BY Shannon Kilpatrick and Brittany Elliser, Managing Directors, KPMG LLP
When the Internal Revenue Service (IRS) Tax Exempt & Government Entities Division released its fiscal year 2025 Program Letter on October 29, 2024, examinations of tax-exempt hospitals were listed as one of the key compliance enforcement priorities. This continues an effort the IRS first revealed in March 2024, when it announced a compliance strategy focused on whether tax-exempt hospitals are meeting the statutory obligations of their tax-exempt charitable status.
The IRS decision to examine tax-exempt hospitals may be the result of recent questions regarding whether these hospitals are doing enough to justify their tax-exempt status. In recent years, there has been a dramatic increase in publications by health-care watchdog groups claiming that certain hospitals are providing less benefit to the community than the value of their tax-exemption. While such assertions have been contested, they have gained attention from the media and federal lawmakers.
Given the increased scrutiny from various quarters and the announced IRS examinations, hospitals have compelling reasons to ensure compliance with tax laws to avoid loss of tax-exemption, monetary penalties, and negative publicity. Specifically, hospitals should ensure compliance with two requirements: the community benefit standard and Section 501(r).
Community Benefit
To qualify for tax-exempt status under the community benefit standard, a hospital’s provision of health care must serve to benefit the community as a whole, rather than serving private interests. In addition to operating an emergency room open to all persons regardless of ability to pay and providing medical care for all persons in the community who are able to pay (either themselves, through private health insurance, or with the aid of public programs such as Medicare and Medicaid), hospitals may demonstrate that they benefit the community as a whole by providing financial assistance to those unable to pay, engaging in medical training and research, and conducting various programs and services to improve health in the community. Community benefit activities are reported annually on Form 990, Schedule H.
However, community benefit activities are not well defined in IRS guidance, and the IRS instructions to Form 990, Schedule H give only loose guidelines on what activities to report and how to quantify such services. This approach provides flexibility to hospitals in a wide range of circumstances to report their activities, but it makes it challenging to compare different hospitals’ community benefit activities and to determine when the community benefit standard has been met. In fact, the IRS has recently been criticized by both lawmakers and the U.S. Government Accountability Office for not clearly defining what services qualify and not updating Form 990 to increase transparency. As it currently stands, community benefit reported on Schedule H includes, but is not limited to, such things as free or discounted care for low-income patients (i.e., financial assistance), unreimbursed costs for Medicaid patients, subsidized health services, health professions education, research, and other community health improvement activities. The IRS has indicated that community benefit is one issue it is reviewing in the current hospital examination program.
Inconsistencies in how hospitals report community benefit have been a longstanding issue. Hospitals may not fully understand current guidelines or may interpret them differently, making possible numerous variations in which activities are captured and how related expenditures are calculated. Because activities may be conducted by various hospital departments, some may be omitted from the reporting. Additionally, differences in hospital organization structures may lead to differing results when comparing hospital to hospital, particularly with regards to the expression of community benefit as a percent of total expenses.
Despite the challenges, tax-exempt hospitals should take steps to ensure that they completely and consistently report their community benefit within the constraints of Form 990, Schedule H instructions, using narrative descriptions where needed to amplify and give color to the hospital’s community benefit story. In addition, a review of all community benefit activities and related expenses, performed internally or with external assistance, may reveal additional or underreported community benefit.
Section 501(r) Requirements
The second area of focus in the IRS’s new wave of hospital examinations is compliance with Section 501(r), which was introduced as part of the 2010 Affordable Care Act to ensure tax-exempt hospitals were focused on the needs of their communities. Compliance with Section 501(r) is required to maintain federal tax-exemption for entities operating state-licensed hospital facilities. Each hospital facility (including those operated through a joint venture) must satisfy the Section 501(r) requirements; failure could result in revocation of the organization’s tax-exempt status or treatment of the hospital facility as if it were taxable.
However, the regulations provide that hospitals will not lose their exempt status if they self-identify and correct (and in some cases disclose) errors and omissions that are not willful or egregious in advance of an IRS audit.
Section 501(r) generally sets forth requirements for a hospital to:
- Conduct a community health needs assessment and adopt an implementation strategy once every three years,
- Establish and publicize a financial assistance policy,
- Limit charges for emergency and other medically necessary care provided to patients eligible for financial assistance, and
- Adhere to specific billing and collection practices.
Unlike the loose rules for reporting community benefit on the Form 990, the regulations interpreting Section 501(r) are very detailed and prescriptive. Almost every department and function of a hospital facility may be touched in Section 501(r) compliance efforts, including accounting, legal, revenue cycle, communications, admissions, and emergency departments, among others. Hospitals have been in a constant state of change in recent years due to such things as challenges caused by the pandemic, changes brought on by cost-cutting measures and mergers/acquisitions, the implementation of new technologies, and changes in revenue cycle vendors, to name a few. If not vigilant, a hospital that was once compliant with the Section 501(r) rules may find itself no longer compliant because of the changes in its operations over time.
Given the heightened scrutiny from the IRS and the costly consequences of failure, tax-exempt hospitals would be wise to conduct mock IRS exams to identify and correct any issues before the IRS comes knocking. A review should be done for each facility a hospital entity owns and operates, including those that they are operated in a joint venture. Often specialty hospitals are a compliance challenge because their operations may be very different from what is contemplated by the Section 501(r) regulations, yet they are still required to be compliant.
A mock IRS exam, preferably conducted by a third-party tax professional who will bring a fresh look to the project, will allow hospitals to identify and correct any discrepancies before the IRS begins an examination. Early detection, correction, and disclosure (if necessary) of any errors can provide protection from the harshest consequences of non-compliance and is therefore often worth the effort involved.
The IRS’s new examination focus on both the community benefit standard and compliance with Section 501(r) highlights the need for tax-exempt hospitals to periodically reevaluate their policies, practices, documentation, and reporting of these requirements for tax-exempt status. Making corrections and adjustments proactively improves compliance and mitigates negative outcomes while demonstrating a commitment to transparency and accountability.