Experts Offer Advice to Charitable Hospitals as IRS Steps Up Audits

As the IRS steps up audits of tax-exempt nonprofit hospitals, experts at Grant Thornton offered advice to help tax professionals and hospitals get prepared.

On a June 12 webinar, health care tax experts Mary Torretta and Erin Couture of Grant Thornton noted that the IRS recently said it plans to open 35 nonprofit hospital examinations in fiscal year 2024. And back in March, the IRS’ Tax-Exempt and Government Entities Division added tax-exempt hospital compliance with requirements under Code Sec. 501(c)(3) — including the community benefit standard — and Code Sec. 501(r) as a new focus area. The plan to step up audits also was referenced in June 11 White House fact sheet, which notes the audits would allow the IRS to “better ensure that nonprofit hospitals provide the community benefits necessary to maintain their non-profit status.”

The renewed focus on hospitals’ nonprofit status comes in the wake of a March 2024 report by the Lown Institute that found that of the nonprofit hospitals evaluated, 80% received a tax break larger than their expenditures on financial assistance and community investment. Among the report recommendations was considering enforcement measures for hospitals found not to comply with community benefit requirements.

And with taxwriters looking at how to revise the Tax Code amid upcoming expirations of 2017 Tax Cuts and Jobs Act (TCJA, PL 115-97) provisions, there’s a high interest in who exactly is getting tax breaks. The tax savings for nonprofit hospitals is not insignificant — a June 12 report of the Committee for a Responsible Federal Budget estimated that between 2025 and 2034, “federal revenue loss from the nonprofit hospital tax exemption will total around $260 billion.” The report also noted that 58% of community general hospitals in the US are exempt from most taxation.

Background.

To qualify as a tax-exempt charitable hospital, hospitals must meet the “community benefit” standard under Code Sec. 501(c)(3) and Rev Rul 69-545 and satisfy applicable requirements under Code Sec. 501(r). To satisfy the community benefit standard, hospitals must be organized as a nonprofit charitable organization to care for the sick; be operated to provide care to all community members that are able to pay the cost, including through a third-party payor; not exclude qualified doctors from the use of their facilities; and not allow their earnings to benefit a private shareholder or individual. They also must file Schedule H to Form 990 annually to provide metrics related to their community benefits.

And under Code Sec. 501(r), hospital organizations claiming to be tax-exempt charitable hospitals need to satisfy a triennial community health needs assessment (CHNA) requirement. The CHNA must identify the relevant community’s health needs and set forth a plan to meet those needs. Failure to do so may subject a hospital to the loss of its tax-exempt status. Noncompliant hospitals also risk incurring an excise tax of $50,000 under Code Sec. 4959 and taxation of their income.

Getting ready.

With this renewed focus on hospitals’ nonprofit status and plans to step up auditing, hospitals and their tax professionals must be alert and prepared, said Torretta and Couture during the webinar.

Torretta offered suggestions on how to get a charitable hospital’s website, staff, and facilities ready for a potential audit. She recommends starting with the hospital’s website because that is likely where an IRS auditor will start. “Make sure you’re presenting the hospital in the best light possible,” she said. Torretta also recommended using Google searches to see if the CHNA and financial assistance policy “pop up.”

Hospitals should ensure any information required under Code Sec. 501(r) can easily be located on the hospital’s website — that includes information about the financial assistance policy in appropriate languages for the community the hospital serves. In addition, she explained, the hospital’s website should offer an up-to-date list of participating providers.

And Torretta said to be sure “you are giving yourself credit” for “investments in the community to make it healthier as a whole” and “your educational activities.” In addition, in medically underserved communities, she said, hospitals can include investment in physicians’ practices.

Also walk around the facility, especially the emergency department, to see if there is clear signage about financial assistance and who to call, said Torretta. “You want to put yourself in the eyes of a potential patient, not a hospital employee looking to check the box,” she explained.

The audit.

Hospitals that receive notice of an audit, said Couture, should take steps right from the beginning for a smoother process. That means having “systems and processes in your mail room that allow the IRS letter to come to the right person” — this can be an issue in “post-COVID times where mail rooms might be virtual.”

Couture recommends developing a strategy before even beginning communications with the IRS agent handling the audit. Consider who will be the contact person with the IRS — Couture said some hospitals choose to have an initial discussion with the agent in addition to having a power of attorney, while others simply let the agent know they are going to have power of attorney. But having the hospital participate in that initial discussion, she said, can “show the organization’s commitment to a smooth process.”

In terms of scheduling the site visit, said Couture, “have some proposed alternative dates that you are looking at” and “work with the agent on timing.” And she suggests setting “ground rules” around how the agent will receive information. “Some agents have moved to receiving documentation through an IRS portal,” said Couture, while others “may say forget the portal — I’m not going to look at anything until my first day on campus.”

Also determine how many agents will be attending the site visit, how many days they will be there, and what kind of room they’ll need access to. The IRS “is in a real training mode because of the amount of agents that are at or close to retirement,” she said, so you may have more than one agent on site.

Leading up to the site visit date, also determine what the IRS agents’ expectations are for a tour or facility review. Then “get the right people ready to do the right things.” Couture suggests nailing down all the details for a smooth visit, including where the agents should park, who will meet them, and what path they will take to your office.

Torretta agreed, adding that most IRS agents she’s encountered “have been quite helpful and really approach [the site visit] from an educational lens.” The agents are “curious about what processes hospitals have in place to make sure that the charitable hospital isn’t overcharging people who are eligible for charity care,” Torretta explained. And “they’re very, very focused on the perception of the patient.”

For more on hospitals as charitable organizations, see Checkpoint’s Federal Tax Coordinator ¶ D-4150 et seq.