Everyone in the hospital revenue cycle community is clamoring to know which hospital lost its tax-exempt status this year, how exactly it all happened, why the hospital in question does not exactly seem to care, and -- in our corner of the world -- what revenue cycle professionals can learn about the situation.

Non-profit hospitals take billions of dollars of tax exemptions every year, so it stands to reason that their eligibility to retain a tax-advantaged position relies on concrete characteristics that set non-profits apart from for-profit enterprises. As jarring as it is that another hospital has lost its preferred tax status, it hasn’t come out of nowhere, and it hardly matters which hospital it was.

Not long ago, insideARM covered the heart of what’s needed to comply with 501(r), and it bears repeating: Municipalities are under pressure. Tax advantages are under scrutiny, and with operating margins so lean, hospitals usually need these breaks to keep afloat. While it may seem like keeping tax status isn’t your job as a rev cycle professional, in fact everyone has a part to play in making sure tax exemption isn’t a problem on top of all the other financial pressures hospital rev cycle teams now face.

We’ve heard this song before

For context and cautionary tales, it’s useful to look in the rear view: Let’s look back at  2015, when a New Jersey tax court case found that Morristown Medical Center, a not-for-profit hospital, was essentially operating like a for-profit entity, and as such, did not qualify for the New Jersey property tax exemption. The judge in that case found that the hospital provided substantial loans, capital, and subsidies to for-profit entities, including physician groups. In this case, the hospital’s operations were under the microscope, rather than a (lack of) community impact.

For Morristown, the issue of the fair market value of executive compensation was called into question. It had not been sufficient in the eyes of the IRS that Morristown Medical had benchmarked executive compensation to that of other, similar hospitals. Why? The hospital could not demonstrate that the compensation at its peer hospitals was reasonable either. Ouch. That seems harsh. And yet, this all underscores the reality that when it comes to hospitals and their claims of serving the greater good, the IRS is really not in the mood to play. The IRS is going to peer into your operational closets, looking for skeletons, and into your claims of benevolence, looking for evidence you are actually serving the community. If you’re in the hospital business, and you are receiving IRS tax exemption, be ready to meet the high bar, or your entire financial model could come crashing down around you. In the end, Morristown Medical Center got stuck paying ten years of back taxes and penalties on portions of the hospital used for certain for-profit activities. That kind of a hit could shutter many medical centers that are already straining under the weight of Medicare scarcity and the burden of insured patients who aren’t paying their balance bills.

Remember too that in 2010, the Illinois Supreme Court upheld the denial of a property tax exemption for Provena Covenant Medical Center. In that case, the court found that the hospital failed to generate most of its money from charity, did not demonstrate its commitment to charity care, and wasn’t able to show it was operating for charitable purposes.

Legislative developments

Many states are discussing bills to adopt statewide rules for not-for-profit hospitals to make some type of payment in lieu of property taxes, without necessarily requiring property tax payments for all hospital real estate and buildings.

Illinois passed a law to this effect in 2012, in the wake of the Provena fiasco, that created a property tax exemption for hospitals. The law established a test to determine eligibility for property tax exemption based on whether the total value of a hospital’s charitable services or activities is at least equal to the hospital’s estimated property tax liability.

The Illinois law has since survived constitutionality challenges in the lower courts. Litigation is still pending on the law, but other jurisdictions are considering the same property tax exemption standards for hospitals. This all bears watching.

Reverberations

Not only are hospitals facing tax-exempt scrutiny by governments, but so are health insurance companies. Remember when the California Franchise Tax Board revoked the tax-exempt status of Blue Shield of California, subjecting the company to state income taxes? California tax officials based the decision, in part, on the company’s $4 billion surplus and on its failure to offer more affordable coverage or public benefits.  

PILOT programs

One alternative to a legislative fix is a Payment In Lieu Of Taxes, also known as a PILOT program. This kind of program often involves special financial agreements between municipalities and hospitals. This type of program can prevent litigation and does not necessarily require legislation, but they’re unregulated and more susceptible to abuse. Already, this type of program is on the decline in 2017 after a popularity peak in 2015.

Moral of the story

Every person on the rev cycle team has a vested interest, and a critical role to play, in helping comply with the rules for tax-exempt hospitals. Unexpected tax bills shutter a hospital at worst, or completely torpedo its financial modeling at best---and revenue cycles are already strained by uncompensated care and the risk of unfavorable policies potentially soon to emerge from Capitol Hill. There’s simply no shortchanging the IRS. Hospitals need financial assistance programs; they need to assess and document a plan to serve the communities in which they exist if they care to maintain a valuable tax advantage.


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