A new focus on Tax-exempt hospitals: Preparing for the audit

In 2010, the Affordable Care Act provided that the IRS should review each hospital’s compliance with IRC Section 501(r) at least every three years and mandated that it report to Congress about that review. In August 2023, four members of the Senate Finance Committee asked the Treasury and the IRS to review its approach and step up IRS oversight of tax-exempt hospitals, especially with an eye to community benefit.

In March, 2024, the Lown Institute reported findings that 80% of nonprofit hospitals give back less to their communities than they receive in estimated tax breaks. That same report included enforcement recommendations for hospitals that are not in compliance with community benefit requirements. “We acknowledge that this report is not unbiased, but it has been used extensively by the media as a touchpoint to examine hospitals in the local community,” said Erin Couture, Grant Thornton Managing Director, Tax Services.

This year, the IRS has made clear that it is not only planning to review the compliance of tax-exempt hospitals with IRC Section 501(r), but it is also planning to take an overall look at their tax-exempt status, including the community benefit standard.

The pressure is on. “The IRS stated that they plan to open at least 35 nonprofit hospital examinations in fiscal year 2024. With that announcement, they’re making it clear that you should not only be alert for a letter in the mail, but it is sending a message to the hospital community that it’s moving forward with a serious initiative around the review of tax exemption,” added Couture.

Preparing for an IRS audit

Armed with the knowledge that these audits are on the horizon, hospitals should take steps now to prepare. “We’re seeing anecdotally more inquiries from the IRS,” said Mary Torretta, Grant Thornton Healthcare Tax Leader. “It’s best practice to prepare for an IRS examination so that if it happens, you’re ready.”

Following are some recommended steps to follow when preparing for an audit:

1. Take this opportunity to reconvene your 501(r) team and charge them with the responsibility to refresh and review your compliance with a goal to ensure that your hospital is presented in the best possible light. Make sure that your teams understand their roles and that you have provided education and training about the requirements of 501(r) and are being thoughtful about how you present your compliance externally.
2. When reviewing your hospital’s compliance, start where the IRS auditor will begin—at the hospital website—and review it from an outsider’s perspective:
   1. Is the information required by 501(r) easy to locate with a basic Google search?
   2. Do your links work? “We see a lot of dead links,” says Torretta. “It’s a good idea to docket to check your links frequently to make sure they are working.”
   3. Is your provider list current? Check to make sure that the list of providers who are participating in your financial assistance policy is current. What date is reported on that list?
   4. Are the policies outlined at your website presented in languages that meet the needs of the demographics of your community?
   5. Are you claiming community benefit credit for your community development and educational activities?
   6. If you are a medically underserved community, are you including your investment in physician practices?
3. Make sure that the information in your Schedule H matches the information on your website and agrees with your financial statements.
4. Take a walk around your facility with a focus on your emergency departments or intake areas. “Put yourself in the shoes of your patients,” said Torretta. “Would a potential patient know that financial assistance is available and the right phone number to call for more information? Are your signs easy to read and displayed in a location that is easy to access?”

You’re selected for an audit: What you can expect 

If your hospital is selected for an examination, you can expect the process to begin with an initial contact letter (by mail) and conclude with a closing letter:

1. The letter. You will receive a letter that includes the agent’s name, location, and specialty, as well as information about when they would like to conduct the initial visit. “The package will also include initial information requests, which could be short or quite voluminous, depending on the audit,” says Couture. It is important to ensure that systems are in place in your mailroom so that the letter goes to the right person at your hospital and does not linger.
2. The initial response. Develop a strategy about who will serve as the contact person. In some cases, the hospital will opt to have an internal representative have an initial discussion with the agent, while in other cases, the hospital will decide to hire outside assistance to correspond under a power of attorney. “You’ll probably want to change the date of the initial visit to give yourself more time to prepare,” said Couture. “So, during that first phone call, make sure you have alternative dates available. Ask questions to get a clear understanding about how the agent expects to receive your documentation, whether through an IRS portal or onsite.”
3. The arrangements. Because the IRS is in a hiring mode due to a wave of planned employee retirements, there may be more than one type of specialist at your review. Ask them about their expectations about the duration of the review and what type of room they will need while on-site. “You should plan for the possibility of providing the agents with a tour of your facilities. As the audit approaches, make sure that you do everything you can to ensure that the agents have a smooth arrival and that you guide them through the facility in a way that puts your organization in the best light,” Couture said.  
4. The on-site visit. Expect a lot of questions, beginning with the CHNA (Community Health Needs Assessment) report. For example:
   1. How do you know you have the right demographics when you describe your service area?
   2. How do you define your community and set your scope?
   3. What is your board’s involvement in the CHNA process?
   4. What is your messaging about your financial assistance?

Agents will also focus on your billing and collections and may ask for samples of billing packages that patients have received to make sure that the AGB (amount generally billed) was not exceeded. “They will also want to interview management about your policies,” said Torretta. “They will be very focused on the perception of the patient and may take tours and pictures of your signage to make sure it is clear to the patient that they will be taken care of by the hospital,” said Torretta.

After the visit

It’s important to understand that the audit does not end when the agents leave. Because the agents’ manager(s) needs to review the file when they return to their office, there is often a need for follow-up after the agents leave the field. “For 501(r), the IRS is able to provide a comment letter,” said Torretta. “If there were any errors or omissions, you should be able to describe to IRS how you will deal with them. If there was an error in your compliance, it will be noted in a comment and you may need to negotiate that with the IRS.”