The IRS, Nonprofit Hospitals, and the Meaning of “Community Benefit”

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Kaiser.org has written an interesting article about the recent two year IRS Study of nonprofit hospitals under 501(c)(3). The IRS queried 5oo nonprofit hospitals, with the study’s findings based primarily upon examination of 489 of those. Under the strictures of 501(c)(3) nonprofits are confined to paying executives “reasonable compensation” and supplying “community benefit.” Unfortunately, neither of these terms are particularly well defined. In the study’s executive summary, the IRS puts it so:

“The community benefit standard is the legal standard for determining whether a nonprofit hospital is exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code.”

“Observations. Both the community benefit and reasonable compensation standards have proved difficult for the IRS to administer. Both involve application of imprecise legal standards to complex, varied and evolving fact patterns.”

The Kaiser article notes that according to the NY Times, “Lawmakers over the last few years have ‘raised concerns over whether nonprofit hospitals provide enough free care and other community benefits to justify their tax exemptions,’ but no test exists for ‘measuring how much community benefit is enough or even what constitutes community benefit.’”

These limitations may be seen in the characterizations of “community benefit” available to the hospitals in the study. Bad debt and Medicare payment shortfalls may be construed as  “community benefit.” As the debt, the credit injury, and the collection calls all inure to the community member who received treatment but could not pay, one might question if the “community benefit” involved in a failure of collection practices might be distinguishable from the “community benefit” involved in intentional charitable care. In addition, there simply is no set criteria to determine the appropriate amounts to be charged as “community benefit.” The IRS study poses the following under the heading of

“Limitations: …although the IRS designated the general categories of activities that could be reported as community benefit for purposes of the study, determining what was treated as community benefit (for example, bad debt or Medicare shortfalls) and how to measure it (cost versus charges) was largely within the respondents’ discretion.

Which is to say that those being monitored (nonprofit hospitals) to gauge the amount of money spent– to justify their tax exempt  status– were free to characterize their contributions in the manner they thought best.

Medicare shortfalls: So… if a non-profit hospital has a fee schedule rate of $100 for a procedure, and Medicare has a reimburse rate of $80 for that procedure, if a “charge” rate of measurement is used then there has been a $20 “community benefit” if the federally designated tax exempt nonprofit hospital accepts as payment the federally designated and predetermined Medicare reimbursement amount. Significantly, 19% of the hospitals also claimed “shortfalls” in payment from private insurers as uncompensated care/community benefit (See Chart: “Figure 82,” p. 105, full report).

Cost vs. Charge: So… if a procedure has a cost to the hospital of $80 and a fee schedule rate of $100, and the recipient of the procedure does not pay and the hospital categorizes the non-payment as “bad debt,” it has the ability to count as “community benefit” not only the cost of its unintended largesse, but also the amount it had expected as profit.

Perhaps even more telling than this latitude in characterization are the amounts actually submitted to the IRS as community benefit. Here are a few of the findings:

• The average and median percentages of total revenues reported as spent on community benefit expenditures were 9% and 6%, respectively.
• Uncompensated care accounted for 56% of aggregate community benefit expenditures reported by the hospitals in the study.
• Uncompensated care was the largest reported community benefit expenditure for each of the study’s demographics, other than for a group of 15 hospitals reporting large medical research expenditures (93% of all research expenditures reported by the study’s respondents).
• Further, the group of 15 hospitals reporting large medical research expenditures materially impacted the overall numbers in this area. For example, when the research group is removed, the percentage of total community benefit expenditures reported as spent on uncompensated care increases from56% to 71%, and that spent on medical research decreases from 15% to 1%.
• Uncompensated care and community benefit expenditures were concentrated in certain hospitals and unevenly distributed. For example,9% of the hospitals reported 60% of the aggregate community benefit expenditures of the overall group; 14% of the hospitals reported 63% of the aggregate uncompensated care expenditures.

So… if we were to take the 15 research hospitals out of the mix, 73% of the “community benefit” for the remaining 474 hospitals was in the form of uncompensated care–Medicare (and private insurance) shortfalls and bad debt inclusive.

In addition, of the substantial uncompensated care component, hospitals contributions were disparate: 14% of the hospitals reported 63% of the total–which is to say that roughly 68 hospitals out of the 489 accounted for 63%, while the other roughly 421 hospitals chipped in a somewhat less magnanimous 37% of the total. This despite the considerable latitude in characterization.

The Kaiser article notes that according to the NY Times

“In a statement, Sen. Chuck Grassley (R-Iowa), who since 2005 has sought to require not-for-profit hospitals to justify their tax exemptions, said that the study did not include adequate definitions or comparable information on community benefits for-profit hospitals provide. He said, “Neither the IRS nor Congress has done a very good job when it comes to establishing the criteria for enjoying this tax status since the IRS scrapped charity care for its community benefit standard in 1969″ (New York Times, 2/13)”