Sixty percent of hospitals in the nation are tax-exempt. “The tax-exempt industry has been the backbone of our national healthcare system,” says Philip Sprinkle with Balch & Bingham in Birmingham. “In addition to being under significantly more scrutiny and financial pressure, the whole tax-exempt financing structure is under attack. We could be seeing the beginning of a sea of change in our healthcare delivery system.”

One of the points of new stress on non-profit hospitals arises from local governments hungry for tax dollars. They are targeting property taxes on structures surrounding non-profit hospitals, such as physician office buildings. “The hospitals are having difficulty justifying those buildings as being tax-exempt, when they’re filled with independent practicing physicians and there are Porsches parked out front,” Sprinkle says.

Traditionally, tax-exempt status for the hospitals relies on federal law determination. “The closer question is whether or not the building near the hospital also qualifies for tax-exemption,” says Hobby Presley with Balch & Bingham in Birmingham. A series of cases brought by property tax assessors in the northern Midwest, are being closely watched. “In Illinois, the property tax offices won a number of cases and re-dedicated medical office buildings to be taxable,” Sprinkle says.

Presley adds that a broader threat comes from states examining the appropriateness of non-profits to be exempted from paying property taxes at all and whether or not each specific hospital is doing enough to qualify for the status.

Another stress tax-exempt hospitals face revolves around finding the capital to build or maintain their facilities. “If you’re building a new non-profit hospital, how do you get funds? Not out of day-to-day revenues,” Sprinkle says. “For-profits can raise money through stock offerings. Non-profits cannot, but they do have access to the tax-exempt bond market.”

This market allows any qualifying, tax-exempt hospital to borrow money at an affordable interest rate by selling bonds at a much lower interest rate than taxable bonds. “The holder accepts the lower interest rate on their investment, because they don’t have to pay income tax on the interest they receive,” Presley says. “The government created the mechanism for tax-exempt hospitals to borrow for capital improvements and equipment, because they don’t have access to the normal equity market.”

This traditional low-interest avenue for garnering the tens of millions needed for upgrades and new structures is about to be clogged. Congress is considering a number of legislative pieces that would reverse the income-tax-free status on these bonds for those in the wealthiest tax bracket. “If the tax incentive isn’t there, why would they choose to buy these lower-interest bonds?” Sprinkle says.

But the federal level is where the real attack on non-profit hospitals is being waged, says Sprinkle. Spurred by Senator Chuck Grassley (R-IA), the General Accounting Office (GAO) completed a study in 2008 to measure the charitable care activity between for-profit and non-profit hospitals. “The GAO suggested there was no difference,” Presley says. “Non-profits dispute it. They say you can’t indicate the impact of care in dollar amounts.”

This finding drove a new reporting requirement to pass in 2010 for tax-exempt hospitals nationwide as part of the Affordable Care Act. Now every tax-exempt hospital must file a Community Health Needs Assessment. The hospitals must identify all the community needs in their market and address how they will or will not devote care and funding toward it. Failure to complete the Assessment means fines and potential loss of tax-exempt status.

Based on these reports of these assessments, due to Congress in 2018, Sprinkle says Grassley plans to impose a five-percent income tax on all tax-exempt entities showing insufficient charitable activity. “But he hasn’t stated a benchmark for charitable healthcare, so that’s even more stress-causing for these hospitals,” Sprinkle says.

The IRS also began new stringent actions toward non-profits. They’re conducting 3,000 audits this year on the 990 forms — the non-profits’ form of a tax return. “The tax-exempts won’t even know they’re under audit unless the IRS identifies a problem,” Sprinkle says. “In 33 years as a health care attorney, I’ve never seen a mass audit of this nature.”

With the financial vulnerability of tax-exempt hospitals, even one slight change can put them out of business. But the potential damage inherent in these sweeping changes could change healthcare drastically, especially in rural areas. In the short run, says Presley, expect a large number of consolidations and acquisitions by larger non-profits.

Both attorneys agree that the more likely scenario will be for-profits buying up the non-profit, full service hospitals and opening urgent care clinics, freestanding emergency rooms or physicians’ offices. “That will really diminish the healthcare options in those areas,” Sprinkle says.

Besides rural hospitals, larger urban non-profits and research hospitals, such as Children’s, could be crippled by the loss of access to low-interest capital funding. “You won’t have the same level of academic and research development in healthcare, because places like University Hospital won’t be able to build research facilities either,” Presley says.

“All this change could be bad or it could be good. And some believe that there’s a better method of providing care,” Presley says. “But if you believe non-profit healthcare fills an important role, then you should be concerned about this.”