Healthcare orgs should monitor IRS’s UBTI focus

A 2024 Program Letter issued by the IRS Tax Exempt & Governmental Entities (TE/GE) division indicated an intent and action plan to “collaborate across IRS on highly complex and or emerging issues including...tax exempt hospitals …”.  This is not new – the 2020 Program Letter issued by the IRS Tax Exempt & Governmental Entities (TE/GE) division indicated a new focus on “hospital organizations with unrelated business income (UBI)” and “UBTI reported on Form 990-T … where expenses materially exceed gross income.”

The IRS is singling out and examining not-for-profit healthcare organizations that report significant UBTI losses. As a result, hospitals with unrelated business activities that have generated significant losses need to be prepared for IRS scrutiny.

With more healthcare organizations pursuing new revenue streams to help them keep pace with rising costs—and with the increase in the use of telemedicine to provide remote care and consultations for “nonpatients”— the challenges involved in the  identification of unrelated income have become greater than ever.

What is unrelated business income?

Healthcare organizations exempt from income tax under § 501(c) of the IRC are not liable for tax on any revenue generated from activities related to the organization’s exempt purpose. Tax-exempt healthcare organization must however, pay income taxes when revenue is earned from a regularly carried-on trade or business not related to the organization’s tax-exempt purpose. “Unrelated business income is not something to be scared of – healthcare organizations just need to be aware of it and plan for potential tax impact of a revenue stream,” said Grant Thornton Managing Director, Healthcare Tax Services, Erin Couture.

Some of the most common sources of UBI included the provision of typical patient services to a non-patient population, this includes pharmacy and laboratory services, fitness facilities and childcare. UBI sources also can include management and administration services and certain joint ventures. It is also important to review the organization’s investment portfolio, investment in alternatives can often result in UBI and other tax reporting consequences.  

“As healthcare systems grow and expand, there’s more potential for UBI, both because you’re extending your footprint and because you’re expanding the activities you may conduct away from the hospital facility,” Couture added.

’Patient’ definition is a key measure

In healthcare, many of the activities that fall into the UBI category are products or services that are not provided to patients. Services provided for the benefit of a patient are generally considered to be related to the tax-exempt mission of the organization and are not taxable to the hospital.

The IRS is still working with a definition of a “patient” that is based on Revenue Ruling 68-376, which defines a “patient” as a person:

• Admitted to the hospital as an inpatient
• Receiving treatment at the outpatient facilities of the hospital
• Refilling a prescription received previously as a hospital patient
• Receiving medical services as part of a hospital-administered home care program
• Receiving care and services at an extended care facility.

“The IRS has not meaningfully updated guidance on who is a “patient” since 1968,” Couture said. “The way that healthcare systems deliver services has advanced significantly since then. Hopefully, we will receive updated guidance as the IRS adapts to the new standards of how care is delivered. Today, it’s important to consider carefully whether the individuals receiving your services have links to your facility as patients for tax purposes.”

Best practices for tracking revenue

For healthcare organizations whose activities include providing laboratory services, selling prescriptions to nonpatients, or other unrelated revenue, it is important to make sure that systems are in place to track this activity. Good financial records that show support for revenue and expense allocation to UBI are necessary both to support reporting and to have if the organization is subject to IRS scrutiny at a later date. “It’s critical to be able to support both revenue and expense allocation at this a key focus area for the IRS upon review,” said Couture.

Following are some best practices for tracking and allocating patient/nonpatient revenue:

• Set up a revenue system that accounts for transaction types. Employ a methodology that enables you to look at patient and nonpatient indicators in the system, often at point of sale or when orders are received. For example, for a prescription transaction, you should be able to indicate whether the sale is to a nonpatient, patient or to a hospital employee.
• Determine the cost of care. Develop an expense allocation methodology that enables you to account for unrelated business income reporting. When using cost accounting or cost-to-charge ratios, consider whether your cost to serve nonpatients is the same as the cost for serving patients because often they are different.
• Keep your finance team in the know. Make sure that they are aware of potential joint ventures and any other new services. “There might be small things that can be corrected at the time of contracting for the joint venture or services that may not affect the delivery from a healthcare perspective but may impact the taxability of the transaction,” Couture said. “They’re part of your team and can often prevent headaches before they occur.”
• Document your positions on whether a class of persons is a patient. Clearly outline the fact pattern for your positions and your conclusions so that you are well prepared before the IRS comes in. “Document. Document. Document. It will make everybody’s life easier,” Couture concludes.