Accurately Telling A Health Care Organization’s Community Benefit Story, Key To Tax-Exempt Status

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By Rick Kes, health care industry senior analyst with RSM US LLP and Rebekuh Eley, partner, exempt organizations with RSM US LLP

Hospitals and health care organizations that have been granted tax-exempt status have the benefit of not being required to pay corporate taxes on the income they produce from related business activities. Achieving and maintaining tax exempt status requires reporting on a variety of conditions, including documenting community benefits and charity care. Accurately calculating these efforts is critical, however, and can be a complex undertaking for many organizations serving their communities. Failing to capture the effort being done now might cause scrutiny later. It’s essential for health care organizations to provide a true depiction of the community benefits provided.

Distinguishing tax-exempt status

Tax-exempt health care organizations described in Internal Revenue Code section 501(c)(3) are required to file Form 990, Return of Organization Exempt From Income Tax, which includes information that provides interested parties a view of the organization’s activities. Some of the most highly publicized data from the Form 990 include an organization’s executive compensation as well as a hospital’s reporting with respect to its compliance with section 501(r), reported on the Schedule H required for all organizations operating a hospital facility.  

Among the most publicized figures from Schedule H is the data regarding a hospital’s financial assistance and community benefit programs. This includes charity care provided and Medicaid short fall (the amount of uncompensated costs from treating Medicaid patients), as well as other benefits provided to the community. This information is one of the factors that may distinguish tax-exempt hospitals from for-profit hospitals that offer the same medical services. The Court of Appeals for the Tenth District quoted Rev. Rul. 98-15 by stating “not every activity that promotes health supports tax exemption under section 501(c)(3)” and “engaging in an activity that promotes health, standing alone, offers an insufficient indicium of an organization’s exempt purpose. Numerous for-profit enterprises offer products or services that promote health.”   

Various stakeholders, including Congress, view this reporting responsibility as the burden tax-exempt health care providers bear to justify their tax-exempt status.  With the comparison of public records between for-profit hospitals and tax-exempt hospitals, there is a perception among some that tax-exempt hospitals need to do more to justify their tax- exempt status.  Although there is no bright line in terms of a minimum amount of community benefit a tax-exempt hospital must provide to maintain its section 501(c)(3) status, organizations have continued to place emphasis on the accurate reporting of these amounts, in part to provide interested parties a true depiction of the benefits they provide the communities they serve. 

Defining charity care

To understand the community benefits hospital systems provide, one must understand what charity care is. Charity care is a term the industry uses to measure the amount of revenues forgone for health care services provided to qualifying individuals. This is a contrast from “bad debt” (or for those Generally Accepted Accounting Principles aficionados “implicit price concessions”). Bad debt is the amount written-off when a health care provider delivers services to a patient, attempts to collect a fee from that patient, and ultimately determines the patient is not going to pay and ceases its efforts to collect the amount due.

Charity care has its own complexity in terms of measurement. Health care providers can usually identify the amount of charges forgone; however, the charges are often hard to compare from one organization to another, as each organization has its own methodologies for determining charges. Accordingly, Schedule H requires hospital organizations to report the cost of charity care and other community benefits, rather than charges, to facilitate comparability and standardization of reporting across organizations. 

How did we get here?

From a tax law perspective, in order to understand where we are with respect to charity care and community benefit, and where we may be headed, we must first take a look back at its evolution and the basis for a hospital’s tax-exempt status.   

In 1956, the IRS issued guidance on the general requirements a hospital must meet in order to qualify for tax exempt status under Internal Revenue Code section 501(c)(3).  Regarding charity care, the ruling notably stated that a tax exempt hospital, “must be operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay.”  

A decade later, the IRS further clarified the tax exemption standard for hospitals, acknowledging in a 1969 revenue ruling the promotion of health for the benefit of the community as a charitable purpose. The ruling specifically cited factors including the operation of an emergency room open to all persons and the provision of hospital care to all persons in the community able to pay as evidence of community benefit. In addition, the IRS modified its position regarding the provision of free or below cost patient care, eliminating these requirements previously set forth in 1956. The ruling also identified the use of surplus funds to improve the quality of patient care, expand facilities, and advance medical training, education, and research programs, as well as a board of trustees representative of the community and an open medical staff, as factors indicative of public benefit.  

Although the IRS has provided a number of factors indicating whether a hospital is operated primarily for charitable purposes, there has been no bright-line test to determine whether a hospital qualifies for section 501(c)(3) status.  As a result, Congress grew concerned that hospitals were not doing enough to “earn” the benefit of their tax-exempt status and, as part of The Patient Protection and Affordable Care Act, codified new requirements under section 501(r) for organizations that operate one or more hospital facilities to maintain their tax-exempt status under section 501(c)(3), as well as a number of additional reporting requirements. 

Section 501(r) imposes four primary requirements that hospital organizations must meet on a facility-by-facility basis in order to be treated as an organization described in section 501(c)(3), in addition to the general requirements for tax exemption under section 501(c)(3). These include the conduct of a community health needs assessment (CHNA), the maintenance of a written financial assistance and emergency medical care policy, the limitation of the amount charged for emergency or other medically necessary care, and the maintenance of a billing and collections policy limiting the use of extraordinary collection activities. With respect to its CHNA, a hospital must conduct a new assessment every three years and must adopt a written implementation strategy which addresses the significant needs identified by the CHNA and how the hospital facility plans to address the health needs of its community. The CHNA must be made widely available to the public both on the hospital’s website and through paper form.  

For all tax-exempt organizations, Form 990 requires reporting on governance, employee compensation, financial information, tax compliance and a multitude of other issues. For hospital organizations, Schedule H is required to provide information on the activities and policies of, and community benefit provided by, the organizations’ hospital facilities and other non-hospital health care facilities operated during the tax year. 

In addition to a host of reporting specifically targeted to assess the hospital facilities’ compliance with the requirements of section 501(r), Schedule H is the data point primarily used to benchmark a hospital’s community benefit.  Specifically, hospitals must report the cost of financial assistance and mean-tested government programs and other community benefit expenses such as: community health improvement services and community health improvement operations, health professions education, subsidized health services, research, cash and in-kind contributions for community benefit and other community benefit costs. These costs are then reduced by any direct revenue from these activities. The net community benefit activities are compared to the hospital’s overall expense to derive a percentage of community benefit expenses from overall expenses. 

What should providers do?

For health care providers, it is as important as ever to accurately capture and measure the organization’s community benefit and take credit for all of their charitable efforts. Tax-exempt hospitals and health systems should ensure that their reporting on Schedule H and to media outlets is complete and accurate, and every community benefit expense is accounted properly. 

Hospitals and health care providers may report on their Schedule H and other documents for the public and stakeholders the impact from completing their implementation strategies to meet the health need deficits identified through their CHNA. They may report on their environmental, social and governance efforts as well. Many constituents are interested in an organization’s formalized policies and programs related to service dedication, environmental protections, social justice efforts and more. An ESG strategy fortifies an organization’s reputation in the community and promotes goodwill. It’s another way to communicate the core passions, benefits and support an organization provides in a community.

In the end, while many health care providers can take substantial credit for their ability to change the health care outcomes of the communities they serve, the key is being able to tell the story. In addition to the accuracy of data points, providers can focus on their impacts in the community and other factors that validate their tax-exempt status. To this end, it is essential that the story of community benefits and other charitable efforts are rigorously and accurately reported.