IRS revokes hospital’s tax exemption

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The Internal Revenue Service revoked an unidentified hospital’s tax exemption in February for failing to conduct a community health needs assessment, in a sign of possible trouble for other nonprofit health care organizations.

In the letter, which the IRS posted online this month, an IRS official cited the reason for the “adverse determination” revoking the hospital’s tax exempt status as being connected with section 501(r) of the tax code, part of the Affordable Care Act. “You are a hospital organization which failed to comply with the requirements of IRC section 501(r), to conduct a community health needs assessment, adopt an implementation strategy and make it widely available to the public,” said the final adverse determination letter. “Contributions to your organization are not deductible under section 170 of the Internal Revenue Code. You are required to file Federal income tax returns on Form 1120.”

Laura Kalick, tax consulting director for BDO’s Healthcare and Nonprofit & Education practices, sees wider implications for other exempt organizations in the IRS determination letter. “A significant number of hospitals are being examined on the issue of 501(r),” she said. “After they issued the regulations, the IRS decided they would train 30 agents to do examinations of the hospitals. They are examining the 2014 year, which is before the date that the regulations became final, but all hospitals at this point are supposed to be in compliance with the final regulations.”

Complying with the final regulations means that certain information is supposed to be put on the hospital’s website, including an application for financial assistance, a plain language summary of the hospital’s financial assistance policies, and a community health needs assessment, which identifies local health issues and how the hospital plans to address them.

“The IRS is surfing the web and finding out whether a hospital is in compliance or not in compliance,” Kalick noted. “Those things might be on the website, but if they dig deeper the actual policy might not have all the elements required by the final regulations. Suffice to say the hospital in question did not have a community health needs assessment, nor did they put one on the website. For the hospitals I see examined, they all have a community health needs assessment and for the most part they have it on the website.”

The determination letter released by the IRS didn’t give the name of the hospital, but Kalick said it appears to be a government hospital.

“The hospital was unusual in that it was a government hospital, so they had a dual status for their exemption,” she said. “On the one hand being a government hospital they are exempt from tax, but then they went and got a 501(c)3 status, which also made them exempt from tax. A lot of hospitals went ahead and got the 501(c)3 status even though they didn’t need it, so they could get certain pension plans that were only available to 501(c)3 organizations, and it’s a little easier to get contributions and fundraise when you have the 501(c)3.”

The hospital might still be able to do fundraising, though, despite the revocation of its status.

“In the letter the IRS says your exemption is revoked and you have to file an 1120, and contributions to you are not tax deductible,” said Kalick. “Those are the standard rules they would say, but because it’s a government hospital, it’s a different story. The other thing is that many of these hospitals have foundations that are fundraising arms, and this has no effect on the foundation they might have. It’s exclusive to the hospital. I don’t know that this hospital has a foundation, but we do know that many hospitals have foundations that raise money for them.”

The hospital has not yet been identified, but Kalick anticipates it will be at some point. “Usually what happens is that the IRS does list organizations that have been revoked in addition to hospitals,” she said. “They’re notifying the public that the contributions are no longer tax deductible, but it takes time for them to make that publication. The organization has a right to go to court and appeal this decision. It’s hard to know when it will be published, but eventually it will be published.”

In this case, the hospital appears to have decided that the community health needs assessment was unnecessary.

“The IRS examined the hospital and found they didn’t have the community health needs assessment,” said Kalick. “The hospital said we really don’t want to spend the money on it and indicated they didn’t need the 501(c)3 status.”

The IRS revocation could provide a lesson to other tax-exempt hospitals not to overlook the regulations.

“The hospital didn’t feel it was particularly harmed by the action, but it’s significant in that it shows what’s a more than minor compliance [issue], and what is considered not inadvertent but willful,” said Kalick. “There are many hospitals out there that are not completely in compliance with the rules. They might think they’re sort of in compliance, but they really need to be in complete compliance to be safe, especially when they do need their 501(c)3 status. I’ve seen situations where hospitals say they’re going to be merging with another hospital so they don’t need to worry about this.”

However, if a hospital’s tax-exempt status is revoked, its merger partner could end up with a big tax liability, and the merger might be called off.

Kalick noted that the IRS’s 2017 work plan included a focus on emerging issues such as the 501(r) and exemption issues.

“The caution is that the IRS is really serious, plus now they’re doing the data analytics with the Form 990,” she said. “Certain things are going to key off an audit, and everybody needs to be mindful. One area that we’ve been told about—it won’t necessarily be an audit but it will be a second look—is when an organization checks the box that there’s been a significant diversion of assets. The IRS is going to take a second look to see if there’s something going on with the institution and if there are more things that are incorrect.”

She pointed out that when an organization discloses on the Form 990 a significant diversion of assets, it often means some fraud has occurred, such as an employee or officer who has stolen money.

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