What Bad-Debt Expense Analysis Tells Charitable Hospitals

With the current focus of the IRS on hospital community benefit, charitable hospitals should consider a renewed look at their hospitals’ bad-debt expenses.

In past years, accounting guidance changes caused bad-debt expense to no longer be reported as a separate line-item on hospitals’ and healthcare organizations’ financial statements. Instead, total revenue already includes the amount a hospital or healthcare organization does not expect to collect from patients. When this concept carries over to Form 990, Schedule H, “Hospitals,” reporting, two relevant questions in Part III, Section A, come into play.

The first relevant question is “Enter the amount of the organization’s bad debt expense. Explain in Part VI the methodology used by the organization to estimate this amount.” A review of submitted Forms 990 reveals that hospitals do not always insert a number for this response. Since the accounting rule change, it is certainly not unusual to see a “0” response with a narrative explanation indicating that financial accounting rules do not call for reporting bad-debt expense as a separate line-item.

The second question is “Enter the estimated amount of the organization’s bad-debt expense attributable to patients eligible under the organization’s financial assistance policy. Explain in Part VI the methodology used by the organization to estimate this amount and the rationale, if any, for including this portion of bad debt as community benefit.” Again, it is not unusual to also see a “0” response to this question in alignment with the previous explanation.

Even if hospital officials do not separately report bad-debt expense on Schedule H, or do not believe that they reasonably can estimate the amount of the organization’s bad-debt expense attributable to patients eligible under the organization’s financial assistance policy, they still should delve into bad-debt expense for internal financial analysis purposes and regularly report on it to the hospital board of directors. Here are five reasons why.

1. An analysis of bad-debt expense provides insight into the financial health of the organization. High levels of bad debt could indicate that a hospital is providing services to a large number of patients who are unable to pay, which could affect the hospital's financial stability. This is particularly important for charitable hospitals, which are required to meet certain community benefit standards to maintain their tax-exempt status.
2. A bad-debt expense analysis can help hospitals refine their financial assistance policies. By understanding the characteristics of the patients who are not paying their bills, hospitals can adjust their policies to better serve those in need while also protecting their financial interests.
3. A bad-debt expense analysis can tell a lot about how successfully a hospital operates its financial assistance program. Is the hospital capturing all patients who are potentially eligible for financial assistance, or does it need more targeted outreach – such as through financial counselors or more assertively addressing financial assistance during the intake process – to ensure that eligible patients are aware of the financial assistance available to them.
4. A bad-debt expense analysis can help measure the success of any presumptive financial assistance practices that a hospital might have in place. A hospital will want to evaluate how many patients are presumptively reclassified from bad debt to financial assistance in relation to total charity, and whether this number or proportion is increasing or decreasing and why.
5. Regularly reporting bad-debt expense to the board of directors is essential for transparency and informed decision-making. The board is responsible for overseeing the hospital's financial practices and ensuring that the organization is meeting its community benefit obligations. Detailed reports on bad debt can help the board understand the challenges the hospital faces and the effectiveness of its financial assistance policies.

While changes in accounting guidance have altered the way hospitals report bad-debt expense, the analysis of this expense remains a critical component of a hospital's financial management and compliance tax requirements – particularly with the current IRS focus on hospital community benefit. Hospitals should scrutinize their bad-debt expense, refine their financial assistance policies, make operational adjustments in their financial assistance program if necessary, and make sure that they are meeting the community benefit standards required to maintain their tax-exempt status. Bad-debt expense analysis is just one component of a larger community benefit analysis that the hospital’s tax adviser can help prepare annually to keep the board and constituents up to date on the hospital’s overall community benefit efforts.