IRS Putting Nonprofit Hospitals Under the Microscope

The IRS has lately been asking hundreds of nonprofit hospitals some tough questions. Over the summer, more than 500 nonprofit hospitals received questionnaires that delved deep into their operations and executive compensation. The questions included: How many individuals received uncompensated care? How much did the hospital spend on such care? If an insurer pays less than the hospital charges, is the difference counted as uncompensated care? Did the hospital charge higher prices to uninsured patients than to those with Medicare, Medicaid or private insurance? Did the hospital's emergency room deny services to any individuals who request such services? The survey landed on hospital administrators' desks just as the tax agency has signaled a desire to start auditing more of the nonprofits on their compliance with tax regulations. At the same time, some Congressional leaders have been pressing for a new, more rigorous definition of "nonprofit," one that they say should weed out hospitals that use questionable accounting practices to qualify for special tax status. "Too many do little to nothing. Too often, it seems that tax-exempt hospitals offer less charitable care and community benefit than for-profit hospitals," Iowa's Sen. Charles Grassley, a Republican and chairman of the Senate Finance Committee, recently told reporters. With Sen. Grassley urging on the IRS at every step, says tax expert Alvin Brown, you can expect to see agents respond by getting overaggressive in targeting nonprofit hospitals. "They take extreme positions, not fair and partial," contends Brown, a tax attorney who has worked in the office of the IRS Chief Counsel. "These guys are looking to put notches in their gun belts." Up until the late 1960s, hospitals were required to provide charity care as a way to qualify for nonprofit, tax-exempt status by the IRS. But then the standards were changed to a "community benefit standard." A hospital could qualify for the favored tax status by offering up community health fairs, free disease screening and medical training or research activities. But even hospitals have disagreed on what should be included or excluded from the list. Hospitals also have had varying standards regarding what would qualify for charity care. The Catholic Health Association, for example, does not believe that hospitals should be able to include either bad debt or losses on Medicare services in their tally of community benefits. Medicare losses, notes the CHA, can easily be a reflection of a hospital's inefficiency. The American Hospital Association, meanwhile, believes that both qualify as legitimate indications of a community benefit intended by the law. For now, though, the ball is in the IRS's court, and the level of official activity has been picking up noticeably. A year ago IRS commissioner Mark Everson told a congressional committee that nonprofit hospitals were one of a range of nonprofit areas that would be under increased scrutiny from tax officials. In particular, he said, the IRS was concerned about the proliferation of joint ventures between nonprofit and for-profit groups, which raised serious issues about how profits and losses were accounted for. And the IRS also intended to put more executive compensation packages under the microscope as well. "We at the IRS are now faced with a healthcare industry in which it is increasingly difficult to differentiate for-profit from nonprofit healthcare providers," Everson said in a May 2005 statement to the United States House of Representatives' Committee on Ways and Means. "We regularly find ourselves engulfed in paper as we attempt to discern whether those in control of a particular nonprofit healthcare provider are acting more as investors for their own account or as stewards of charitable assets." Until now, nonprofit hospitals have operated largely free of IRS oversight. As Everson pointed out to Congress, between 1995 and 2005 only some 375 audits were conducted on nonprofit hospitals –– out of approximately 7,000 organizations with that label. That, he added, was about to change. With that forewarning, Brown says that any sensible nonprofit should move fast to get ahead of the investigations now headed their way. "The first thing they have to do is look at their operations," he says. "The hospital administrator is a business person, not a tax person. Doctors are not tax lawyers. I'm going to assume that there's an enormous abuse of the standards. That's not derogatory … people just don't know. What I would do is do a checklist of issues and go through those issues and bring somebody in to consult with them to give them an opinion, some idea of the standards they should be using." Then they should beef up their community benefits to make sure they can pass an IRS audit. Brown has also posted a Web site — www.irsforum.org — that he hopes hospitals will use to help share their experiences. "They have a lot to lose," says Brown. "They can lose their tax-exempt status, and that's a horrible thing to happen to them."