IRS Publishes Final Guidance for Tax-Exempt Hospitals Regarding Section 501(r) Compliance

January 9, 2015

On December 29, 2014, the Internal Revenue Service (“IRS”) released final regulations pertaining to Section 501(r) of the Internal Revenue Code of 1986, as amended (the “Code”). The final regulations may be found here (“Final Regulations”).

Section 501(r) of the Code imposes certain requirements on hospital organizations which are exempt from federal income tax under Section 501(c)(3) of the Code. The Final Regulations provide definitive guidance for tax-exempt hospital organizations regarding, among other topics, hospital obligations under Section 501(r), the types of entities that must comply with the outlined obligations, and the penalties for failure to meet the obligations (including for a tax-exempt hospital organization that operates more than one hospital facility where one hospital facility fails to meet the obligations).

Below is an executive summary of bulleted highlights regarding the Final Regulations, a brief summary of the background information regarding Section 501(r) of the Code, a brief summary of the proposed regulations and notices, and finally a more detailed summary of some of the key provisions of the Final Regulations.

Executive Summary

Below are highlights of some of the key areas addressed in the Final Regulations:

Clear definitions of “hospital organization” and “hospital facility.”
Separate hospital facilities within the same building may jointly comply with many of the requirements of Section 501(r) of the Code.
Tax-exempt hospital organizations need not meet the requirements of Section 501(r) of the Code with respect to any hospital facility they are not operating. Whether they are “operating” a hospital facility turns on the ownership of capital or profits interest in an entity treated as a partnership for federal tax purposes.
An omission or error must be minor in order to be corrected and not considered a failure, and an option for correction without disclosure will be available only if the omission or error is minor and either inadvertent or due to reasonable cause.
A hospital facility that fails to meet the community health needs assessment (“CHNA”) requirements will be subject to an excise tax under Section 4959 of the Code, notwithstanding its correction and disclosure of the failure; provided, however, that a hospital facility’s omission or error with respect to the CHNA requirements will not be considered a failure to meet the CHNA requirements if the omission or error is minor and either inadvertent or due to reasonable cause and if the hospital facility corrects the omission or error.
The IRS will consider all relevant facts and circumstances when determining whether to revoke a tax-exempt hospital organization’s status under Section 501(c)(3) of the Code as a result of a failure to meet one or more requirements of Section 501(r) of the Code.
A tax-exempt hospital organization operating more than one hospital facility that fails to meet one or more of the requirements of Section 501(r) of the Code separately with respect to a hospital facility during a taxable year will be subject to a facility-level tax, but such deficiency alone will not jeopardize the tax-exempt status of the hospital organization.
Clarifications with respect to CHNA requirements.
A hospital facility’s implementation strategy must be a written plan that, with respect to each significant health need identified through the CHNA, either: (1) describes how the hospital facility plans to address the health need, or (2) identifies the health need as one the hospital facility does not intend to address and explains why the hospital facility does not intend to address the health need.
Clarifications with respect to requirements of the “Financial Assistance Policy.”
Clarifications that the “Emergency Medical Care Policy” must prohibit debt collection activities that interfere with the provision, without discrimination, of emergency medical care regardless of where such activities occur.
A hospital facility must limit the amounts charged for any emergency or other medically necessary care it provides to a financial assistance policy-eligible individual to not more than amounts generally billed, and must limit the amounts charged to financial assistance policy-eligible individuals for all other medical care covered under the financial assistance policy to less than the gross charges for that care.
A hospital facility cannot engage in extraordinary collection actions against an individual to obtain payment for care before making reasonable efforts to determine whether the individual is financial assistance policy-eligible for the care.

Background to Section 501(r)

In 2010, the Patient Protection and Affordable Care Act added Sections 501(r) and 4959 to the Code and amended Section 6033(b) of the Code. Section 501(r)(1) of the Code provides that a hospital organization will not be treated as tax exempt (as described in Section 501(c)(3) of the Code) unless the organization meets the requirements of Sections 501(r)(3) through (r)(6) of the Code as follows:

Section 501(r)(3) of the Code requires a tax-exempt hospital organization to conduct a CHNA at least once every three years and to adopt an implementation strategy to meet the community needs identified in the assessment.
Section 501(r)(4) of the Code requires a tax-exempt hospital organization to maintain a qualified financial assistance policy and an emergency medical care policy.
Section 501(r)(5) of the Code requires a tax-exempt hospital organization to limit the amounts it charges for emergency or medically necessary care and prohibits a tax-exempt hospital from using its gross charges in such cases.
Section 501(r)(6) of the Code requires a tax-exempt hospital organization to comply with certain billing and collection procedures.

The requirements of Section 501(r)(3) of the Code became effective for each tax-exempt hospital organization’s first tax reporting year beginning after March 23, 2012. The other requirements of Section 501(r) of the Code went into effect with each hospital organization’s first tax reporting year beginning after March 23, 2010.

Proposed Regulations and Notices

Among the guidance provided by the IRS and the United States Department of the Treasury (“Treasury Department”) were two sets of proposed regulations and two notable notices.

The first set of proposed regulations was published by the IRS and the Treasury Department on June 26, 2012, and such regulations pertain to the requirements of Sections 501(r)(4), (r)(5) and (r)(6) of the Code, as well as proposed definitions of certain key terms used in the proposed regulations (collectively, the “2012 Proposed Regulations”). The second set of proposed regulations was published by the IRS and Treasury Department on April 5, 2013. The regulations pertain to the CHNA requirements and the related excise tax set forth in Section 4959 of the Code and the reporting obligations set forth in Section 6033 of the Code in addition to revising the definitions of “hospital organization” and “hospital facility” contained in the 2012 Proposed Regulations (collectively, the “2013 Proposed Regulations”).

Additionally, in January 2014, the IRS and Treasury Department issued two notices with respect to Section 501(r) of the Code. The first, Notice 2014-2, affirmed that tax-exempt hospital organizations could rely on all of the provisions of both the 2012 Proposed Regulations and the 2013 Proposed Regulations, and that tax-exempt hospital organizations could rely on Section 1.501(r)(3) of the 2013 Proposed Regulations for any CHNA-conducted implementation strategy adopted on or before the date that is six months after final or temporary regulations were published. The second, Notice 2014-3, established the IRS’ proposed correction and disclosure procedures pursuant to which the IRS may excuse a tax-exempt hospital organization’s failure to meet certain requirements related to Section 501(r) of the Code.

Final Regulations

The Final Regulations both adopt and amend the 2012 Proposed Regulations and 2013 Proposed Regulations. The preamble to the Final Regulations is helpful in describing where the Final Regulations adopt and/or modify the 2012 Proposed Regulations and 2013 Proposed Regulations. Below are more detailed summaries of the key provisions of the Final Regulations.

Definition of Hospital Organization and Hospital Facility

As a preliminary matter, the Final Regulations amend the definitions of “hospital organization” and “hospital facility” to provide additional clarity. “Hospital organization” is defined as “an organization recognized (or seeking to be recognized) as described in section 501(c)(3) that operates one or more hospital facilities.” The Final Regulations also clarify that “hospital organizations” include government hospital organizations described in Section 501(c)(3) of the Code. “Hospital facility” is defined as “a facility that is required by a state to be licensed, registered, or similarly recognized as a hospital.”

The Final Regulations also address how both (i) a single tax-exempt hospital organization that operates multiple buildings, and (2) multiple tax-exempt hospital organizations that operate within the same building, fit within the aforementioned definitions. Multiple buildings operated by a tax-exempt hospital organization under a single state license are considered to be one collective hospital facility for purposes of compliance with Section 501(r) of the Code; notwithstanding, a hospital facility consisting of multiple buildings could, if desired, assess the health needs of the different geographic areas or populations served by the different buildings separately and document the assessments in separate chapters or sections of the hospital facility’s CHNA report and implementation strategy.

Separate hospital facilities within the same building are considered separate “hospital facilities” (because they have separate licenses), but the Final Regulations permit such separate hospital facilities to jointly comply with many of the requirements of Section 501(r) of the Code. For example, such separate hospital facilities are permitted to have identical or joint financial assistance policies and other policies as long as the information in the policy or policies is accurate and clearly states its applicability to each hospital facility. Additionally, if such hospital facilities define their communities to be the same, they may conduct a joint CHNA and adopt a joint implementation strategy addressing the significant health needs identified in the joint CHNA.

Operating a Hospital Facility

The 2013 Proposed Regulations provided that an organization “operates” a hospital facility if it owns a capital or profits interest in an entity treated as a partnership for federal tax purposes that operates the hospital facility.

The Final Regulations adopt this concept with two minor caveats. First, an organization is considered to own a capital or profits interest in an entity treated as a partnership for federal tax purposes if it owns such an interest directly or indirectly through one or more lower-tier entities that are treated as partnerships for federal tax purposes. This means that the distinction as to whether Section 501(r) of the Code applies to certain practices or entities providing care in a hospital facility depends on how the practices or entities are classified for tax purposes. For example, a hospital facility would not be subject to the requirements of Section 501(r) of the Code with respect to the services provided by a taxable corporation providing services in the hospital facility, even if the corporation is wholly or partially owned by the tax-exempt hospital organization that operates the hospital facility because the corporation is a separate taxable entity. On the other hand, a hospital facility would be subject to the requirements of Section 501(r) of the Code with respect to the services provided by a limited liability company providing services in the hospital facility of which the tax-exempt hospital organization is the sole member or owner and the entity is treated as a partnership for federal tax purposes. Furthermore, any care provided in a hospital facility by an entity treated as a partnership for federal tax purposes in which the tax-exempt hospital organization operating the hospital facility has a capital or profits interest that is an unrelated trade or business need not meet the requirements of Section 501(r) of the Code.

Second, a tax-exempt hospital organization need not meet the requirements of Section 501(r) of the Code with respect to any hospital facility it is not “operating” within the meaning of the defined term.

The Final Regulations also establish that a tax-exempt hospital organization is not required to meet the requirements of Section 501(r) of the Code with respect to any activities that constitute an unrelated trade or business described in Section 513 of the Code with respect to the tax-exempt hospital organization.

Minor Errors and Omissions

Both the 2013 Proposed Regulations and Notice 2014-3 address the correction and disclosure of errors pertaining to reporting required by Section 501(r) of the Code. Although the IRS and Treasury Department intend to release a revenue procedure finalizing the guidance set forth in Notice 2014-3, the Final Regulations delve into additional details regarding the correction and disclosure of errors.

An omission or error must be minor in order to be corrected and not considered a failure under Section 1.501(r)-2(b) of the Final Regulations, and an option for correction without disclosure will be available only if the omission or error is minor and either inadvertent or due to reasonable cause.

With respect to minor omissions or errors, the Final Regulations clarify the following:

In the case of multiple omissions or errors, omissions or errors are minor only if they are minor in the aggregate.
The fact that the same omission or error has occurred and been corrected previously tends to show that an omission or error is not inadvertent.
A hospital facility’s establishment of practices or procedures reasonably designed to promote and facilitate overall compliance with Section 501(r) of the Code prior to the occurrence of an omission or error tends to show that the omission or error was due to reasonable cause.

The correction of minor omissions or errors must include establishment (or review and, if necessary, revision) of practices or procedures that are reasonably designed to achieve overall compliance with the requirements of Section 501(r) of the Code.

Additionally, the Final Regulations clarify that disclosure is reserved for those omissions and errors that rise above the level of “minor” and have a broader scope and greater impact on individuals within the hospital facility’s community, as well as those that are neither inadvertent nor due to reasonable cause and thus involve a degree of culpability on the part of the hospital facility.

Excise Tax for Failure to Meet CHNA Requirements

The 2013 Proposed Regulations stated that a hospital facility may, in the discretion of the IRS, be subject to an excise tax under Section 4959 of the Code for a failure to meet the CHNA requirements, notwithstanding the hospital facility’s correction and disclosure of the failure in accordance with the relevant procedures. To eliminate uncertainty, the Final Regulations specify that a hospital facility that fails to meet the CHNA requirements will be subject to an excise tax under Section 4959 of the Code, notwithstanding its correction and disclosure of the failure; provided, however, that a hospital facility’s omission or error with respect to the CHNA requirements will not be considered a failure to meet the CHNA requirements if the omission or error is minor and either inadvertent or due to reasonable cause and if the hospital facility corrects the omission or error. Therefore, the Final Regulations make clear that such a minor omission or error related to the CHNA requirements that is corrected will not give rise to an excise tax under Section 4959 of the Code.

Revocation of Status Under 501(c)(3) of the Code

Consistent with the 2013 Proposed Regulations, the Final Regulations specify that the IRS will consider all relevant facts and circumstances when determining whether to revoke a tax-exempt hospital organization’s status under Section 501(c)(3) of the Code as a result of a failure to meet one or more requirements of Section 501(r) of the Code. Examples of the types of facts and circumstances that will be considered include:

the size, scope, nature, and significance of the organization’s failure;
the reason for the failure;
whether the same type of failure has previously occurred;
whether the tax-exempt hospital organization had, prior to the failure, established practices or procedures reasonably designed to promote and facilitate overall compliance with the requirements of Section 501(r) of the Code;
whether such practices or procedures were being routinely followed; and
whether the failure was corrected promptly.

Taxation of Noncompliant Hospital Facilities

The Final Regulations provide for a facility level tax for a tax-exempt hospital organization operating more than one hospital facility that fails to meet one or more of the requirements of Section 501(r) of the Code separately with respect to a hospital facility during a taxable year. The facility-level tax applies to a tax-exempt hospital organization that continues to be recognized as described in section 501(c)(3), but would not continue to be so recognized if the noncompliant facility were the only hospital facility operated by the organization.

The facility-level tax is applied to income derived from the noncompliant hospital facility (“noncompliance facility income”) during the taxable year of noncompliance. Noncompliant facility income derived from a hospital facility during a taxable year will be the gross income derived from that hospital facility during the taxable year, less the deductions allowed that are directly connected to the operation of that hospital facility during the taxable year, excluding any gross income and deductions taken into account in computing any unrelated business taxable income described in Section 512 of the Code that is derived from that hospital facility during the taxable year.

In computing the noncompliant facility income of a hospital facility, the gross income from (and the deductions allowed with respect to) the hospital facility may not be aggregated with the gross income from (and the deductions allowed with respect to) the tax-exempt hospital organization’s other noncompliant hospital facilities subject to tax pursuant to the Final Regulations or its unrelated trade or business activities described in Section 513 of the Code.

Application of the facility-level tax will not, by itself, result in the operation of the noncompliant hospital facility being considered an unrelated trade or business.

CHNA

Consistent with the 2013 Proposed Regulations, the Final Regulations specify that:

In conducting a CHNA, a hospital facility must both define the community it serves and assess the health needs of that community
The hospital facility must document the CHNA in a written report that is adopted for the hospital facility by an authorized body of the hospital facility.
The hospital facility must make the CHNA report widely available to the public.

A hospital facility is deemed to be in compliance on the date it has completed all of the steps outlined above.

The Final Regulations make it clear that hospital facilities may build upon previously conducted CHNA’s, but solicitation and consideration of input from persons representing the broad interests of the community must occur with each CHNA. Additionally, hospital facilities are given flexibility to define the communities they serve or intend to serve (both in addressing needs identified through their CHNAs and otherwise) taking into account all relevant facts and circumstances; provided, however, that hospital facilities may not exclude medically underserved, low-income, or minority populations.

To assess the health needs of its community, a hospital facility must identify the significant health needs of its community, prioritize those health needs, and identify potential measures and resources (such as programs, organizations, and facilities in the community) available to address the health needs. The Final Regulations provide additional examples of health needs a hospital facility may consider in its CHNA, such as identifying the need to address financial and other barriers to care, to prevent illness, to ensure adequate nutrition, and to address social, behavioral, and environmental factors that influence health in the community. The Final Regulations also adopt the 2013 Proposed Regulations by requiring a hospital facility’s CHNA report to describe the process and criteria used in prioritizing the significant health needs identified and requiring a hospital facility to take into account community input not only in identifying significant health needs but also in prioritizing such health needs.

Furthermore, the Final Regulations adopt the sources of individuals representing the broad interests of the community proposed in the 2013 Proposed Regulations, which require that a hospital facility take into account input received from, at a minimum, the following three sources: (1) at least one state, local, tribal, or regional governmental public health department (or equivalent department or agency) with knowledge, information, or expertise relevant to the health needs of the community; (2) members of medically underserved, low-income, and minority populations in the community, or individuals or organizations serving or representing the interests of such populations; and (3) written comments received on the hospital facility’s most recently conducted CHNA and most recently adopted implementation strategy (to inform and influence future CHNAs and implementation strategies). As outlined in the 2013 Proposed Regulations, a hospital facility also may, but not need, solicit input from additional sources.

Akin to the 2013 Proposed Regulations, the Final Regulations provide that a hospital facility must document each CHNA in a CHNA report that is adopted by an authorized body of the hospital facility and includes: (1) a definition of the community served by the hospital facility and a description of how the community was determined; (2) a description of the process and methods used to conduct the CHNA; (3) a description of how the hospital facility solicited and took into account input received from persons who represent the broad interests of the community it serves; (4) a prioritized description of the significant health needs of the community identified through the CHNA, along with a description of the process and criteria used in identifying certain health needs as significant and prioritizing those significant health needs; and (5) a description of resources potentially available to address the significant health needs identified through the CHNA.

Implementation Strategies

Consistent with the 2013 Proposed Regulations, the Final Regulations specify that a hospital facility’s implementation strategy must be a written plan that, with respect to each significant health need identified through the CHNA, either: (1) describes how the hospital facility plans to address the health need, or (2) identifies the health need as one the hospital facility does not intend to address and explains why the hospital facility does not intend to address the health need. The Final Regulations do not provide details regarding the elements that must be included in the implementation strategy pursuant to Sections 501(r)(3) and 501(r)(4) of the Code, but rather allow hospital facilities flexibility to determine applicable content.

The Final Regulations require an authorized body of a hospital facility to adopt an implementation strategy to meet the health needs identified through a CHNA on or before the 15th day of the fifth month after the end of the taxable year in which the hospital facility finishes conducting the CHNA.

Financial Assistance Policy

Consistent with the 2012 Proposed Regulations, the Final Regulations provide that a tax-exempt hospital organization meets the requirements of Section 501(r)(4)(A) of the Code with respect to a hospital facility it operates only if the tax-exempt hospital organization establishes for that hospital facility a written financial assistance policy that applies to all emergency and other medically necessary care provided by the hospital facility. The financial assistance policy must list the providers, other than the hospital facility itself, delivering emergency or other medically necessary care in the hospital facility and specify which providers are and are not covered by the hospital facility’s financial assistance policy.

The financial assistance policy must apply to all emergency and other medically necessary care provided in a hospital facility by a partnership owned in part by, or a disregarded entity wholly owned by, the tax-exempt hospital organization operating the hospital facility, to the extent such care is not an unrelated trade or business with respect to the tax-exempt hospital organization.

If a hospital facility outsources the operation of its emergency room to a third party and the care provided by that third party is not covered under the hospital facility’s financial assistance policy, the hospital facility may not be considered to operate an emergency room for purposes of the factors considered in Revenue Ruling 69-545 (1969-2 CB 117) (concerning whether a nonprofit hospital claiming exemption under Section 501(c)(3) of the Code is operated to serve a public interest, with one activity being the operation of a full time emergency room).

The Final Regulations require that the financial assistance policy describe discounts available under the financial assistance policy (rather than all discounts offered by the hospital facility, as proposed in the 2012 Proposed Regulations); provided, however, that only the discounts specified in a hospital facility’s financial assistance policy may be reported as “financial assistance” on Schedule H of the Form 990.

A hospital facility may grant financial assistance under its financial assistance policy notwithstanding an applicant’s failure to provide the specified information and documentation, but a hospital facility’s financial assistance policy must describe any information obtained from sources other than individuals seeking assistance that the hospital facility uses, and whether and under what circumstances it uses prior financial assistance policy-eligibility determinations.

The Final Regulations, like the 2012 Proposed Regulations, provide that a financial assistance policy established by a hospital facility must describe the hospital facility’s actions in the event of nonpayment unless the hospital facility has established a billing and collections policy that describes the actions. To be “established,” such policies must be adopted by an authorized body of the hospital facility.

As discussed in the 2012 Proposed Regulations, the Final Regulations continue to require a hospital facility to make the financial assistance policy documents available upon request and widely available on a website and to notify and inform both visitors to the hospital facility and members of the community served by the hospital facility about its financial assistance policy.

Emergency Medical Care Policy

The 2012 Proposed Regulations provided that a hospital facility must establish a written policy that requires the hospital facility to provide, without discrimination, care for emergency medical conditions (within the meaning of the Emergency Medical Treatment and Labor Act, section 1867 of the Social Security Act (42 U.S.C. 1395dd)) to individuals, regardless of whether they are financial assistance policy-eligible. The Final Regulations are revised to prohibit “debt collection activities that interfere with the provision, without discrimination, of emergency medical care,” regardless of where such activities occur.

The preamble to the Final Regulations clarifies that the emergency medical care policy may be included in the same document with the financial assistance policy.

Limitation on Charges

The Final Regulations provide that a tax-exempt hospital organization meets the requirements of Section 501(r)(5) of the Code with respect to a hospital facility it operates only if the hospital facility limits the amounts charged for any emergency or other medically necessary care it provides to a financial assistance policy-eligible individual to not more than amounts generally billed. The Final Regulations also require a hospital facility to limit the amounts charged to financial assistance policy-eligible individuals for all other medical care covered under the financial assistance policy to less than the gross charges for that care. Hospital facilities are permitted to use the look-back method to base amounts generally billed on the claims of Medicare fee-for-service plus all private health insurers, as well as on Medicare alone. Additionally, hospital facilities are permitted to determine amounts generally billed under the prospective method based on Medicaid, either alone or in combination with Medicare fee-for service. A hospital facility may change the method it uses to determine amounts generally billed at any time, but must update its financial assistance policy accordingly.

The Final Regulations apply the amounts generally billed limitation of Section 501(r)(5) of the Code to all individuals eligible for assistance under the hospital facility’s financial assistance policy, without specific reference to the individual’s insurance status. For purposes of the limitation on charges set forth in Section 501(r)(5) of the Code, a financial assistance policy-eligible individual is considered to be “charged” only the amount he or she is personally responsible for paying after all deductions and discounts (including discounts available under the financial assistance policy) have been applied and less any amounts reimbursed by insurers.

Billing and Collection

The Final Regulations provide that a tax-exempt hospital organization meets the requirements of Section 501(r)(6) of the Code with respect to a hospital facility it operates only if the hospital facility does not engage in extraordinary collection actions against an individual to obtain payment for care before making reasonable efforts to determine whether the individual is financial assistance policy-eligible for the care. For this reason, and consistent with the 2012 Proposed Regulations, a hospital facility will be considered to have engaged in extraordinary collection actions against an individual to obtain payment for care if the hospital facility engages in such extraordinary collection actions against any other individual who has accepted or is required to accept responsibility for the first individual’s hospital bill for the care. This provision, though, does not require a hospital facility to make reasonable efforts to determine financial assistance policy-eligibility before engaging in extraordinary collection actions against private or public insurers or any other liable third parties that are not individuals.

The Final Regulations contain a number of changes to Section 1.501(r)-6(c) of the 2012 Proposed Regulations that are intended to simplify the presentation of the applicable rules and not to have a substantive effect, including, for example, that hospital facilities must wait 120 days after the first post-discharge billing statement to commence extraordinary collection actions against patients whose financial assistance policy-eligibility is undetermined and that hospital facilities must wait 240 days after the first post-discharge billing statement to allow a patient to apply for financial assistance.

Effective Date

The Final Regulations will be effective for the taxable year beginning after December 29, 2015.

Conclusion

Tax-exempt hospital organizations should carefully review the Final Regulations to understand the nuances of the information discussed above as well as additional details pertaining to compliance with Section 501(r) of the Code.