The IRS recently issued a private letter ruling revoking a hospital’s Section 501(c)(3) tax-exemption on account of failing to meet Section 501(r) requirements. As you are likely aware, Section 501(r) and its detailed implementing regulations set forth various conditions for Section 501(c)(3) hospitals to remain tax-exempt, which include numerous detailed requirements within the following general categories, among others:
- Conducting, documenting and widely publicizing a Community Health Needs Assessment (CHNA) and implementation strategy (every 3 years)
- Adopting and publicizing a detailed Financial Assistance Policy and accompanying documents (e.g., plain language summary, billing/collection policy, application, notices, signs, etc.)
- Limiting charges to those eligible for financial assistance to no more than amounts generally billed
- Not engaging in extraordinary collection actions before making a reasonable effort to determine financial assistance eligibility
In the above case, the hospital conducted a CHNA but failed to widely publicize it or develop and adopt an accompanying implementation strategy, citing a lack of financial resources. Nevertheless, in revoking the hospital’s tax-exempt status, the IRS concluded that such failures were “egregious” in terms of severity and also “willful” because hospital administrators, during an IRS audit, demonstrated that they did not intend to, and did not have the financial resources or staff to, comply with the CHNA and implementation strategy requirements under Section 501(r). While, interestingly, the hospital appears to have been indifferent to loss of its tax-exempt status (and may even have welcomed it), this ruling is still instructive in outlining the CHNA/implementation strategy requirements and reiterating the importance of Section 501(r) compliance and self-correction in advance of an IRS audit or review.
Failure to meet any of the detailed Section 501(r) requirements could result in excise taxation (i.e., $50,000 for CHNA errors/omissions) and/or revocation of tax-exempt status, as demonstrated by the above-described ruling. Section 501(r) regulations and IRS Rev. Proc. 2015-21 provide a process whereby non-complying hospitals can avoid such consequences by promptly identifying and correcting certain Section 501(r) failures, and, in some cases, disclosing such failures and corrective actions in detail on IRS Form 990, which process the hospital must at least start before any IRS audit commences. However, “willful or egregious” failures (i.e., resulting from gross negligence, reckless disregard or willful neglect) can still result in revocation of exempt status regardless of whether such errors are promptly and completely remediated and disclosed. Importantly, prompt discovery/correction is one of the key factors that the IRS uses to determine whether the failure is “willful or egregious.”
Moreover, the law requires that the IRS conduct a review of the community benefit activities of every tax-exempt hospital every three years, including a review of Section 501(r) compliance. Such periodic reviews are not limited to IRS Form 990s but also include a review of hospital websites, published policies and other publicly-available information, and which reviews generally take place without formal notification of the hospital under review. To date, several hundred of these “soft” reviews have resulted in a referral for formal examination, which might have been the case in the above-described revocation ruling.
Ultimately, hospitals must strive to uncover (and correct) any Section 501(r) compliance issues before any IRS examination commences. We strongly recommend that Section 501(c)(3) hospitals remain vigilant with respect to Section 501(r) compliance and implement procedures whereby failures can be promptly discovered, reported, evaluated, corrected and disclosed as appropriate, the existence of which procedures is another key factor that the IRS uses to determine whether a failure is “willful or egregious.”