1. law, govt and politics
2. legal issues
3. legislation
4. tax laws

This is a sample of the instructor resources for Introduction to the Financial Management of
Healthcare Organizations, Fifth Edition, by Michael Nowicki. This sample contains the
instructor notes and PowerPoint slides for Chapter 3.
The complete instructor resources consist of 29 pages of instructor’s notes, 946 PowerPoint
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Chapter Three Discussion Questions
1. Explain the rationale for granting organizations tax-exempt status.
•
•
Relieves the government of the burden of having to provide the service itself
Reward organizations for providing services that enhance community values and
goals
2. Identify the benefits and burdens of tax-exempt status for hospitals.
Benefits:
•
•
•
Eliminates tax liability
Eliminates the organization from having to pay most business fees and licenses
Organization is able to issue tax-exempt bonds
Burdens:
•
•
•
•
•
Cannot participate in political campaigns
Cannot attempt to influence legislation
Cannot lend any part of organization's income without adequate security and
interest
Cannot make any investments for more than adequate consideration
Cannot sell an asset for less than adequate consideration
3. What are the steps necessary to qualify for tax-exempt status?
•
•
•
Operate exclusively for charitable, scientific, or educational reasons
Serve public rather than private interests
Not engage in prohibited transactions
4. What are the bases of legislative, judicial and IRS challenges to tax-exempt status?
Legislative:
•
•
Taxpayer Bill of Rights II - indirectly addresses tax-exempt issues. Provides
intermediary sanctions the IRS must take before revoking an organization's taxexempt status
Patient Protection and Affordable Care Act - new requirements for tax-exempt
hospitals
o Community health needs assessment
o Financial assistance policies
o Limiting charges
o Avoidance of extraordinary billing and collection practices
Judicial:
•
•
•
•
Courts review tax-exempt status
Utah Supreme Court - Not-for-profit hospitals had evolved to a position that made
it impossible to differentiate them from for-profit hospitals; Not-for-profit hospitals
should be reviewed more frequently and rigorously.
Provena Catholic Hospital - Illinois Supreme Court denied tax-exempt status due
to aggressive collection policies and using for-profit entities for key hospital
affairs.
Methodist Hospital in Houston - tax-exempt status revoked due to failure to
provide adequate charity care
o Task force was developed to define uncompensated care
o Texas Health Policy Task Force- provide charity care (minus bad debt and
contractual allowances, includes charity care and losses to Medicaid)
equal to local and state tax-exempt benefits received by hospitals.
IRS:
•
•
IRS began auditing tax-exempt organizations, including hospitals in 1992
Coordinated examination programs audit tax-exempt organizations on the
following:
o Community benefits standards
o Unreasonable compensation and inurements
o Financial analysis
o Joint ventures
o Independent contractors
5. Will the Patient Protection and Affordable Care Act of 2010 be viewed as a friend or
foe to tax-exempt hospitals?
•
Foe for tax-exempt hospitals because
o Justification required for needs identified but not explained with resources
o Community health needs assessment is required
o Hospitals required to develop, implement, and publicize financial
assistance policies, and include criteria for financial assistance, methods
of applying for assistance, basis for determining the amount charged to
patients, permissible debt collection actions for patients on financial
assistance, and the availability of emergency care regardless of the
patient’s ability to qualify for assistance.
o Hospitals are required to limit their charges to patients eligible for financial
assistance to no more than the lowest amount billed to insured patients.
•
Friend for tax-exempt hospitals because
o Hospitals will have new volumes of insured patients which should reduce
both the hospital bad debt and charity care
Tax Status of Healthcare
Organizations
Tax Status
Tax Status of Healthcare
Organizations
Learning Objectives
• Analyze the rationale for tax-exempt status and apply the
rationale to healthcare.
• Appreciate the value of tax-exempt status.
• Identify the steps necessary to qualify for tax-exempt status.
• Relate the importance of community benefits to tax-exempt
status in healthcare.
• Examine judicial challenges to tax-exempt status.
• Examine legislative challenges to tax-exempt status.
• Examine IRS challenges to tax-exempt status.
Tax Status of Healthcare
Organizations
• For-profit organizations pay taxes.
Tax Status
Tax Status of Healthcare
Organizations
• For-profit organizations pay taxes.
– Federal and state income tax on their income
– State and local sales tax on their purchased
goods/services
– Local real estate and personal property tax on
their land, buildings, and major equipment
Tax Status
Tax Status of Healthcare
Organizations
• Non-profit organizations pay no taxes.
Tax Status
Rationale for Tax-Exempt Status
Tax Status
Rationale for Tax-Exempt Status
• Relieves the government of the burden
of providing services
Tax Status
Rationale for Tax-Exempt Status
• Relieves the government of the burden
of providing services
• Rewards the organization for performing
services that enhance beneficial
community values and goals
Tax Status
Value of Tax-Exempt Status for 122Bed Hospital
$2,188,810
Federal Income Tax
State Income Tax
497,660
Real Estate Tax
230,950
Personal Property Tax
125,160
35,760
City Property Tax
3,078,340
Total Tax Liability
223,500
Business Licenses/Fees
1,341,000
Incremental Debt Cost
Total Value of Tax-Exempt Status
Tax Status
$4,642,840
Qualifying for Tax-Exempt Status
(501-C-3)
Tax Status
Qualifying for Tax-Exempt Status
(501-C-3)
• Operate exclusively for charitable,
scientific, or educational reasons
– Revenue Ruling 56-185: financial ability standard-provide care to those who can’t afford to pay for
care
– Revenue Ruling 69-545: community benefits
standard--promoted health deemed beneficial to
the community (I.e. emergency rooms)
– Revenue Ruling 83-157: emergency room
exemptions if services were duplicated
Tax Status
Qualifying for Tax-Exempt Status
(501-C-3)
• Serve public, rather than private,
interests, in that the organization’s
income does not benefit individuals
Tax Status
Qualifying for Tax-Exempt Status
(501-C-3)
• Cannot engage in prohibited transactions
including, but not limited to, the following:
– Participate in political campaigns
– Attempt to influence legislation
– Lend any part of the organization’s income with receiving adequate
security and interest
– Pay compensation in excess of reasonable salary levels
– Making investments for more than adequate consideration
– Sell an asset for less than adequate consideration
– Subvert in any manner substantial portions of income or assets
– Make any part of services available on a preferential basis
Tax Status
Case Study
• You are a tax attorney & consultant to Doctor’s
Hospital, a for-profit, physician-owned hospital.
You are scheduled to give a presentation to the
board regarding the advantages related to
converting the hospital to not-for-profit tax
status.
• What are you arguments?
• What are the board’s likely arguments to remain forprofit?
Tax Status
Is there a significant difference
between the amount of community
benefits offered by non-profit and forprofit hospitals?
Tax Status
Is there a significant difference?
• Relman--medical-industrial complex
Tax Status
Is there a significant difference?
• Relman--medical-industrial complex
• Bromberg--for-profit hospital spokesperson
Tax Status
Is there a significant difference?
• Witek, Milligan, and Ryan 1993 study-including taxes as a community benefit,
for-profit hospitals provide significantly
more community benefits
Tax Status
Is there a significant difference?
– 1991 Georgia Hospitals
– % of adjusted gross revenue
Ownership
Indigent care
Taxes
Total Benefit
County
6.0
(4.0)
2.0
Non-profit
4.1
0.0
4.1
For-profit
2.5
3.9
6.4
Tax Status
Is there a significant difference?
• In 2004, Richard Scruggs began seeking
class-action status in 49 lawsuits accusing
370 not-for-profit hospitals of overcharging
the uninsured and using aggressive
collection methods against poor patients.
Tax Status
Is there a significant difference?
• The lawsuit against the Providence Health
System which operates several hospitals in
Washington state and Oregon is
representative. Citing the Providence
mission to provide “universal access to
health care, social justice and compassion
for all members of our society” with “special
concern for the poor and vulnerable”,
Scruggs argued:
Tax Status
Is there a significant difference?
“In fact, contrary to these representations, Providence discriminates
against the very patients who are supposed to benefit most from its
charity care by engaging in a pattern and practice of charging inordinately
inflated rates to its uninsured patients, including Plaintiffs and the Class
they seek to represent, that are far higher than the rates it charges its
insured patients for the same services.
Providence publicly represents itself as a 'not-for-profit medical care
provider,’ and it receives millions of dollars each year in tax exemptions
under Section 501(c)(3) of the federal tax code, 26 U.S.C. §501(c)(3), as
a charitable, 'non-profit' organization that is required by law to engage in
exclusively charitable purposes. Providence Oregon is similarly exempt
from Oregon property taxes based on its charitable, 'non-profit' status.
Tax Status
Is there a significant difference?
In fact, again contrary to its representations, Providence is extremely
profitable. For example, in 2002, which is the most recent year for which
data is available, Providence Oregon obtained over $1.2 billion in
revenue, it held over $250 million in cash and investment securities, and
the cost of its physical plant (land, buildings and equipment) was over
$1.1 billion.
The same year, Providence Oregon's President and CEO, Henry G.
Walker, received over $1.4 million in compensation and benefits, its four
Vice Presidents received an average of over $565,000 in compensation
and benefits, and the average compensation and benefits of its five
highest paid employees other than officers and directors was $460,000.”
Tax Status
Is there a significant difference?
• In 2006, Providence Health System along
with Legacy Health System and Sutter
Health settled the uninsured billing cases
while denying wrongdoing.
Tax Status
Is there a significant difference?
• 2006 Community Benefits Standards
– AHA argues that the cost of bad debt as well as charity
care along with losses to both Medicare and Medicaid
should be counted.
– CHA argues that the cost of bad debt and the loss to
the Medicare program should not be counted.
– HFMA P&P Board Statement #15 is consistent with the
CHA standard.
Tax Status
Is there a significant difference?
• December of 2006,CBO Report on the
provision of community benefits by not-forprofit hospitals.
– Both for-profit and not-for-profit hospitals in five states,
California, Florida, Georgia, Indiana, and Texas, were
examined (n=1,057).
– Acknowledging the lack of industry consensus on what
constitutes community benefits and how such benefits
should be measured, the CBO report defined
community benefits as the provision of uncompensated
care, the provision of services to Medicaid patients, and
the provision of certain specialized services that have
been traditionally identified as unprofitable.
Tax Status
Is there a significant difference?
– CBO found, on average, that not-for-profit provided
higher levels of uncompensated care and were more
likely to provide unprofitable specialized services.
– For-profit hospitals provided care to more Medicaid
patients as a percent of their total patient population
and for-profit hospitals were found to operate in areas
with lower average incomes, higher poverty rates, and
higher rates of uninsured.
– The CBO also reported the results of the Joint
Committee on Taxation which valued the total taxexemptions for the nation's not-for-profit hospitals for
2002 at $12.6 billion with exemptions from federal taxes
accounting for about half of the total.
Tax Status
Judicial Challenges to Tax-Exempt
Status
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Board of Equalization of Utah County v.
Intermountain Health Care, 709 P.2d 265
– Utah, 1985
• “Tax exemptions confer an indirect subsidy and are usually
justified as the quid pro quo [consideration] for charitable
entities undertaking functions and services that the state
would otherwise be required to perform. A concurrent
rationale used by some courts, is the assertion that the
exemptions are granted not only because charitable entities
relieve government of a burden, but also because their
activities enhance beneficial community values and goals.
Under this theory, the benefits received by the community
are believed to offset the revenue lost by reason of the
exemption (emphasis added).
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– Attorney General Maddox filed suit against
Methodist for providing inadequate charity
care.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– Methodist attempted to defend itself citing
large amounts of contractual allowances as
community benefits.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– Attorney General Maddox appointed task force
which sided with Methodist
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– District judge dismissed the case against
Methodist in 1993, explaining that Methodist
had broken no state laws.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– Local tax appraisal district sent letters to
Methodist Hospital and other non-profit
hospitals in Harris County asking for data to
support tax-exempt status.
Tax Status
Judicial Challenges to Tax-Exempt
Status
• State of Texas v. Methodist Hospital 1988
– Governor appointed the Texas Health Policy
Task Force which made a 1993
recommendation to the legislature that nonprofit hospitals provide community benefits
equal to the value of their local and state taxexempt benefits (see Texas SB 427).
Tax Status
Judicial Challenges to Tax-Exempt
Status
• St. Luke’s Regional Medical Center,
Boise, Idaho
– County authorities sent a $3.4 million property
tax bill in 1997 based on the following:
• Hospital was not sufficiently supported by donations
• Recipients of services at the hospital were expected
to pay
• Hospital did not provide community benefit because
the costs of charity care and bad debts were shifted
to other patients
• Hospital was too profitable-8.9% net income
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Harrisburg Hospital, Harrisburg,
Pennsylvania
– In 1998, an appeals court upheld the
revocation of the hospital’s tax exempt status,
because it had not been operated free of the
profit motive:
•
•
•
•
Hospital passed surpluses to corporate parent
Hospital’s CEO made $400,000
Hospital’s bonus plan included financial goals
Hospital required physicians sign non-compete
clauses
Tax Status
Judicial Challenges to Tax-Exempt
Status
• Dartmouth-Hitchcock Medical Center in
Lebanon, New Hampshire
– In 1998, city revoked tax-exempt status and
sent hospital $6.5 million tax bill based on the
following:
• Hospital had collection policy that encouraged full
pay
• Hospital provided 2.9% of revenue in charity care,
an amount also provided by for-profit hospitals
• The hospital used surpluses to fund its for-profit
subsidiary
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
– IRS assessed $1.2 million in 1996
– St. David’s paid, but filed suit
– Both sides agreed the 1997-2001 that were owed
would not be paid pending outcome of the suit
– June 7, 2002, St. David’s won in federal district
court
– September, 2002, federal government appeals
decision to fifth circuit
– November 7, 2003, fifth circuit overruled district
court decision and sent the case back for trial
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
–
In reversing the trial court, the fifth circuit said:
“If more than an insubstantial amount of the
partnership’s activities further non-charitable
interests, then St. David’s can no longer be
deemed to operate exclusively for charitable
purposes. Therefore, even if St. David’s performs
important charitable functions, St. David’s cannot
qualify for tax-exempt status...if its activities
substantially further the private, profit-seeking
interests of HCA.”
Tax Status
Judicial Challenges to Tax-Exempt
Status
St. David’s/HCA v. IRS
– On March 4, 2004, the trial court determined that
St. David’s had not ceded control and therefore
returned a verdict in favor of St. David’s.
– In May, 2004, U.S. Justice Department announced
that they had decided not to appeal the March 4
jury decision. Had St. David’s lost the appeal, it
would have owed more than $40 million in back
taxes and penalties.
Tax Status
Case Study
• You are the President and CEO of St. Michael’s
Hospital for Children, you arrive at work to find
television cameras and news reporters in your
office. A national news story had aired the
previous evening calling into question the taxexempt status of non-profit hospitals. You feel
compelled to address the issue from the local
perspective.
• What is your press release?
Tax Status
IRS Challenges to
Tax-Exempt Status
• Responding to public pressure to reduce
federal budget deficits, the IRS began
auditing tax-exempt organizations in 1987.
Tax Status
IRS Challenges to
Tax-Exempt Status
• By 1992, the IRS had audited 233 taxexempt health care organizations and
found frequent irregularities in physician
recruiting arrangements (Herman
Hospital) and unrelated business income.
Tax Status
IRS Challenges to
Tax-Exempt Status
• 1991 Coordinated Examination Program
(CEP)
– Community benefit standard including
instances of patient dumping
Tax Status
IRS Challenges to
Tax-Exempt Status
• 1991 Coordinated Examination Program
(CEP)
– Unreasonable compensation and private
inurement
Tax Status
IRS Challenges to
Tax-Exempt Status
• 1991 Coordinated Examination Program
(CEP)
– Financial analysis of affiliated entities and
unrelated business income
Tax Status
IRS Challenges to
Tax-Exempt Status
• 1991 Coordinated Examination Program
(CEP)
– Joint ventures
Tax Status
IRS Challenges to
Tax-Exempt Status
• 1991 Coordinated Examination Program
(CEP)
– Independent contractors
Tax Status
IRS Challenges to
Tax-Exempt Status
• By June, 2000, the IRS had identified 875
audit candidates. The first 63 audits closed
with an average assessment of $2.5 million
and an average audit length of 3 years.
Tax Status
IRS Challenges to
Tax-Exempt Status
• IRS made the following changes to be
effective in 2003
– Information on fund-raising activities;
– Information on corporate responsibility
practices
– Information on grants to foreign organizations
– see www.irs.gov/ind_info/bullet.html
Tax Status
IRS Challenges to
Tax-Exempt Status
• In 2006, in conjunction with the Exempt
Organization Compensation Initiative, the
IRS sent compensation questionnaires
(Form 13790) to approximately 600 taxexempt hospitals. The initiative was
triggered by incomplete or insufficient
answers to Form 990 for 2005 which
resulted in 200 examinations.
Tax Status
IRS Challenges to
Tax-Exempt Status
2008--Revised Form 990 for non-profits
– Hospital operations
• Schedule H sets a uniform standard for tallying and
reporting charity care
• Cost breakdown for eight charity care and
community-benefit expenses
• Cost breakdown for bad debt and Medicare
expenses including an estimate of the amount to be
considered for community benefit considerations
Tax Status
IRS Challenges to
Tax-Exempt Status
2008--Revised Form 990 for non-profits
– Executive compensation
• Disclose each perk provided to officers, directors,
and key employees
• Indicate which of six acceptable methods was used
to set CEO’s compensation
• Provide breakdown of compensation for highly paid
employees
Tax Status
IRS Challenges to
Tax-Exempt Status
2008--Revised Form 990 for non-profits
– Governance
• Indicate if governing body reviewed Form 990
before submission. Explain process of review
• Indicate how the organization “regularly and
consistently” monitors and enforces its conflict-ofinterest policy
• Describe if and how the organization makes public
its governing and conflict-of-interest policies and
financial statements
Tax Status
IRS Challenges to
Tax-Exempt Status
• In 2009, the IRS released its final report
on exempt organizations hospital study
which was the result of an IRS study on
nonprofit hospitals beginning in 2006.
• Based on a survey of 500 nonprofit
hospital in 4 communities, benefit findings
included:
Tax Status
IRS Challenges to
Tax-Exempt Status
• Considerable diversity in the demographics, community benefit
activities, & financial resources
• The average & median percentages of total revenues report spend
on community benefit activities were 9% & 6% respectively with the
lowest in rural hospitals
• Uncompensated care was the largest reported community benefit56% of community benefit expenditures, 23% medical education &
training, 15% research, & 6% community programs
• Excess of revenues over expenses for the sample was 5%
• Average total compensation amounts paid to top management
official were $490,000 & $377,00.
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• Attempts by Rangel (D-NY), Donnelly
(D-MA), and President Clinton had
limited success.
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• Taxpayer Bill of Rights II, which was
signed into law in 1996
– Requires tax-exempt organizations to disclose
excess benefit transactions on Form 990 each
year
– Expands public access to Form 990
– Executives pay a 10 percent tax on the
amount of the excess if corrected and
reported, 200 percent tax on unreported
excesses that executives personally benefited
Tax Status
Federal Legislative Challenges to
Tax-Exempt Status
• The Patient Protect and Affordable Care Act
of 2010
• Requirements for tax-exempt hospitals:
1. Complete a community health needs assessment
2. Develop, implement and publicize financial
assistance policies
3. Limit charges to individuals eligible for assistance
to the amount billed to insured patients
4. Avoid certain billing and collection activities
Tax Status
State Legislative Challenges to
Tax-Exempt Status
Tax Status
State Legislative Challenges to
Tax-Exempt Status
• Texas Senate Bill 427 signed into law in
1993
Tax Status
State Legislative Challenges to
Tax-Exempt Status
• Texas Senate Bill 427 signed into law in
1993
– Establishes a legal duty for non-profit hospitals
to provide community benefits (unreimbursed
costs of providing charity care patients and
unreimbursed costs of providing care to
Medicaid patients) in amounts equal to
• 4 percent of the hospital’s net revenues
• 100 percent of the hospital’s state and local taxexemptions
Tax Status
State Legislative Challenges to
Tax-Exempt Status
• As of 2009, 10 states have both
mandated & voluntary reporting of
community benefits
• 14 states have mandated reporting
• 19 states and the District of Columbia
have voluntary reporting
• 7 states have no reporting of community
benefits
Tax Status
Case Study
• Related to the earlier case, do you have
additional arguments to covert a forprofit hospital to a not-for-profit hospital
in lieu of the Patient Protection and
Affordable Care Act?
• Does the board have a different position
based on the Act?
Tax Status
Key Points
• Tax-exempt status has several advantages
for healthcare organization
• Tax-exempt organizations must meet several
criteria including the provision of community
benefits
• Legislatures, courts, and the IRS have
challenged tax-exempt organizations
including hospitals
• The Patient Protection and Affordable Care
Act of 2010 provides national criteria for nonprofit hospitals
Tax Status
Discussion Questions
1. Explain the rationale for granting organizations
tax-exempt status.
2. Identify the benefits and the burdens of taxexempt status for hospitals
3. What are the steps necessary to qualify for taxexempt status?
4. What are the bases of legislative, judicial, and
IRS challenges to tax-exempt status?
5. Will the Patient Protection and Affordable Care
Act of 2010 be viewed as friend or foe to taxexempt hospitals?
Tax Status