Hospital Loses IRS Tax Exemption for Noncompliance with ACA

Community Open House / Source: Bill McChesney

August 17, 2017; Becker’s Hospital Review

The Internal Revenue Service (IRS) issued a letter in February of this year, recently released, which announced the revocation of a nonprofit hospital’s federal tax exemption for failing to comply with the Affordable Care Act, specifically the requirement to conduct a “community health needs assessment” (CHNA), develop an action plan based on the CHNA, and to “widely disseminate” the plan once it’s developed and approved by the hospital’s board.

A technical review by WithumSmith+Brown, PC discusses the requirements of the Internal Revenue Code (IRC) section 501(r), added to the tax code as part of the Affordable Care Act.

The name of the hospital has not been disclosed by the IRS, but it is a “dual status” hospital, operating with both charitable tax-exempt status and governmental status. According to WithumSmith, the hospital is also a federally designated “disproportionate share hospital” (DSH), meaning that a significant share of the hospital’s revenues come from patients covered by Medicare or paid for by state and local government using non-Medicaid and non-Medicare funds.

The unnamed hospital’s dual status may be the key to why its tax exemption was revoked. Under the ACA, the penalty for a nonprofit hospital failing to perform a CHNA is a $50,000 excise tax, not revocation of exemption. However, as WithumSmith notes,

[S]ince the administrators of the Hospital indicated that the Hospital did not need to be tax-exempt and that it did not have the financial wherewithal or the staff to comply with IRC §501(r)(3), the IRS, in making its adverse determination, stated that “Consequently, (Hospital’s) failure to meet the requirements of §1.501(r)-3 is considered willful. Especially in light of the fact that the organization expressed on several occasions that they did not need to be exempt under IRC §501(c)(3) and that this status at times actually got in the way of their ability to be involved in various Medicare reimbursement programs.”

CHNAs are a well-intended requirement because they encourage nonprofit hospitals to do two things: 1) substantiate their existence as charitable institutions rather than as medical organizations; and 2) assess the healthcare-related needs of their communities without regard to the services they currently provide or are planning to provide. Done correctly, CHNAs are not cheap. Initial cost estimates range from $60,000 to $150,000  depending on a nonprofit hospital’s size and the complexity of the communities it serves. Small nonprofit hospitals operating on slim margins and nonprofit hospitals already losing money see CHNA compliance as a major hurdle and look for alternatives. NPQ has reported on examples of nonprofit hospitals voluntarily giving up their IRS tax exempt recognition due in large part to what they see as the burdens of nonprofit regulatory compliance.

The IRS’s action is a cautionary tale for all nonprofit hospitals, regardless of potential dual status as governmental entities. As the law firm Baird Holm notes in a June 2017 blog post, the IRS is actively auditing nonprofit hospitals for compliance with Section 501(r), including its requirement to perform a CHNA. NPQ has reported on the IRS’s recent technological advances in electronic analysis of Form 990 returns, making it far easier to identify which hospitals report noncompliance on their Schedule H, the schedule specifically required for nonprofit hospitals. Will more nonprofit hospitals be fined or have their tax exemption placed at risk, and will more nonprofit hospitals facing IRS enforcement action decide to give up tax exemption and switch to for-profit or governmental status?—Michael Wyland