Understanding the value of a hospital’s tax-exempt status

Steve Lenivy, Kim Scifres, Gina Ardillo

This article is the second in a series of three articles published in connection with the 2023 Crowe Community Benefit Roundtable Series. Our previous roundtable, hosted on June 21, 2023, addressed how states are holding tax-exempt hospitals accountable for community benefit, and our third and final roundtable article will relate to community benefit benchmarks, peer comparisons, and community benefit trends.

To maintain federal tax-exempt status under Section 501(c)(3) of the IRC, not-for-profit hospitals must meet a community benefit standard. The community benefit standard essentially seeks to ensure that not-for-profit hospitals invest in activities that promote community health in exchange for their tax-exempt status.

Why is the value of a hospital’s tax-exempt status important?

Due to mounting pressures from various government and public sources focused on not-for-profit hospitals, the community benefit provided by a not-for-profit hospital serves as a quantifiable metric for determining the validity of its tax-exempt status. Media outlets and government officials alike are advocating for increased regulatory oversight of the community value provided by not-for-profit hospitals. For example, the Lown Institute published findings suggesting that a large number of hospitals are failing to provide value to the community equivalent to the value of those hospitals’ tax breaks.¹ Additionally, a growing number of state agencies are evaluating the available avenues to increase the community benefit provided by not-for-profit hospitals within the state, and Iowa Senator Chuck Grassley is continuing his efforts for increased monitoring and enforcement of the community benefit standard.

Not-for-profit hospitals are making headlines for potentially failing to justify their tax-exempt status. Local and national media outlets have insinuated a failure to provide sufficient benefits to the community in relation to the value of their tax-exempt status, and as a result, it has become increasingly important for not-for-profit hospitals to effectively communicate their community benefit efforts to the public. While no federal requirement currently exists to perform such a calculation – and the states that currently impose this type of requirement use varying definitions of “community benefit standard” – quantifying the value of a not-for-profit hospital’s tax-exempt status can demonstrate the comparative value of the hospital to the communities it serves.

The oversight of charitable organizations is not uniform across states, but many are exploring options for enforcing a community benefit standard that is definable. Several state regulatory agencies have implemented reporting procedures requiring not-for-profit hospitals to meet a certain community benefit standard by tying community benefit to another financial metric, such as the value of the hospital’s property tax exemptions or the hospital’s net revenue. Some states have imposed mandatory contributions in lieu of taxes on not-for-profit hospitals to drive additional benefits to the community, while others are focusing on curtailing aggressive collections practices that pressure patients eligible for financial assistance to pay.

At a federal level, on Aug. 7, 2023, Senators Grassley, Elizabeth Warren, Raphael Warnock, and Bill Cassidy, M.D., issued a bipartisan letter to the commissioner of the IRS and the Tax Exempt and Government Entities Division, along with a letter to the U.S. Department of the Treasury inspector general for tax administration (TIGTA), requesting additional information regarding the IRS’ current practices for community benefit monitoring and enforcement of the community benefit standard. The letters also outlined suggested measures for the IRS to take to address concerns surrounding oversight of not-for-profit hospitals.

In their letter to the IRS, the senators urged that a review of Form 990, “Return of Organization Exempt From Income Tax,” Schedule H, “Hospitals,” be included in the 2023-2024 IRS Priority Guidance Plan and requested that responses to the following points be provided within 60 days of receipt of the letter:

Provide a list of the most commonly reported community benefit activities that qualified a not-for-profit hospital for tax exemptions in fiscal years 2021 and 2022. Please categorize by charity care, unreimbursed costs of Medicaid, community health improvement activities, professional development, and other.
Describe the updates the IRS has made since September 2020 to the instructions to Form 990 Schedule H to modify how community benefit information is identified and provided.
- Describe the rationale for these updates to Form 990 Schedule H.
- Describe how these updates to Form 990 Schedule H have improved clarity in reviewing community benefit information.
- What additional updates did the IRS consider in its review of Form 990?
How many hospitals did the IRS identify as “at risk” for noncompliance with the community benefit standard since spring 2021 when the IRS implemented several of the Government Accountability Office’s recommendations related to establishing a well-documented process to identify hospitals at risk for noncompliance?

Describe how these changes affected the effectiveness of reviewing hospitals’ community benefit activities.

Provide a list of the not-for-profit hospitals that the IRS referred to its audit division for potential Patient Protection and Affordable Care Act (ACA) violations from fiscal year 2019 to fiscal year 2022.
- How many of these hospitals were referred because of noncompliance issues related to the community benefit standard?
- How many not-for-profit hospitals reported no spending on community benefits in 2022?
Provide a list of not-for-profit hospitals that lost their tax-exemption due to noncompliance with the community benefit standard since the full implementation of the ACA on Jan. 1, 2014.
Provide a list of not-for-profit hospitals that had their IRS Form 990 rejected for failing to meet requirements related to community benefit reporting.
Provide a list of not-for-profit hospitals that failed to file an annual Form 990 with the IRS from fiscal year 2019 to fiscal year 2022.
- How many of these not-for-profit hospitals were issued penalties for this failure?
- How many of these not-for-profit hospitals had their tax-exempt status revoked?
What other challenges does IRS face in its ability to oversee tax-exempt hospitals?²

In the letter to TIGTA, the senators requested that TIGTA develop an audit plan to be undertaken during 2024 that includes the following actions:

Determine whether the IRS is effectively ensuring that not-for-profit hospitals comply with tax-exempt requirements and are providing sufficient community benefit.
Evaluate the IRS’ process for identifying hospitals at risk for noncompliance with the community benefit standard and its resolution process to ensure future compliance.
Assess the effectiveness of the IRS’ controls to detect and prevent hospitals’ underinvestment in improving community health.
Review and assess the effectiveness of the community benefit standard, as outlined in Revenue Ruling 69-545, in its ability to determine whether a hospital is organized and operated for the charitable purpose of promoting health.
Evaluate the adjustments the IRS made to Form 990 Schedule H instructions for transparency, consistency, and comprehensiveness in reporting.
Evaluate the existing standards for financial assistance policies and practices that reduce unnecessary medical debt from patients who qualify for free or discounted care.
Review the effectiveness of IRS’ efforts to ensure hospitals make reasonable efforts to determine whether individuals are eligible for financial assistance before initiating extraordinary collection actions.
Identify the pervasiveness of not-for-profit hospitals billing patients with gross charges.
Identify the challenges the IRS faces in its ability to oversee tax-exempt hospitals.³

How can my hospital proactively address concerns raised by the senators and by recent media publications?

Not-for-profit hospitals can take several actions to proactively address the increased scrutiny, including:

Quantifying the value of the hospital’s tax-exempt status
Ensuring that any activities conducted by the hospital that can be counted as community benefit are appropriately factored into any community benefit reporting
Reviewing the current processes and procedures of the hospital’s community benefit department
Implementing processes that allow for a continuous review of the hospital’s compliance with the requirements of Section 501(r), including the hospital’s financial assistance policy and the related policies and procedures

How can hospitals quantify the value of their tax-exempt status?

A charitable organization’s tax exemption could be considered one of the organization’s greatest intangible assets, with favorable tax treatment available from several sources. However, federal authoritative guidance currently does not exist regarding which specific benefits should be included in the valuation of a hospital’s tax-exempt status. This lack of prescribed federal guidance generally allows for some judgment to be exercised by the hospital when evaluating which items to include in this calculation, the level of detail to analyze, and whether to perform this calculation on a consolidated or facility-by-facility basis. The following are examples of items that a hospital might include in its calculation:

Federal income tax
State income tax/state gross receipts tax
Local income tax/local gross receipts tax
Federal unemployment tax
State unemployment tax
Sales tax
Real estate/real property tax
Personal property tax
Favorable bond financing – interest rate differential
The ability to receive charitable contributions that are tax-deductible to the donor
Benefits from 340B Drug Pricing Program

The value of a hospital’s tax-exemption for each of these items can be quantified by calculating what the hospital would pay if it were a for-profit hospital as compared to what the hospital actually paid as a tax-exempt hospital. For example, a tax-exempt hospital pays federal income tax at 21% only on the net income of activities considered to be unrelated business taxable income but would pay federal income tax at 21% on the net taxable income of all activities conducted by the hospital if the hospital was organized as a for-profit organization.

Are all activities that can be counted as community benefit being appropriately factored into your hospital’s community benefit reporting?

A detailed, holistic review of both a not-for-profit hospital’s current community benefit reporting and its activities within the community might reveal that the hospital is conducting activities that could be counted as community benefit but are partially or completely excluded from community benefit reporting. Ensuring that all eligible activities are included helps make sure community benefit reporting is an accurate representation of the hospital’s impact on the community and demonstrates its commitment to serving the community’s needs.

Are your hospital’s community benefit department’s current processes and procedures effective and efficient?

Assessing the effectiveness of current practices in community benefit monitoring and reporting can help identify opportunities for improvement, allowing for more efficient and comprehensive reporting. For example, the hospital should evaluate whether its community benefit department is adequately staffed by individuals who are appropriately educated and whether the department is regularly monitoring ongoing legislation, state regulatory trends, and news publications for any relevant information related to community benefit requirements.

Are you implementing processes for continuous review of your hospital’s compliance with Section 501(r) requirements?

Now that more than a decade has passed since the enactment of Section 501(r), many hospitals have experienced turnover of the staff involved in the original implementation of the requirements imposed by regulations. Some of the responsibilities handled by those individuals might no longer be assigned to specific employees. It is crucial for each not-for-profit hospital to designate specific individuals responsible for ensuring compliance with Section 501(r) requirements. For example, continuous review of the hospital’s financial assistance policy and the related policies and procedures is important to ensure that all patients eligible for financial assistance are applying for financial assistance. If the hospital reports bad debt expense attributable to such a patient, a review of current practices creates space for the hospital to implement changes to ensure that these patients receive the assistance for which they are eligible.

What’s next for not-for-profit hospitals amid increased scrutiny of tax-exempt status?

The value of a not-for-profit hospital’s tax-exempt status is under increased scrutiny from various government and public sources. This scrutiny is driven by concerns that some hospitals might not be providing sufficient community benefits to justify their tax-exempt status. In light of this increased scrutiny, not-for-profit hospitals can take several proactive steps, including quantifying the value of their tax-exempt status, ensuring all activities that can be counted as community benefit are appropriately factored into community benefit reporting, reviewing the current processes and procedures of the hospital’s community benefit department, and implementing processes that allow for a continuous review of the hospital’s compliance with the requirements of Section 501(r).

As the landscape continues to evolve, not-for-profit hospitals must stay informed and prepared to demonstrate their value to the communities they serve.