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Sen. Grassley Releases Staff Report Proposing Nonprofit Hospital Reforms


Email Alert

July 19, 2007

As if digesting the redesigned Form 990 and proposed Stark law and other changes in the physician fee schedule were not enough, on July 17 Sen. Grassley posted a press release and a minority staff discussion draft (Staff Report) outlining various nonprofit hospital reform proposals. The press release was dated July 18 to coincide with the anticipated release of the IRS report on the hospital community benefit reviews initiated last year. The Staff Report includes a wide range of reform proposals aimed primarily at 501(c)(3) hospitals. It would affect virtually all nonprofit/for-profit healthcare joint ventures, corporate governance standards, certain executive perquisites (like spousal travel), hospital billing and collection practices, minimum charity care standards (5% of the greater of operating revenue/expens e), possible conversion of 501(c)(3) hospitals to 501(c)(4) status (with the 5% standard for 501(c)(4) hospitals becoming a community benefit test, defined somewhat more broadly than charity care), and higher management taxes (25% with no cap) for hospital managers participating in the approval of excess benefit transactions with fewer defenses (no more initial contract exception or rebuttable presumption of reasonableness). Sen. Grassley's press release and staff report on recommended nonprofit hospital reforms can be found at the Finance Committee website.

The Staff Report calls for comments on the proposed reforms, with comments due by August 24. It specifically invites comments on a wide range of sensitive topics, including: the need for transition rules; how "hospital" should be defined and how the new rules should apply to multi-hospital systems; whether the Sarbanes Oxley Act should be applied to larger nonprofit hospitals; whether DSH and GME payments should be netted out in the calculation of whether hospitals meet minimum charity care standards; implications of the proposals on bond financing in healthcare; and whether various subsidized low margin healthcare services should count toward the minimum charity care standard.

The report is not legislation, but if it is transformed into legislation and enacted as proposed even without some of the broader implications of the requested comments, it could represent the most significant change in exemption standards for hospitals in nearly 40 years. The following paragraphs summarize key provisions of the report for nonprofit hospitals.

  • The charity care standard would be divided into three standards: free care to all at some multiplier; a minimum of 5% of the greater of operating expenses or operating revenues spent on charity care; and a formula for computing minimum charity care percentages for joint ventures. The Staff Report also recommends a mandatory community needs assessment every three years (with "consultation" from "local advocates" or representatives of HHS). The Staff Report references 501(c)(4) status for hospitals, anticipating at least some conversions from 501(c)(3) to (c)(4) status, including discussion of the need to adopt conversion procedures for the anticipated changes in status. For 501(c)(4) hospitals, the charity care standard would be changed to a community benefit standard for exemption (spending that same 5% minimum on community benefit). In other words, the current 501(c)(3) test of community benefit would no longer suffice for 501(c)(3) status but could qualify a hos pital for 501(c)(4) status. What counts as "community benefit," however, would be strictly prescribed and limited to charity care, an ER open to all, burn units, trauma centers, health professional education and training, health research, and activities designed to respond to a community needs assessment. Critical access hospitals would be exempt from the 5% standards whether treated as 501(c)(3) or (c)(4) organizations. It is unclear whether transition rules would make satisfactory accommodation for bonds and charitable contributions. Under current law, Section 501(c)(4) organizations cannot finance projects with tax-exempt bond proceeds or benefit from charitable contributions. They also may find it difficult if not impossible to maintain property tax exemption.

  • In the billing and collection area, the Staff Report recommends maximum charges for the medically indigent uninsured (not more than the lower of the amount paid by Medicare or Medicaid or actual hospital cost). This would apply up to 200% or 300% of the Federal Poverty Level (FPL). The Staff Report also recommends amending the Federal Debt Collection Practices Act to apply to both nonprofit and government hospitals' internal billing and debt collection functions.

  • Corporate governance is also targeted in the Staff Report, including legislating a community board with no more than 25% insiders on any nonprofit hospital boards (whether a Section 501(c)(3) or (c)(4) organization). For this purpose, "insiders" would include management, employees, physicians, and anyone deriving financial gain from the hospital by contract or otherwise, directly or indirectly, other than "reasonable directors' fees." Other governance recommendations include mandating a detailed conflict of interest policy, requiring that hospital boards be responsible for charity care and billing practices (and other matters outlined in HFMA Statement No. 15, Appendix A), and noting that hospital board (as suggested by the draft of the redesigned Form 990) should review the Form 990 annually (which could be 300+ pages for larger hospitals/systems in the format of the redesigned Form 990). The staff report also would mandate annual reporting by nonprofit and governmen t hospitals to the IRS and the public, for "transparency," a variety of information that in part mirrors the expanded disclosure on the redesigned Form 990, including new Schedule H for Hospitals. The Staff Report's transparency disclosures for nonprofit and government hospitals would include charity care and community benefit expenditures and offsetting funding, and details of joint ventures and their charity care or community benefit policies.

  • Harkening back to the proposals that resulted in the excess benefit rules, the Staff Report suggests an excise tax on all 501(c)(3) and (c)(4) hospitals that fail to meet the proposed quantitative standards for exemption (5% charity care or community benefit test). The tax would be twice the amount of the shortfall. So if the 5% amount is $10 million and a hospital provides $6 million, the tax would be $8 million (twice the difference of $10 - 6 million), with discretion for the IRS to reduce it to only the amount of the difference without doubling if the hospital has a favorable track record (e.g., in compliance 4 of 5 years). The report also suggests a recapture of prior tax benefits if exemption is revoked, and even suggests that HHS take revocation or repeated failure to meet the quantitative exemption standards into consideration in determining whether or not to revoke Medicare provider status (but also giving consideration to the effect of loss of Medicare participa tion on the provision of healthcare in the community, particularly to the indigent).

  • For joint ventures, there would be a mandatory charity care standard (see above), and neither the initial contract exception nor the rebuttable presumption of fair market value would apply (meaning more joint ventures could result in excess benefits under Section 4958 if they involve disqualified persons and it is likely that more joint ventures would be audited). To compound the risk, the Staff Report also recommends expanding the definition of who is a disqualified person in a circular fashion to include any party who "participates" (undefined) in a nonprofit/for-profit joint venture where that person receives "an excess financial benefit" or the tax-exempt hospital "receives a disproportionate financial detriment." Plus, any hospital manager approving the deal with knowledge of the excess benefit could be taxed at 25% of the excess benefit (potentially with no cap on total liability, as compared to the current 10% tax rate capped at $20,000 per transaction in excess be nefit excise tax liability). Although the 25% tax rate is referenced in a paragraph of the Staff Report focusing on joint ventures, the wording suggests it may apply more broadly to any excess benefit transaction.

  • Executive compensation is also addressed, with a recommendation to prohibit payment of country club fees, spousal travel, private air transport (other than for medical services), loans to executives, and at least severely limiting payment for first class travel. The report also recommends eliminating the initial contract exception for all employment contracts.

The joint venture and excess benefit provisions may be the most unexpected proposals in the Staff Report, but other proposals could mean very big dollars to many hospitals, like a return to a minimum charity care standard with a potentially financially crippling excise tax for falling short. Some of the remaining provisions would have a minimal effect on many hospitals (e.g., charity care at 200% of FPL), but others could have far-reaching ramifications and stunt the development of needed joint ventures or put smaller and low-margin hospitals at significant financial risk. The possibility of a conversion to 501(c)(4) status would also likely be of little use to many hospitals who would face the prospect of their bonds becoming taxable absent transition provisions, plus loss of endowments and other charitable contributions. As Sen. Grassley has reiterated, the Staff Report itself is not legislation. It is, however, a menu of potential nonprofit hospital reforms that is now open for debate in Congress and may lead to the most significant hospital tax legislation in decades.

We would like to thank Gerald M. Griffith, Esquire (Jones Day, Chicago, IL) for preparing this email alert.

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