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Beyond Community Benefit: A New Standard for Tax-Exempt Hospitals
Brett Jackson*
Introduction
In this piece, I will briefly summarize the current community benefit standard in order to
address its shortcomings. Next, I will propose a higher standard that hospitals should be held to
in order to deserve tax exemption. Finally, I will propose a joint venture to demonstrate how a
hospital would satisfy the higher standard.
Community Benefit Standard
Presently, hospitals that seek exemption from federal income taxation under §501(c)(3)
must adhere to the community benefit standard.i (Tax-exempt status for hospitals provides
billions in tax savings annually for hospital organizations.ii) Revenue Ruling 69-545 noted
certain characteristics that would meet the community benefit threshold: a board comprised of
civic leaders, open privileges to any qualified medical doctor, open privilege to the doctors to
lease available space, an emergency room that will take all patients in needs, etc.iii “The
delineation of these factors is the closest the IRS has come to explicitly defining the term
‘community benefit.’”iv
Hospitals are given some wiggle room in this standard as compared to the previous
charity care standardv, which required free or discount care for patients who could not afford the
provision of medical services. For example, an emergency room is not required if there is already
one nearbyvi, and it need not serve an entire community as long as the class served is still
sizable.vii
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This standard was relaxed mostly because the passage of Medicare and Medicaid made
some believe that there would be no more need for hospitals to provide charity care.viii The new
standard also reflected modern trends in hospital service. “[T]he enactment of that legislation
[Medicaid and Medicare] could not alone have served as a reason to change the standards. By
1969, the role of hospitals in most of the United States had changed dramatically in that most had
developed into community-based resources that generally provided services to all segments of
the communities in which they were located.”ix
Additionally, the IRS took the position that the promotion of health was in and of itself a
charitable purposex, relying on historical definitions of charity. Still, this was an amorphous
concept. “In testimony before Congress in the early 1990s, the Treasury Department resisted
calls for specific guidelines on community benefit and pointed out that crafting a specific charity
care standard would create an ‘incentive to divert . . . services to the form of care that best
protects [hospitals] tax-exempt status,’ rather than allow for a range of useful efforts focused on
the needs of specific communities.”xi
Some felt the IRS was even too lax with this definition. “In 1996, the Taxpayer Bill of
Rights authorized ‘intermediate sanctions,’ allowing the IRS to impose more moderate penalties
for more moderate violations of the sixth requirement listed above, avoiding private gains or
excess benefits in favor of reinvesting surplus profits. However, the IRS has rarely applied these
intermediate sanctions to hospitals, and they do not directly address community benefit
violations.”xii This IRS inaction was perhaps among a line of complications in health policy
caused by the federal government:
[t]he effort to link charity care to hospitals' tax exemption does not occur in a vacuum. Indeed, it occurs in an atmosphere where government has set health-care policy on a course that is antithetical to the provision of increased amounts of charity care.
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The result of government actions has been to increase the numbers of uninsureds or underinsureds while decreasing the reimbursements to hospitals.xiii
However, even within this relaxed community benefit standard, hospitals had been the
subject of much controversy.xiv There was a closing gap in how tax-exempt hospitals differed
from private hospitals besides the tax exemption. “Ample research has demonstrated no
significant, consistent advantage of nonprofit health care over for-profit care.”xv “Furthermore,
reports have suggested that tax-exempt hospitals do not provide much more uncompensated care
for uninsured Americans than for-profit hospitals, which are not exempt from taxes, and that the
amount of charity care provided by tax-exempt hospitals does not equal the value of the tax
exemptions they receive.”xvi Hospitals were charging indigent patients much higher rates than
those negotiated with insured patients.xvii Administrators were being paid exorbitant salaries.xviii
Extreme collection practices were being taken to collect bad debt.xix “[C]ollection tactics of non-
profit hospitals consist of forcing low-income patients with outstanding bills into bankruptcy,
garnishing a patient's wages by 30% of their weekly income, seizing savings accounts, taking out
liens on patients' property, foreclosing on their homes, and negotiating deals for a patient to pay
off his medical debt with compounding interest rates making it impossible to ever be debt free.”xx
Then, almost absurdly, the uncollectible debt was being labeled as charity care to bolster the
hospital’s justification for exemption. “The final insult comes after tax-exempt hospitals, having
harassed patients incessantly for payment, finally make a business decision to write off the
amount due. In doing so, the hospital includes this bad debt as part of its community benefit.”xxi
Uninsured individuals were even suing hospitals around the nation for their collection
practices.xxii Some states had even begun to set their own standards for nonprofit hospitals, partly
because states and their localities lose so much revenue to nonprofit hospitals in the way of
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income and property tax.xxiii Texas was fairly blunt on this point by “ enacting legislation in 1993
that requires each nonprofit hospital in the state to provide charity care at least equal in value
either to the hospital's state and local tax subsidies or to four percent of the hospital's net
revenue.”xxiv
§501(r)
§501(r) was included in the Affordable Care Act and delineates strict guidelines for
hospitals who seek §501(c)(3) status. “This provision of the ACA was co-authored by Senator
Charles Grassley, one of the most vocal critics of hospitals' lack of accountability to demonstrate
quantifiable community benefits in return for heir tax exemption and the egregious practices
some hospitals engaged in with respect to uninsured patients.”xxv “Almost 3,400 nonprofit and
governmental hospitals are subject to these new requirements.”xxvi
The roots of §501(r) can be traced to proposals by the American Health Association, an
organization that lobbies for hospitals:
the AHA had previously provided three legislation proposals ‘to improve care provided by not-for-profit hospitals.’ The proposals included: (1) providing ‘discounts to all uninsured individuals of limited means and then mak[ing] [the] discount publicly available,’ (2) requiring ‘not-for-profit hospitals to implement a common definition of the ‘community benefit’ they provide and disclose the amount of the benefit,’ and (3) including provisions for ‘strengthening transparency, governance, and accountability of charitable organizations.’xxvii
Specifically, §501(r) requires four proactive measures from hospitals: alerting patients to
the existence of financial assistance, matching qualifying patients with the financial assistance,
curbing aggressive collection techniques, and conducting a community health needs assessment.
Hospitals will lose their exemption and possibly be subjected to other fines if they do not meet
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all 4 measures.xxviii Each hospital in a hospital system must individually meet all 4
requirements.xxix
A More Proactive Orientation
While §501(r) may do much in requiring more action from tax-exempt hospitals, it is
unclear whether these 4 provisions will be enough. Instead of the current community benefit
standard and in light of the billions of dollars in savings that tax exemption entails, hospitals
should have to demonstrate a heightened level of proactive care. In this piece, the new standard
will be referred to as proactive care. This proactive care standard would be more specific and
targeted than either community benefit or charity care.
Instead of merely treating all the sick people in a community, a proactive orientation also
requires actions by the hospital to cure the community’s biggest woes. This could mean cancer,
diabetes, or any other affliction that disproportionately affects the community relative to national
health data.
Proposed Joint Venture
To illustrate how proactive care works in practice, consider a joint venture between a
§501(c)(3) hospital and a private health insurance company. Both of these organizations are
located in and service a city disproportionately affected by the human immunodeficiency virus
(HIV.) (According to the Center for Disease Control, 50% of all persons living with HIV live in
only 12 cities.xxx xxxi)
The objective of the joint venture would be to prevent new infections, to educate the
public about how the virus is transmitted, and to increase the quality of life of those already
infected with the virus. The venture would provide screenings open to the public to test if they
have the virus. The venture would also educate the public about methods of transmission. It
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would provide medication to members of the public afflicted by the virus at no cost. It would
also provide, for no cost, an expensive medication (pre-exposure prophylaxis or PrEP) to
members of the public who have not been affected but are at a high risk of infection.
The education efforts would include providing research about effective treatments to
medical professionals and education the public about the dangers of the virus and how it is
spread. Though the insurance company already has a customer base that will benefit from the
educational material, the efforts will be guided to everyone in the community. Everyone in the
community will benefit from better control of the virus, because of the nature of how it is spread,
not just those currently infected. Thus, the broad class needed for a §501(c)(3) should be thought
to include the entire community and not just the afflicted patients.
The treatments would also be open to everyone in the community, whether or not that
insurer currently insures them. Even patients with insurance often have trouble affording HIV
treatment without government grants or programs, so this would add the exempt purpose of
relieving the burden of government:
[o]ne of the long-standing theories regarding the role of nonprofit organizations is that they should perform some function that government would otherwise have to perform. The government has the choice of either directly providing the service or subsidizing a nonprofit organization to meet the same service or social obligation, such as serving the patients that would otherwise be seen by a nonprofit hospital. This is generally considered part of the overall governmental subsidy theory.xxxii
Structural Concerns
The joint venture would be organized as an LLC. The exempt hospital would be the
managing member and have a majority of voting power on the board of directors. The
incorporation documents should state that the LLC was created for exempt purposes and cannot
deviate from these exempt purposes. The documents should “limit the hospital’s obligation to
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fund future capital contributions to the ancillary venture.”xxxiii The exempt hospital will not
guarantee any debt.xxxiv The documents should also pay attention to the percentage of doctors on
the board, as that has been a controversial topic in past hospital joint ventures.xxxv
The hospital would provide space for a headquarters and staffing, consisting of doctors,
nurses, medical administrators, and other employees for all aspects of the venture’s operations.
The insurer would provide cash to pay for medicine, testing supplies, and educational materials.
Typically, private companies are lured into joint ventures with exempt organizations in
highly profitable areas. However, this operation would not yield profit. The benefits to the
insurer are more long term and abstract. There would be good publicity generated by its
involvement. This will generate goodwill within the community. A profitable insurer may be
convinced of the benefit of participating to generate loss and drive down other profits. Providing
this care at no cost may help the insurer meet its medical loss ratioxxxvi, a measure of how much
of customer premiums are spent on administrative costs vs. actual medical care. If not enough is
spent on care, the insurers must return percentages of the premiums back to the customer.
Finally, an insurer in one of the cities with a high rate of infection may believe it would be
ultimately cheaper to treat HIV in this method instead of having it spread to more of its
customers and increase future care costs.
Without a concrete profit motive, the hospital is in less risk of improper behavior brought
on by the venture than in typical profitable areas. The hospital will have to pay attention to
compensation of the board and highly paid employees such as doctors or administrators, but it
already had that responsibility on its own.
There are four requirements to satisfy the community benefit standard after passage of
§501(r): alerting patients to the existence of financial assistance, matching qualifying patients
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with the financial assistance, curbing aggressive collection techniques, and conducting a
community health needs assessment. These four steps, especially the community health needs
assessment, already push the hospitals past the somewhat lax old thinking of the community
benefit standard into a more proactive mindset. A proactive care standard complements this new
provision well. It requires the hospitals to follow up on the findings of the community health
needs assessment and look for creative ways to solve the particular issues affecting a community.
Conclusion
The proposed proactive care standard is certainly a heightened standard and a marked
change from current policy. Perhaps all but the most proactive hospitals should be organized as
private entities, despite worries that this will fundamentally alter the delivery of healthcare:
“doctors, nurses, pharmaceutical companies, local pharmacies, medical equipment providers, insurance companies, etc. all operate as for-profit entities. As a nation, we do not seem to distrust our doctors because they practice their profession for a profit. We do not begrudge the local pharmacy their for-profit orientation. We do not ask whether the wheelchair manufacturer is nonprofit or for-profit. Why is it, therefore, that a suggestion that hospitals might be able to operate in a similar for-profit environment without destroying the health care system is met by exemption proponents with such disdain?”xxxvii
Perhaps the solution is for these private and private-oriented hospitals to be legislated
into a §501(c)(4)-like status by Congress, where they would pay no income tax but would not
have all the perks of §501(c)(3) status. Charity status would be reserved for the most proactive
hospitals truly serving in their communities.
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i
*B.S. Finance, Louisiana State University; JD, Louisiana State University; LL.M. Candidate Georgetown University Law Center 2015
Rev. Rul. 69-545, 1969-2 C.B. 117 (1969)ii Lunder, Erika and Edward Liu “501(c)(3) Hospitals and the Community Benefit Standard” Congressional Research Service 2009.iii Id.iv Kevin B. Fischer, Tax Exemption and the Health Care Industry: Are the Challenges to Tax-Exempt Status Justified?, 49 Vand. L. Rev. 161, 166 (1996)v Rev. Rul. 56-185, 1956-1 C.B. 101 (1956)vi Rev. Rul. 83-157, 1983-2 C.B. 94. (1983)vii Rev. Rul. 69-545, 1969-2 C.B. 117 (1969)viii Lunder, Erika and Edward Liu “501(c)(3) Hospitals and the Community Benefit Standard” Congressional Research Service 2009.ix Douglas M. Mancino, The Impact of Federal Tax Exemption Standards on Health Care Policy and Delivery, 15 Health Matrix 5, 11 (2005)x Rev. Rul. 56-185, 1956-1 C.B. 101 (1956)xi Jessica Berg, Putting the Community Back into the "Community Benefit" Standard, 44 Ga. L. Rev. 375, 403 (2010)xii Id. at 377xiii Helena G. Rubinstein, Nonprofit Hospitals and the Federal Tax Exemption: A Fresh Prescription, 7 Health Matrix 381, 404-05 (1997)xiv Lunder, Erika and Edward Liu “501(c)(3) Hospitals and the Community Benefit Standard” Congressional Research Service 2009.xv John D. Colombo, J.D. & Mark A. Hall, J.D., The Future of Tax-Exemption for Nonprofit Hospitals and Other Health Care Providers, 2 Health Matrix 1, 32-33 (1992)xvi Michael J. DeBoer, Religious Hospitals and the Federal Community Benefit Standard-Counting Religious Purpose As A Tax-Exemption Factor for Hospitals, 42 Seton Hall L. Rev. 1549, 1551-53 (2012)xvii Lunder, Erika and Edward Liu “501(c)(3) Hospitals and the Community Benefit Standard” Congressional Research Service 2009.xviii Id.xix Id.xx Merritt A. Dattel, Policy Comment: A Game of Hide and Seek: A Critique of the Free Care System of Non-Profit Hospitals in Massachusetts, 2 J. Health & Biomedical L. 129, 136-37 (2006)xxi Terri L. Brooks, Billions Saved in Taxes While Millions Underserved-What Has Happened to Charitable Hospitals?, 8 Hous. Bus. & Tax L. J. 391, 416-18 (2008)xxii Jessica Berg, Putting the Community Back into the "Community Benefit" Standard, 44 Ga. L. Rev. 375, 377 (2010)xxiii Id.xxiv Jack Hanson, Are We Getting Our Money's Worth? Charity Care, Community Benefits, and Tax Exemption at Nonprofit Hospitals, 17 Loy. Consumer L. Rev. 395, 399 (2005)xxv Mary Crossley, Tax-Exempt Hospitals, Community Health Needs and Addressing Disparities, 55 How. L.J. 687, 692-93 (2012)xxvi Section 501(R) Requirements for Section 501(C)(3) Hospitals, 24 TXNEXEMPT 03, 3xxvii John M. Quirk, Turning Back the Clock on the Health Care Organization Standard for Federal Tax Exemption How Recent Irs Litigation Positions, Federal Court Decisions, and Congressional Proposals Have Abandoned the "Community Benefit St, 43 Willamette L. Rev. 69, 91 (2007)xxviii Section 501(R) Requirements for Section 501(C)(3) Hospitals, 24 TXNEXEMPT 03, 10
xxix Id.xxx Diagnoses of HIV Infection in the United States and Dependent Areas, 2011HIV Surveillance Report, Volume 23xxxi See also: Epidemiology of HIV Infection United States – 2013 John T. Brooks, M.D. Epidemiology Branch Division of HIV/AIDS Prevention, CDC (http://www.acthiv.org/2013_presentations/1-ACTHIV%20-%20BROOKS%20plenary%202013-03-21.pdf)xxxii Jack E. Karns, Justifying the Nonprofit Hospital Tax Exemption in A Competitive Market Environment, 13 Widener L.J. 383, 519 (2004)xxxiii Sanders, Michael I. “Joint Ventures Involving Tax–Exempt Organizations” 803 (4th edition 2013)xxxiv Id. at 797xxxv Id. at 748xxxvi Kaiser Family Foundation “Explaining Health Care Reform: Medical Loss Ratio (MLR)” February 29, 2012xxxvii John D. Colombo, The Failure of Community Benefit, 15 Health Matrix 29, 53-54 (2005)