Tax-exempt healthcare systems need to tell the story of their mission in action — what they do for their patients and for the community at large.
Tax-exempt healthcare systems collectively cost the government billions of dollars in unassessed corporate income taxes, tax-exempt bonds and unpaid unemployment taxes. In exchange, healthcare systems provide their communities with essential care, jobs and other benefits. In recent years, there has been greater scrutiny of whether this benefit deserves tax-exempt status. The Lown Institute recently studied 275 hospital systems against available data, and asserted that 227 of them had a “fair share deficit,” providing charity care that didn’t equal the value of their tax exemption.
This focus on the benefits provided by tax-exempt health systems is not new, but it has received additional attention from the IRS, legislators, donors and other constituents in a post-COVID-19 world. That’s why it’s essential for hospitals to clearly and comprehensively capture their benefits to the community.
No magic numbers — just powerful narratives
When comparing your system to others, it’s important to consider the varied state payment schemas and state rules regarding Medicare. It’s also important to account for the differentiators of your hospital. For instance, a children’s hospital will have very different expenses than an academic medical center.
Your work starts with some serious fact gathering. To gather the facts behind these numbers, you often need to follow policies that were established without considering tax implications. The IRS Form 990 is central to an organization’s evidence of Section 501(r) compliance, and you should start by pulling your Schedule H, and your competitor’s. Look thoughtfully at your Schedule H, Part I, Line 7, and Schedule H, Part II.
“You often have to work within the restraints of policies developed by other departments, and you get data from those departments after the fact. You are working to complete a puzzle with pieces missing and bent.”
“You often have to work within the restraints of policies developed by other departments, and you get data from those departments after the fact. You are working to complete a puzzle with pieces missing and bent,” said Grant Thornton Principal and Healthcare Tax Leader Mary Torretta.
To capture the real and tangible facts, you need to explore several key strands of information. For instance, your system may have offered additional community benefit services during COVID-19 or changed its Financial Assistance Policy (FAP).
Healthcare heroes — how you served during COVID-19
“For your current Form 990, it’s the first full year of COVID-19 reporting,” said Erin Couture, Grant Thornton Healthcare Tax Managing Director. “It can’t be business as usual. Ask ‘how did COVID-19 impact our reporting, and what areas of focus on Schedule H should we examine?’” Consider some key questions, like:
- Did COVID-19 change who was served by your FAP?
- Are the numbers you’re seeing really covered by your FAP or by an ad hoc COVID-19 program?
- What caused any fluctuations?
- What other actions did COVID-19 prompt? These could include government-mandated data collection, public education around health services, testing initiatives, contact tracing programs, vaccination efforts and community service messaging.
- What programs are you offering for Community Health Improvement Services? Are they free or at nominal cost? How are they documented?
“It’s the first full year of COVID-19 reporting. It can’t be business as usual. Ask ‘how did COVID-19 impact our reporting, and what areas of focus on Schedule H should we examine?’”
Many healthcare services are particularly valuable because they proactively improve health rather than reactively treating illness. Make sure to capture your expenses in all of these areas.
Revenue is also part of this story, especially for new COVID-19-related programs. Look at reimbursements like Provider Relief Funds and FEMA, paying attention to the revenue and expense timing under your accounting year. The practice should follow the accounting method you use for the rest of your returns.
As it impacts community benefit expense percentage, Form 990, Part I, Line 7 should always be the first consideration in reporting activities on Schedule H. However, don’t force what doesn’t fit. Schedule H, Part II, which is also publicly disclosed, is a great place to explain anything that doesn’t fit in Part I. It’s another forum to tell the story of what the hospital has done for the community.
Remember that the IRS is not your only audience. Be transparent. Frame the revenue in a way that your donors and other sophisticated constituents will find clear and credible.
Don’t forget subsidized services
In addition to those services that clearly are provided for community benefit, many systems offer “subsidized health services” — clinical services at a financial loss to the organization. The financial loss is measured after removing losses associated with bad debt, financial assistance, Medicaid and other means tested government programs. Subsidized health services must meet an identified community need and must not be available to the extent needed unless provided by the health system.
These can be inpatient/outpatient services, but also look at specialized ICU services, mental health programs, COVID-19-related clinics and physician clinics in certain rural or remote areas that wouldn’t be present otherwise. This loss may be reportable on Schedule H, Part I, Line 7 as community benefit expense.
Finally, take a look at your research activities. Even if there will be offsetting revenue, document both the revenue and expense in your community benefit reporting.
Clarify your story
Look at ways that you can clarify your report and capture clearer information in the future.
For example, consider if bad debt is included in functional expenses you can remove from the denominator of total expenses, giving you a higher community benefit ratio. You simply have to disclose what you’ve done in the narratives.
Then, going forward, push your systems teams to document charity care. Make sure patients go through the FAP process at intake. Although you can arrive at the same accounting result by using a bad debt write-off, you won’t get credit for it as a community benefit unless they are determined as FAP eligible.
Medicare shortfalls can sometimes be positioned as a community benefit. In 2019, 72% of 2,900 hospitals reported Medicare shortfalls. The federal government reimbursed less than the cost for treating these patients. You can sometimes describe this shortfall as a community benefit, provided the facts support it and you note in your narrative.
Be prepared for an IRS audit
The IRS reviews the Section 501(r) compliance of about 1,000 of the 3,000 tax-exempt hospitals every year, meaning that all hospitals are reviewed at least once every three years as required by Section 501(r). So, it’s best to be prepared. Here are some best practices:
- Make sure everything is on your website.
“If you haven’t been notified, you’ve probably already gone through a compliance check,” Torretta said. “The IRS always starts with the website. So, if your information is all readily available on the website, often you won’t get a letter.”
- Post an up-to-date provider list.
For these purposes, “up-to-date” means this quarter. Is there a date on your provider list showing you are out of compliance?
- Establish written policies and procedures.
“If you have written policies and procedures that ensure you have best practices, the IRS is just much more pleasant to work with,” Couture said. “For example, document when you’ll check signage, when you’ll check the website and who’s assigned to it. The IRS loves to see that you have a methodology and a way to ensure compliance. When you have an error, it’s much easier to say, ‘It was an error, but we have best practices.’”
- Educate your front desk personnel on what to do when the IRS calls or visits.
You want to avoid a deer in the headlights look. Have a policy specifying what they should do, and whom they should contact. Make sure they are trained on it.
- Walk the building.
The IRS will. Check to make sure that relevant posters are up and they provide relevant information. Make sure brochure racks are full of helpful FAP information.
Ultimately, Torretta and Couture emphasized that you shouldn’t do this alone. Make friends in the organization who understand specific programs. They will help you complete the puzzle, this year and next — and they can help you tell the whole story.
Mary is a Tax Principal in Grant Thornton's Not-For-Profit and Healthcare Practice and is solely dedicated to tax-exempt clients. As a tax attorney, Mary is responsible for research in the legal and business consequences of tax planning strategies, tax controversy, applications for exemption, and private letter ruling requests for not-for-profit organizations.
- Not-for-profit and higher education
- Human capital services
Erin Couture is a Managing Director in Grant Thornton’s Not-For-Profit, Healthcare and Higher Education Practice and is dedicated to meeting the needs of tax-exempt clients.
- Not-for-profit and higher education
- Human capital services
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