, their priority and the resources available to them, from at least three (3) sources: governmental public health departments, medically underserved, low income and minority populations, and persons who submitted written comments on the hospital’s most recently publically published CHNA report. A hospital need only take into account the input actually received from these sources, provided it made reasonable efforts to secure input from each source. The CHNA report must document the results of and processes and methods used in conducting the CHNA. The report must be made widely available for public inspection and on a website for nine (9) years.

Implementing the CHNA

Referencing the totality of the community health needs identified in the CHNA, a hospital must create a written implementation strategy that indicates either how it plans on addressing a health need or that it will not address a health need and why. The implementation strategy must be adopted by an authorized body of the hospital on or before the unextended due date of the Form 990, for the taxable year in which the CHNA was conducted.

When describing how the hospital will address health needs, the implementation strategy must: (1) describe the actions the hospital intends to take to address the health need and the anticipated impact of these actions; (2) identify the resources the hospital plans to commit to address the health need; and (3) describe any planned collaboration between the hospital and other organizations in addressing the health need. If the hospital opts to not address a health need, the implementation strategy must explain why (e.g., resource constraints or lack of expertise).

The Final Regulations allow unaffiliated hospitals to adopt joint CHNA reports and implementation strategies as long as all the hospitals define their community to be the same, each hospital’s role and responsibilities are clearly identified, and certain other specific requirements are met.

Reporting Requirements Related to CHNAs

The Final Regulations require that a hospital provide with its Form 990 a description of how it is addressing the significant community health needs identified for each facility it operates through its most recently conducted CHNA, or, if no actions were taken with respect to one or more of those identified health needs, the reasons no actions were taken. In addition, the hospital must provide a copy of its audited financial statements with Form 990 and disclose on Form 990 the amount of any excise tax imposed on the hospital during the taxable year for failure to comply with CHNA requirements. Governmental hospitals that are excused from filing Form 990 are relieved from these new reporting requirements applicable to Form 990, however, they must meet all Section 501(r) requirements that do not involve disclosure on or with Form 990.

Financial Assistance Policies — IRC § 501(r)(4)

Section 501(r)(4) requires a hospital to establish, adopt, and implement (i.e., consistently carry out) a written Financial Assistance Policy (“FAP”) that applies to all emergency and other medically necessary care in each hospital facility it operates. Alternatively, hospital facilities that are part of a larger organization may adopt a single, joint policy. Requirements for FAPs are these:

  • The FAP must list all providers, other than the hospital itself, that provide emergency and medically necessary care. This list must identify which providers are covered by the hospital’s FAP, and which are not.
  • The FAP must specify the eligibility criteria that the hospital uses to determine who may receive financial assistance, explain how an individual applies for financial assistance, and from what sources as well as the type of information the hospital uses to determine eligibility. Hospitals have some flexibility in defining eligibility criteria, establishing the time period used to determine FAP eligibility, and accepting various forms of evidence from applicants to demonstrate eligibility.
  • The FAP must describe all financial assistance available under the FAP, free or discounted care, and the basis for calculating amounts ultimately charged to the patients that receive financial assistance under the FAP.
  • The FAP must include the hospital’s billing and collection procedures. The procedures must describe: (1) the manner in which collections may be obtained, including any extraordinary collection actions (ECAs); (2) the process and time frames used in taking a permitted action, including, at a minimum, what “reasonable efforts” it will make to determine if a patient is FAP-eligible before starting an ECA; and, (3) the department that has authority to order ECAs.
  • The FAP must be “widely publicized.” A FAP is widely publicized if: (1) the FAP, FAP application, and plain-language summary of the FAP are available on a website and in hard-copy via mail and in public locations in the hospital, including, at a minimum, the emergency room and admissions areas; (2) the hospital notifies and informs hospital patients about the FAP by (a) offering a paper copy of the FAP plain-language summary at patient intake or discharge, (b) including on billing statements a “conspicuous written notice” that informs patients about the availability of financial assistance, directs patients to the department in the hospital facility that can provide information about the FAP, and guides patients to the website that contains the FAP, FAP application, and plain-language summary, and (c) constructing a “conspicuous public display” of the FAP in public locations in the hospital; (3) the hospital notifies and informs the broader community, especially targeting those members of the community most likely to need financial help; and (4) the hospital translates the FAP, FAP application, and plain-language summary into the primary language of each limited English proficiency language group that constitutes the lesser of 1,000 individuals or 5% of the community served.

In addition to, or within the FAP, the hospital must have a written emergency medical care policy that provides that the hospital facility will provide non-discriminatory emergency medical care, regardless of the patient’s FAP eligibility, in accordance with the Emergency Medical Treatment and Labor Act (EMTALA).

Limitation on Charges — IRC § 501(r)(5)

Two Forms of Limitation

Under the Final Regulation, limitations are placed on hospital charges for the care provided to individuals eligible for assistance under the hospital’s FAP. There are two limitations. In the case of emergency or other “medically necessary care,” hospitals are limited to charging no more than the “amounts generally billed (AGB)” to individuals who have insurance covering such care. For all other medical care covered under the FAP, the hospital must charge less than the “gross” charges or charge master rate. This means the established price that the hospital “consistently and uniformly” charges patients before applying any contractual allowances, discounts or deductions, for such care. An eligible individual is considered to be “charged” only the amount he or she is personally responsible for paying after all deductions, discounts (including those available under the FAP) and insurance reimbursements have been applied.

Amounts Generally Billed

The AGB must be determined pursuant to one of two methods set out in the regulations or other methods specified in future regulations or IRS guidance. The two methods in the Final Regulations are the “look-back” method and the “prospective Medicare or Medicaid” method. The look-back method involves calculating a percentage (the “AGB Percentage”), which is then applied to the hospital’s gross charge. The AGB Percentage must be calculated annually and is essentially a ratio of all amounts claimed and allowed by insurers for emergency or other medically necessary care to the gross charges for that care. When determining amounts allowed by health insurers, the hospital can include in the calculation both amounts paid by the insurer and the amounts the individual is personally responsible for paying in the form of co-payments and the like. The hospital can pick the group of insurers it wishes to use for this calculation from among three options: Medicare fee for service only; Medicare fee-for-service (FFS) and all private health insurers; or Medicaid, either alone or in combination with one of the other two options.

The prospective Medicare/Medicaid method determines the AGB by using the billing and coding process that the hospital facility would use if the FAP eligible individual were a Medicare FFS or Medicaid beneficiary. The AGB will equal the amount the hospital determines would be allowed by Medicare or Medicaid or both for the care (including any beneficiary personal responsibility).

The Final Regulations provides a safe harbor for certain charges in excess of AGB in the case of emergency or other medically necessary care or in excess of gross charges for any medical care covered under the FAP, if (i) the charge in excess of AGB was not made or requested as a precondition to the provision of the medically necessary care, (ii) the FAP eligible individual had not yet submitted a completed FAP application, and (iii) if the individual subsequently submitted a completed application and was granted FAP eligibility, the hospital refunds whatever amounts the individual has paid that exceed the amount he would be personally responsible for as a FAP-eligible individual. The concept of “medically necessary care” can be determined from several alternative sources, including definitions under applicable state law, the Medicaid definition, or a definition that refers to generally accepted standards of medicine in the community or to a determination by the examining physician.

Limits on Extraordinary Collection Actions — IRC § 501(r)(6)

IRC § 501(r)(6) prohibits tax-exempt hospitals from engaging in extraordinary collection actions (“ECAs”) against an individual until they have made “reasonable efforts” to determine whether the individual is FAP-eligible. The Final Regulations provide guidance on what constitutes ECAs and what satisfies the reasonable effort requirement.

What Constitutes an ECA

ECAs include: (i) any action by a hospital that requires legal or judicial process, such as placing a lien on property or garnishing wages, (ii) referring a case to a debt collector or (iii) reporting an individual to a consumer credit reporting agency or credit bureau. Actions which are not considered ECAs (and therefore do not require a determination of FAP-eligibility) include: (i) actions which do not require judicial process or reporting an individual to a reporting agency, such as sending a patient a bill, calling a patient or writing off an account, (ii) placing a lien against third parties that caused a patient’s injuries or (iii) filing a claim in a bankruptcy proceeding.

Reasonable Efforts to Determine FAP Eligibility

A hospital generally satisfies the reasonable efforts requirement to determine FAP-eligibility if it notifies the individual about the FAP before initiating ECAs and does not engage in ECAs for 120 days from the date it provides a patient with the first post-discharge billing statement. In order to satisfy the notice requirement, at least 30 days in advance of initiating ECAs, the hospital must provide: (i) written notice of availability of financial assistance for eligible individuals and (ii) written notice describing the ECAs that could be initiated to obtain payment and the deadline date by which time ECAs would commence and make reasonable efforts to orally notify a patient about the hospital’s FAP. These notification requirements cannot be bypassed by asking patients to waive their rights to receive required notice or their rights to apply for assistance.

The Final Regulations also create an FAP application period that begins on the date care is first provided and generally ends on the 240th day after the date that the patient is provided with the first post-discharge billing statement. In the event a patient provides a complete FAP application within the application period, the hospital must suspend ECAs until determining the patient’s FAP eligibility. If a patient provides an incomplete FAP application, the hospital must suspend ECAs and satisfy additional notice requirements to allow the patient an opportunity to properly complete the FAP application.

Since a hospital will be held responsible for the actions taken by collection agencies with which it contracts or by entities to which it sells debt, careful attention to these requirements will be extremely important.

Failure to Satisfy the Requirements of Section 501(r)

The Final Regulations describe the consequences of failure to satisfy various portions of Section 501(r). Failure could result in facility-level taxes and penalties, or even threaten an organization’s exemption from federal income tax.

Minor Omissions and Errors

Minor omissions and errors will not be considered a failure to meet the requirements of Section 501(r), if such omission or error was minor and either inadvertent or due to reasonable cause, and the hospital corrects such omission or error promptly after its discovery. In regard to minor, the Final Regulations provide that in the case of multiple transgressions, the omissions or errors are considered minor only if they are minor in the aggregate and the fact that the same omission or error has occurred and been corrected previously is a factor tending to show that such omission or error is not inadvertent. With respect to reasonable cause, a hospital’s establishment of practices or procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with Section 501(r) prior to the occurrence of an error is a factor tending to show that the omission or error was due to reasonable cause.

Excusing Certain Failures if Hospital Corrects and Discloses

A hospital’s failure to meet one or more of the requirements of Section 501(r) that is neither willful nor egregious is excused if the hospital corrects the failure and provides disclosure in accordance with procedures set forth by the IRS. The Final Regulations provide that a “willful” failure includes a failure due to gross negligence, reckless disregard, and willful neglect. A hospital failing to meet the CHNA requirements of Section 501(r)(3) will be subject to an excise tax (discussed below), notwithstanding its correction and disclosure of the failure.

Excise Tax For Failure to Meet CHNA Requirements

The Code imposes a $50,000 excise tax on a hospital that fails to meet the CHNA requirements with respect to any taxable year. The excise tax applies if a hospital fails one or any combination of the component requirements of Section 501(r)(3). A separate $50,000 does not apply for each component nor is the tax less than $50,000 if a hospital fails some, but not all, of the components. Some hospital omissions or errors with respect to Section 501(r)(3) requirements will not be considered failures subject to the excise tax if the omission or error was minor and either inadvertent or due to reasonable cause and the hospital corrects the omission or error. In contrast, a hospital’s failure to meet Section 501(r)(3) requirements will give rise to the excise tax notwithstanding its correction and disclosure pursuant to applicable IRS rules. A hospital liable for the excise tax in any taxable year must file IRS Form 4720 by the 15th day of the fifth month after the end of its tax year.

Facility-Level Tax on Noncompliant Hospital Facilities

The Final Regulations provide for a facility-level tax for a hospital operating more than one facility that fails to meet one or more of the requirements of Section 501(r) separately with respect to a hospital during a taxable year. The facility-level tax applies to a hospital that continues to be recognized as exempt under Section 501(c)(3), but would not continue to be so recognized if the noncompliant facility were the only hospital operated by the organization. The tax is applied to income derived from the noncompliant hospital during the tax year of noncompliance and is computed in accordance with federal corporate income tax rules (or in accordance with federal trust tax rules if the hospital is organized as a trust). Application of the facility-level tax to a noncompliant hospital will not, in and of itself, adversely affect the tax-exempt status of bonds issued to finance the noncompliant hospital and will not be treated as an unrelated trade or business.

Revocation of Section 501(c)(3) Status

A hospital failing to meet one or more of the requirements of Section 501(r) may have its Section 501(c)(3) status revoked as of the first day of the taxable year in which the failure occurs. The IRS will consider all relevant facts and circumstances when determining whether revocation is warranted, including the size, scope, nature, and significance of the hospital’s failure, as well as the reason for the failure and whether the same type of failure has previously occurred. The IRS will also consider whether the hospital had, prior to the failure, practices or procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with Section 501(r), whether such practices or procedures were routinely followed and whether the failure was corrected promptly.

For questions, please contact Patricia A. Hintz at (414) 277-5833 / pat.hintz@quarles.com, Alyce C. Katayama at (414) 277-5823 / alyce.katayama@quarles.com, Michael A. Levey at (414) 277-5171 / michael.levey@quarles.com, or your local Quarles & Brady attorney.

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