The IRS is underway with conducting audits of 35 §501(c)(3) hospitals, which it announced in June 2024, with a particular focus on “community benefit.” Targeted hospitals appear to be those who reported low community benefit percentages on their IRS Form 990.

Below are key background points and take-aways for nonprofit hospitals in light of these audits and the IRS’ announced prioritization of focus on hospitals’ compliance with §501(c)(3) requirements, as well as given ongoing scrutiny of nonprofit hospitals by the press, lawmakers, government regulators and the public.

Background – Requirements for §501(c)(3) Hospitals

In addition to the regular requirements for §501(c)(3) tax-exempt status, hospitals are subject to the following requirements (described by the IRS here):

• Community Benefit Standard. The “community benefit” standard, established in 1969 under Rev. Rul. 69-545, generally requires hospitals to:
  • Operate an emergency room open to all, regardless of ability to pay.
  • Maintain a board of directors drawn from the community (a “community board”).
  • Maintain an open medical staff policy.
  • Provide hospital care for all patients able to pay, including those who pay their bills through public programs such as Medicaid and Medicare.
  • Provide free or subsidized care to the indigent.
  • Use surplus funds to improve facilities, equipment, and patient care.
  • Use surplus funds to advance medical training, education, and research.
• Section 501(r). Internal Revenue Code Section 501(r), established in 2010 by the Patient Protection and Affordable Care Act (PPACA), generally requires hospitals to do the following (described by the IRS here), with detailed requirements under the related Regulations:
  • Conduct a community health needs assessment (CHNA) every 3 years and adopting an implementation strategy to meet the identified community health needs.
  • Establish a written financial assistance policy (FAP) and a written emergency medical care policy for a hospital facility it operates.
  • Limit the amount charged for any emergency or other medically necessary care it provides to a FAP-eligible individual to not more that the amount generally billed (AGB) to individuals who have insurance covering such care.
  • Make reasonable efforts to determine whether an individual is eligible for assistance under the hospital organization’s financial assistance policy (FAP) before engaging in extraordinary collection actions (ECAs) against that individual.
• IRS Reporting & Public Disclosure. The annual Form 990 information return filed by tax-exempt organizations with the IRS requires detailed reporting for hospitals on Schedule H. Form 990s are often viewed by the press, various government regulators and current and prospective donors and funders.
• IRS Review. PPACA required the IRS to review hospitals’ community benefit activities at least once every 3 years. A 2023 report by the Government Accountability Office found the IRS’ efforts to be lacking.

A hospital’s Section 501(c)(3) tax-exempt status can be revoked for failure to comply with the requirements above. An excise tax penalty of $50,000 is imposed on certain violations of the Section 501(r) CHNA requirements.

Scrutiny of Nonprofit Hospitals

The IRS’ audit focus on community benefit follows ongoing scrutiny of nonprofit hospitals by U.S. Congress, the press and other government regulators in terms of how much care they provide for the poor, aggressive collections efforts, Americans struggling with medical debt and justifying the billions in tax breaks that they receive. In some cases, specific hospitals have been called out in the press. Similar concerns have arisen at the state level in the context of hospitals seeking property tax exemption and states considering or passing legislation to better define charity care.

Here are some examples:

• A recent report from the Committee for a Responsible Federal Budget reported that of the country’s 5,129 community general hospitals, 58% are nonprofit organizations that are exempt from most taxation, referencing an estimate that they received approximately $28 billion in tax exemptions in 2020. The report states that “nonprofit hospitals are failing to meet community benefit obligations under all but the broadest (many argue, overly expansive) definitions” and asserts that policymakers should reduce those tax benefits and/or enforce stricter requirements for community benefit. The American Hospital Association issued a sharp critique of the report.
• A March 2024 report by the Lown Institute scrutinized how much hospitals contribute back to their communities. The report notes: “Out of 1,773 nonprofit hospitals evaluated, 77% spent less on charity care and community investment than the estimated value of their tax breaks — what we call a “fair share” deficit.”
• The White House noted the IRS’ hospital audit effort in June 11, 2024 fact sheet, stating that the audits would “better ensure that nonprofit hospitals provide the community benefits necessary to maintain their non-profit status.” 

Observations

• The tax law generally does not require any particular nature or amount of financial assistance or community benefits. Accordingly, IRS efforts to enforce the law cannot address some of the underlying points of criticism and public policy concerns. 
• While scrutiny has been focused on the amount of financial assistance and community benefit that hospitals provide and their patient collections efforts, the requirements are more focused on process rather than specific requirements. 

Action Items

Proactive Steps

Nonprofit hospitals should proactively demonstrate compliance with community benefit requirements to avoid becoming targets for IRS audits or media scrutiny.

• Review the Hospital Website. Review your hospital’s website for technical compliance with §501(r), such as to ensure that the Financial Assistance Policy, plain language summary, application form and list of participating providers are easily found, as well as the Community Health Needs Assessment and Implementation Strategy. Ensure all website links are working.
• Ensure Community Benefits are Captured. Ensure your hospital is proactively capturing and publicizing all community benefit and financial assistance efforts within the community on an ongoing basis – which may occur across a broad spectrum of activities. For example, ensure that your Form 990 reflects all community benefits reported on community benefit reports required at the state level. Focus on Social Determinants of Health (SDoH) efforts. Ensure that information is gathered across efforts for organizational annual reports and any ESG reporting. Efforts to capture can vary greatly – e.g., efforts to attract physicians whose specialty is underserved in the area, various community education, training for healthcare professionals, scientific research, hiring from local underprivileged communities, and more.
• Joint Ventures & Affiliates. Focus on compliance and efforts to serve the community through joint ventures, as well as efforts to support affiliates and subsidiaries in such efforts.
• Communications Plan. Focus on public messaging – on the website, social media and other outward communications. Keep in mind that communications are not only about compliance with IRS requirements and reducing the risk of being selected for an audit, but can also impact scrutiny for property tax exemption, for example, and impact reputation and relationships with community stakeholders.
• Documentation. Focus on creating a strong paper trail of the hospital’s dedication to financial assistance and community benefit – particularly in Board and Committee minutes, which could be scrutinized in an audit.
• Review Non-501(r) Compliance. Aside from §501(r), other areas the IRS tends to focus on in audits include compliance with:
  • Political Activities. Given the current election cycle, it’s a good time to review and remind staff of the political activity prohibition and what that can look like in the workplace.
  • §4960 Tax/Excess Compensation. Check for compliance with Internal Revenue Code §4960 excise tax on compensation paid over $1 million paid to a “covered employee” and certain parachute payments. Review current practices for executive compensation generally under the excess benefit transaction rules.
  • Worker Classification. The IRS continues to focus on whether workers are properly classified as independent contractors instead of employees. This is a likely area for scrutiny in an audit.
• Schedule Periodic Updates & Training. Ensure that the hospital’s financial assistance and billing and collections policies are reviewed periodically to ensure that they remain accurate in how they are operationalized, and provide periodic training to ensure compliance and demonstrate good faith.
• Mock Audits. Consider a mock audit.
• Transactions. When acquiring facilities or engaging in transactions, ensure that the documentation reflects the requirements and that related outward communications reflect the desired messaging focusing on benefitting the community.
• Monitor Developments. Stay tuned for developments, given the scrutiny and government focused described above.

If selected for an audit:

If your hospital is selected for an audit, advance preparation can make a big difference. 

• Conduct a Walk-Through. Make a checklist of the numerous specific requirements and do a walk-through of hospital facilities as if you were a patient, to ensure technical compliance with §501(r), as the IRS could do. For example, check for financial assistance materials in the admitting and emergency room areas. Check for how a patient would encounter opportunities for financial assistance.
• Distinguishing Facts. Identify aspects of your hospital that are unique (e.g., the population served, challenges for the local community, etc.), especially in ways that may not be readily apparent to an outside observer. Prepare to emphasize to the IRS should take those into account in demonstrating compliance with the legal requirements on your particular facts.
• Staff Preparation. Identify the right staff internally with deep knowledge of CHNA and FAP process and how they are operationalized and prepare them for what to focus on and how to effectively communicate with the IRS.

• Coordination & Messaging. Work closely with legal counsel and accounting firm on reviewing compliance and strategizing about messaging. 

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