IRS Provides Additional Guidance for Non-Profit Hospitals

Written by Kate Stewart

Last week, the IRS issued a Notice of Proposed Rulemaking (“2013 Proposed Rule”) regarding the community health needs assessment (“CHNA”) requirement of 26 U.S.C. § 501(r)(3) (added to the Internal Revenue Code by the Affordable Care Act).  Section 501(r) imposes new requirements on hospitals that are exempt from taxation under Section 501(c)(3).  In addition to the requirements applicable to all 501(c)(3) organizations, nonprofit hospitals must: (1) establish a financial assistance policy, (2) limit charges for patients eligible under the financial assistance policy, (3) follow new billing and collections guidelines, and (4) conduct a CHNA.   

As with many other aspects of the Affordable Care Act, the implementation of Section 501(r) has been a lengthy process.  The IRS previously issued twoTreasury Notices addressing the CHNA requirement and also issued a Notice of Proposed Rulemaking on other portions of 501(r) in June 2012 (the “2012 Proposed Rule”).  The IRS intends to finalize all of the regulations under 501(r) simultaneously.  The 2013 Proposed Rule provides much-needed guidance on the CHNA, addresses penalties for non-compliance, and updates some definitions relevant to all of the requirements under Section 501(r). 

Definitional Guidance

Section 501(r) applies to an “organization which operates a facility which is required by a State to be licensed, registered, or similarly recognized as a hospital, . . .”  The 2013 Proposed Rule provides updated guidance on the definition of a facility and the definition of operating a hospital.  As these definitions apply to all of Section 501(r), they should be carefully reviewed by hospital organizations.   

• Defining a Facility - In contrast to prior guidance, the 2013 Proposed Rule now states that if a hospital organization operates a hospital in multiple buildings under a single state license, those buildings are all considered a single hospital facility for purposes of the 501(r).  The IRS has requested comments on whether there should be exceptions to this rule. 
• Defining Operating - The 2013 Proposed Rule also addresses entities that operate hospitals through joint ventures or other entities treated as partnerships for tax purposes.  Here, the general rule is that an organization is considered to operate a hospital if it is a partner in an entity that operates a hospital.  The 2013 Proposed Rule provides two exceptions that hospitals that have partnered with another entity to operate a hospital will want to examine closely.  First, in keeping with prior IRS guidance on nonprofit ancillary joint ventures, if the nonprofit hospital organization does not have sufficient control in the partnership entity to ensure that the partnership will further its exempt purpose, the organization is not considered to operate the hospital for purposes of Section 501(r).  Based on prior guidance, the entity will treat the income from the partnership as unrelated business income.  Second, the 2013 Proposed Rule provides a grandfathering exception for entities organized primarily for educational or other exempt purposes (and not for operating a hospital) that, prior to March 23, 2010, entered into a joint venture to run a hospital under which the entity does not have sufficient control over the operation of the hospital facility.

Penalties for Non-Compliance

Although the 2012 Proposed Rule provided a great deal of guidance on compliance with Section 501(r), it did not address the penalties for non-compliance.  The 2013 Proposed Rule addresses both non-compliance with 501(r) and the revocation of 501(c)(3) status.  In general, the IRS has given hospitals some flexibility with respect to compliance and provides that minor, inadvertent errors that are identified and corrected by the hospital will not be considered a failure to comply with 501(r). 

The 2013 Proposed Rule states that the revocation of a hospital’s 501(c)(3) status will be based on a facts-and-circumstances analysis taking into account the size, nature, and scope of non-compliance.  It also clarifies that where a hospital organization operates multiple hospital facilities and one facility is not in compliance, the organization can lose its tax-exempt status with respect to that one hospital without losing its overall tax-exempt status. 

Section 4959 of the Internal Revenue Code separately provides for a $50,000 excise tax for a hospital organization that fails to meet the CHNA requirements of Section 501(r)(3).  The 2013 Proposed Rule clarifies that the penalty will be imposed on a facility-by-facility basis, to prevent large hospital systems from choosing to pay one $50,000 penalty rather than comply with the CHNA requirement. 

The Community Health Needs Assessment

Section 501(r)(3) requires a hospital organization to conduct a CHNA every three years.  The 2013 Proposed Rule addresses many of the questions raised by Notice 2011-52.  In particular, the 2013 Proposed Rule does the following:

1. Preserves flexibility for hospitals in defining their geographic area;
2. Clarifies that the CHNA need only identify significant health needs in the community and need not prioritize the non-significant needs identified;
3. Provides guidance on how input from the community is to be provided, including requiring written comments from the public that are to be taken into consideration in the next CHNA;
4. Preserves the ability of a hospital organization to collaborate with other hospital organizations in conducting its CHNA; and
5. Gives guidance on how the CHNA report is to be made available to the public.

Compliance Dates

The statutory effective date of Section 501(r)(3) is the first taxable year beginning after March 23, 2012.  Hospitals can continue to follow and rely on the guidance found in Notice 2011-52 for a CHNA conducted prior to October 5, 2013.  Comments on the proposed rule must be received by the IRS by July 5, 2013. 

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