(a) Low-Income Housing

Low-income housing and economic development projects receive significant government funding. As a result, the policies affecting them are subject to change as the persons in charge of their local, state, and federal funding sources change and, correspondingly, the standards for tax exemption change. Some low-income housing units constructed before 1980 were privately owned. The significant income tax benefits and federal funding available made low-income housing a favored investment, typically in the limited partnership form. As government funding was cut and eliminated during the 1980s and the 1986 Tax Reform Act virtually killed the tax advantages of passive ownership, low-income housing lost its appeal. Renovations and owner attention waned, and many such properties were put up for sale or foreclosed on. Congress and the Resolution Trust Company responded to the need to protect the tenants by adopting policies encouraging charities to acquire such units.

Acquisition and maintenance of low-income housing units has long been considered a charitable activity because it accomplishes several purposes: relieving the suffering of the poor, eliminating discrimination, relieving the burdens of government, combating community deterioration, and promoting social welfare.⁴⁸ The IRS originally adopted the current baseline, or minimum level, of low-income residents of 75 percent in 1993, when factors indicating whether the housing project serves a charitable class were added to the Internal Revenue Manual (IRM).⁴⁹ The standards were revised in 1995 and 1996 and finalized in a revenue procedure. The preamble to the guidelines says that they are intended to help charities involved in low-income housing and facilitate the exemption application process, to be applied prospectively. It behooves existing projects to conform, if possible, to the safe harbor rules, particularly when the more lenient facts and circumstances might apply:

• At least 75 percent of the units are occupied by residents who qualify as low-income individuals.
• Either 20 percent of the residents renting units must qualify as very low income, or 40 percent of the units must be occupied by residents whose income does not exceed 120 percent of the area's very-low-income limit.
• Up to 25 percent of the units may be rented at market rates to persons whose income exceeds the low-income limit.

A project not meeting the safe harbor percentages can still seek to qualify for exemption by demonstrating qualification through facts and circumstances, such as combating community deterioration, lessening the burdens of government, and eliminating discrimination and prejudice. The facts and circumstances that can be considered include the following:

• A substantially greater percentage of residents than required by the safe harbor rules with incomes up to 120 percent of the area's very-low-income limit.
• A limited degree of deviation from the safe harbor percentages.
• Limitation of rents to ensure that they are affordable to low-income and very-low-income residents.
• Participation in a government housing program designed to provide affordable housing.
• Operation through a community-based board of directors, particularly if the selection process demonstrates that community groups have input into the organization's operations.
• The provision of additional social services affordable to poor residents.
• A relationship with an existing §501(c)(3) organization active in low-income housing for at least five years, if the existing organization demonstrates control.
• Acceptance of residents who, when considered individually, have unusual burdens such as extremely high medical costs that cause them to be in a condition similar to persons within the qualifying income limits, in spite of their higher incomes.
• Participation in a home ownership program designed to provide home ownership opportunities for families that cannot otherwise afford to purchase safe and decent housing.
• Existence of affordability covenants or property restrictions.

Financing for low-income housing projects is often provided partly or wholly by commercial investors, either as lenders or as owners, so the criteria listed here deserve careful consideration. A California nonprofit corporation established to serve as general partner and essentially lend its tax status to a low-income housing project was deemed to serve the private interests of its investors and did not qualify for exemption.⁵⁰ To obtain property tax reductions, local law required that a nonprofit serve as the manager of housing projects. Housing Pioneers, Inc.'s only duty was to maintain sufficient records to retain the property exemption; it served as managing partner in name only. Although it used its modest fee for services to finance job training, counseling, and rent subsidies for the low-income residents, these activities were insufficient to outweigh the significant tax benefits flowing to the individual investors who also controlled its board.⁵¹ Instead, an organization established to provide credit enhancement services to developers of low-income housing meeting the standards previously listed was found to be exempt.⁵²

(b) Credit Counseling and Mortgage Assistance Organizations

Historically, organizations that provided credit counseling and mortgage assistance services were eligible for §501(c)(3) exempt status only if they met two very different tests:

1. They serve members of a charitable class.⁵³
2. They do not provide private benefits to insiders.⁵⁴

Since the services they render are those typically provided by for-profit commercial companies and they are often established by commercial lenders, the IRS examined these organizations during 2005.

The IRS emphasized several portions of §501(q)⁵⁵ in denying exemption to a prospective credit counseling organization. Charging fees that are consistent with market rates for similar counseling by a for-profit entity rather than rates based on the recipient's ability to pay was deemed to evidence operation as a commercial, rather than charitable, business. Another fact leading to denial was that the CEO controlled the organization and the “entire enterprise [was] carried on in such a manner as to substantially benefit the CEO in her personal capacity.”⁵⁶

The issues of concern to the IRS have been illustrated in several Private Letter Rulings. In one ruling, a lease-to-own program conducted in connection with an unrelated mortgage lender failed to qualify for classification as a charitable organization.⁵⁷ The program was limited to government and §501(c)(3) borrowers and provided homeowner education, credit counseling services, and ongoing monitoring and counseling to low- to moderate-income persons.⁵⁸ According to the IRS, the program was not charitable because “it appears that many, perhaps most, of your tenant-purchasers will not be low-income, let alone very-low income. Nor have you established that merely not owning a home qualifies a person as ‘distressed.’” The standards for qualifying low-income housing projects⁵⁹ were cited as appropriate criteria for identifying a counseling program that serves a charitable class.

The fact that client services were provided by two for-profit entities—a bank with a name similar to the organization and a real estate agency—with which the organization's two board members were associated was deemed to evidence private benefits. The IRS determined that the program was conducted to benefit the private interests of its founders, citing the standard that a “single nonexempt purpose, if more than insubstantial in nature, will defeat exemption, regardless of the number or importance of the truly exempt purposes.”⁶⁰

The Pension Protection Act of 2006 established new §501(q), which sets forth special requirements for credit counseling organizations (CCOs) seeking §501(c)(3) or (c)(4) status. Credit counseling services include providing educational information to the general public on budgeting, personal finance, financial literacy, saving and spending practices, and the sound use of consumer credit, and/or assisting individuals and families with financial problems by providing them with counseling.⁶¹

Organizations providing such services must:

• provide credit counseling services tailored to the specific needs and circumstances of consumers,
• not make loans to debtors (other than loans with no fees or interest) and may not negotiate the making of loans on behalf of debtors,
• provide services for the purpose of improving a consumer's credit record, credit history, or credit rating only to the extent that such services are incidental to providing credit counseling services, and
• not charge any separately stated fee for services for the purpose of improving any consumer's credit record, credit history, or credit rating.

Additionally, CCOs may not refuse to provide services to a client due to inability to pay or lack of participation in a debt management plan.⁶² The organization must establish a fee policy which requires fees to be reasonable, allows fees to be waived for clients who cannot afford to pay, and generally prohibits basing the fee on a percentage of the client's debt, payments under a debt management plan, or any projected savings to the client resulting from the debt management plan.⁶³ The governing body of the organization must be controlled by those who represent the interests of the community and not by persons who are employed by the organization or who benefit financially from the organization's activities.⁶⁴ Also, ownership by the CCO of interests in for-profit subsidiaries which conduct credit-related activities (lending, credit repair, etc.) is limited. Lastly, the CCO may not receive payment for referring clients to other providers for debt management plan services,⁶⁵ payment processing, or similar services.

If the CCO intends to qualify under §501(c)(3) (as opposed to §501(c)(4)), it is subject to the following additional requirements:⁶⁶

• It may not solicit contributions from a client during the initial counseling process or while the client is receiving services from the organization.
• Certain revenues related to debt management plan services are limited to 50 percent of the total revenues of the organization. A transition rule was in effect for the first three years after the date of enactment (80 percent, 70 percent, 60 percent).

If instead the CCO intends to qualify under §501(c)(4), the organization will only so qualify if it notifies the IRS that it is applying for recognition as a credit counseling organization.⁶⁷

Down-payment assistance programs have also been troubling and were the subject of examinations by the IRS during 2006–2008. The concern is the “funnel of down-payment assistance from sellers to buyers through self-serving, circular-financing arrangements.”⁶⁸ The potential for classification as charitable for such programs can also be evaluated in light of published guidance.⁶⁹ With two examples of acceptable and one unacceptable program, the IRS provides the following criteria:

Acceptable

• Organization X's mission is to relieve the poor, distressed, and underprivileged by enabling low-income persons access to housing (citing Rev. Rul. 70-585).⁷⁰
• X requires a home inspection to ensure that the house the applicant intends to buy will be habitable.
• X provides financial counseling seminars and other educational programs to help prepare potential home buyers for the responsibility of home ownership (citing Rev. Rul. 61-138).
• X solicits donations to support the program with broad-based fund-raising efforts.
• X's grant-making staff is not informed of seller's or realtor's identity. Thus, X is not “beholden to any particular donors or other supporters whose interest may conflict with that of the low-income buyers X is working to help.”⁷¹
• Any benefits accruing to the sellers or realtors who participate in the transaction do not detract from the charitable purposes of relieving the poor and distressed (citing Rev. Ruls. 72-559, 74-587, and 76-419).

Unacceptable

• Y funds down-payment assistance with seller and other real estate–related businesses that stand to benefit from the transactions.
• Y, in considering an applicant, is able to take into account whether the home seller or another interested party is willing to make a payment to Y to support the purchase.
• Most of Y's revenue comes from seller payments.
• Buyer payments are equal to seller payments in substantially all transactions.

Thus, the ruling concludes that Y cannot qualify for §501(c)(3) classification because of the benefit provided to sellers and real estate–related businesses. The IRS cites the Better Business Bureau case⁷² that says, “the presence of a single … [nonexempt] purpose, if substantial in nature, will destroy exemption regardless of the number or importance of truly… [exempt] purposes.” Though the conclusion does not literally say so, the IRS essentially concluded that Organization Y collected unrelated business income from the sellers. The ruling cites the classic attribute of a contribution—detached and disinterested generosity—as the distinguishing characteristic that renders a payment from the identified seller as essentially a fee for services.⁷³

A company providing another form of mortgage assistance was found not to be exempt. It purchased homes in danger of foreclosure and rented them back to former owners. The owners did not need to be poor and distressed and the record indicated that the homes were chosen for their investment potential.⁷⁴

(c) Economic Development

Society's welfare may be promoted by exempt organizations working in concert with for-profit businesses, rather than directly with members of a charitable class. Supporting business programs that provide job training and placement, loans, and other services available in a commercial setting may be treated as a charitable activity. Although the private business owners may stand to gain from the activity, such a program that has significant public benefit may qualify for exemption. Evaluating relative benefits is difficult, and the line separating the private and public interests is often very thin. Again, the rules may be influenced by the current opinion of lawmakers in regard to using tax policy to support social programs.

Economic development corporations (EDCs) typify this sort of charity. EDCs relieve poverty, combat community deterioration, lessen neighborhood tension, and strive to reduce the economic effect of prejudice and discrimination against minorities. An EDC qualifying as a charitable organization must be established to benefit disadvantaged members of the public.⁷⁵ Examples of programs approved as charitable by the IRS include:

• Making loans and purchasing equity interests in businesses unable to obtain conventional loans because of their location in an economically depressed urban area and/or ownership by members of a minority or other disadvantaged group.⁷⁶
• Establishing an industrial park in an economically blighted area to attract tenants willing to give employment and training opportunities to unemployed or underemployed residents in return for favorable lease terms.⁷⁷
• Having a small business investment company provide low-cost or long-term loans to businesses not able to obtain funds from conventional commercial sources, with preference given to businesses that provide training and employment opportunities for the unemployed or underemployed residents of economically depressed areas.⁷⁸

Conversely, an organization formed to increase business patronage for stores in economically depressed areas was noncharitable.⁷⁹ The balance of private/public interests tilted too far in favor of private. The IRS said the absentee, nonminority owners suffered no distress as a result of their operation in the depressed area. Instead, the project's efforts to increase sales served to promote the private business owners who had formed the organization. An economic development subsidiary of an accredited college of engineering and management was found to be charitable by the IRS based on the following three factors distilled from the published rulings:⁸⁰

1. Assistance is provided to help local businesses or to attract new local facilities of established businesses or to attract new local facilities of established outside businesses.
2. The type of assistance provided has noncommercial terms and the potential to revitalize the disadvantaged area.
3. There is a nexus between the business entities assisted and relieving the problems of the disadvantaged area, or between the businesses and a disadvantaged group, such as a minority, in the area.

EDCs may qualify as exempt under §501(c)(3), (4), and/or (6), further indicating the complexity of the fine private/public line evidencing charitable status.

(d) Public Interest Law Firms

Organizations performing legal services must successfully answer a series of questions to prove that their law practice serves charitable purposes. One concern is whether their clients qualify as members of a charitable class, such as the poor, persons who are discriminated against, or persons whose freedom is jeopardized. Another concern is how their business policies are distinguishable from those of commercial law firms. In 1971, the IRS approved exemption for public interest law firms when providing “representation in cases of important public interest that are not economically feasible for private firms.”⁸¹

The expectation of a legal fee or award cannot be a motivating factor in selection of cases, and the organization cannot withdraw from a case if the client later becomes unable to pay. Also, charges may not exceed the actual cost of the litigation. In essence, charges based on the client's ability to pay, rather than the amount of work involved, support designation as an exempt organization. IRS policy essentially says that some portion of the organization's financial support should come from donations of cash and services.

Guidelines providing specific sanctions for public interest law firms (PILFs) were issued in 1992 (effective retroactively to taxable years beginning after December 31, 1987). To be exempt, the organization must possess the following characteristics:

• Litigation must not represent a private interest, but must instead be “said to be in representation of a broad public,” such as class actions, suits seeking injunctions against actions harmful to the public, or test cases where the private interest is small.
• Litigants are not represented in actions between private persons when the financial interests at stake would warrant private legal representation, except that the PILF can serve as a friend of the court when an issue in litigation affects or will have an impact on a broad public interest.
• The nonprofit must achieve its objectives through legal and ethical means with no disruption of the judicial system, illegal activity, or violations of applicable canons of ethics.
• Litigated cases are described in detail annually on Form 990, including a rationale for the determination that they would benefit the public generally. Fees sought and recovered in each case must also be reported.
• Organizational authority, including approval of policies, programs, and compensation arrangements, rests with an independent board of trustees or a committee that is not controlled by employees or litigators.
• There must be no arrangement to accept donations from litigants to cover costs.
• The nonprofit may not be operated, through sharing of office space or otherwise, in a manner so as to create identification or confusion with a particular private law firm.
• Fees charged to clients may not exceed the cost of providing the legal services, and, once representation is started, the PILF cannot withdraw because the litigant is unable to pay the contemplated fee.
• Out-of-pocket cost reimbursements may be accepted from clients.
• Total attorney fees, both court-awarded and those received from clients, may not exceed 50 percent of the nonprofit's total costs of performing litigation services, calculated on a five-year rolling-average basis. If an exception to this limit “appears warranted,” a ruling request may be submitted.
• Attorneys must be paid on a straight salary basis; compensation levels must be reasonable and not established by reference to any fees received in connection with the cases they have handled; and the fees must be paid to the organization, not to the individual attorneys.⁸²

(a) Charity Care

A hospital does not qualify as a charitable organization merely because it promotes health. Over the years, there have been controversies between the IRS, courts, health-care organizations, and the doctors who staff them, seeking to find a suitable definition for a health-care entity that qualifies as a charitable one. In 1974, a court had to remind the IRS that promotion of health is a charitable purpose listed under the law of charitable trusts.¹¹⁸ This broad category encompasses hospitals, clinics, homes for the aged, hospices, medical research organizations, mental health facilities, blood banks, home health agencies, organ donor retrieval centers, health maintenance organizations (HMOs), medical centers, hospital holding companies, and many other entities that provide care to promote health. After first arguing that a charity hospital had to provide care to the indigent, the IRS compromised with a community benefit standard. A health-care organization that can satisfy most of the seven factors listed later in this section was allowed charity status. Nonetheless, the IRS has continued to encourage service to indigents. Operating a full-time emergency room open to all regardless of a person's ability to pay is strong evidence that a hospital is operating to benefit the community.¹¹⁹ Regarding Geisinger Health Plan, a division of Geisinger Hospital, the court opined that to qualify as a tax-exempt charitable organization, a hospital must do more than design a subsidized-fees program for the indigent. The facts indicated that a minuscule amount of services were provided to indigents.¹²⁰ Again, in the Redlands Surgical Services case, the Tax Court thought one of the indicators of community benefit is whether the organization provides free care to indigents.¹²¹ The objective of the community benefit standard is to ensure that adequate health-care services are actually delivered to those in the community who need them.

As the cost of medical care began to accelerate in the 1980s and the number of persons to whom such care was unavailable rose, pressure mounted on Congress to change the rules. Unfortunately, the number of uninsured persons without adequate care has not measurably improved, and the pressure on nonprofit organizations to meet this societal need remains high. The following summary of the issues involving health-care organizations presents a brief overview of this complex subject. The Wiley Nonprofit Series includes a book entitled The Law of Tax-Exempt Healthcare Organizations, 4th Edition, which contains comprehensive consideration of the issues.¹²²

Internal Revenue Manual §7.20.4-9 has a Guide Sheet entitled “Hospitals, Clinics, and Similar Health Care Providers Reference Guide Sheet.” This extensive 12-page guide lists issues the determination technicians are to answer when processing applications for exemption and should be carefully studied in that context; the guide can also be used by providers to evaluate ongoing qualification for §501(c)(3) exempt status.

A tax-exempt health-care provider must serve its charitable class—the sick—rather than those who manage it. The IRS's initial opinion on this subject was that a charity hospital “must be operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay.”¹²³ In 1969, the IRS eased this policy and recognized that the charitable purpose of promoting health is served, even if the cost is borne by patients and insurance companies.¹²⁴ Later, the IRS refined its position: “[T]o be exempt a hospital must promote the health of a class of persons broad enough to benefit the community and must be operated to serve a public rather than a private interest.”¹²⁵ Management style and financial facts that distinguish an exempt hospital from a for-profit one provide the evidence of public purpose. Indicators of a hospital's charitable nature as originally set out by the IRS,¹²⁶ and still cited today, are called the community benefit standards and include the following:

• Control by a community-based board of directors with no financial interest in the hospital.
• Open medical staff with privileges available to all qualified physicians.
• Emergency room open to all (unless this duplicates services provided by another institution in the area).
• Provision of public health programs and extensive research and medical training.
• No unreasonable accumulation of surplus funds.
• Limited funds invested in for-profit subsidiaries.
• A high level of receivables from uncollected billings.

Each of the IRS continuing education texts in recent years contains an update on issues facing health-care providers. The texts must be carefully studied by those representing hospitals and other health-related entities.¹²⁷ The texts are available on the IRS Exempt Organizations Internet site (www.irs.gov/charities).

(b) Private Inurement

To achieve and maintain tax exemption, a health-care organization cannot allow its earnings or properties to benefit its medical staff or other private individuals. The IRS closely scrutinizes contractual relationships with physicians and, until 1996, maintained a policy that no more than 20 percent of the board members could be physicians. Under a Community Board and Conflicts of Interest Policy,¹²⁸ the IRS eased this policy if less than 50 percent of the board is constituted of physicians and the organization in question has an adequate conflict-of-interest policy.¹²⁹ Other factors that the IRS has said evidence private inurement to physicians include:

• Favorable rental rates and exclusive use of facilities by a limited group of doctors.¹³⁰
• Profitable services (e.g., a lab) operated by private owners.¹³¹
• A newly established nonprofit paying a high price to purchase a proprietary hospital.¹³²
• Excessive compensation to medical staff¹³³ and joint ventures.¹³⁴

After many years of private rulings and guidelines, the IRS issued a formal revenue ruling on incentives that a tax-exempt hospital may offer to recruit private practice physicians to join its staff or work in its medical community.¹³⁵ The ruling stipulates that it applies only to hospitals that have the following characteristics:¹³⁶

• The hospital is a §501(c)(3) organization that operates to promote health (its exempt purpose) by the standards for exemption set forth in Rev. Rul. 69-545.¹³⁷
• The hospital meets the operational test and engages, to a substantial extent, in activities that further its exempt purposes and are reasonably related to accomplishing that purpose in keeping with the standards described in Rev. Ruls. 80-278 and 80-279.¹³⁸
• The physicians do not have a substantial influence over the affairs of the hospitals recruiting them so that they would be treated as disqualified persons under §4958,¹³⁹ nor do they have any personal or private interest in the hospital that could result in private inurement. The recruitment package must not be structured as a device to distribute net earnings of the hospital to the physician.
• The hospital must not engage in substantial unlawful activities inconsistent with charitable purposes.

The ruling states that the determination of whether the recruitment incentives cause the organization to violate the operational test is based on all relevant facts and circumstances and contains five scenarios illustrating this position. The first four provide for acceptable recruitment incentives that do not result in private inurement to the physicians. In Situation 5, the hospital is found to operate for substantial nonexempt purposes and fails to qualify for exemption.

Situation 1. Hospital A is the only hospital within a 100-mile radius and designated by the U.S. Public Health Service as a Health Professional Shortage Area for primary medical care professionals. The hospital has a demonstrated need for OB-GYNs in its service area. The hospital recruits a physician who has recently completed an obstetrics and gynecological residency to establish and maintain a full-time practice in its service area and become a member of its medical staff. A signing bonus is paid, a professional liability insurance premium is paid for a limited period of time, below-market office rent for a limited number of years (after which time the rent will be at fair value; again, number not given) is provided, the physician's residential mortgage is guaranteed, and start-up financial assistance bearing “reasonable terms” is provided. The written incentive package is negotiated in an arm's-length fashion in accordance with guidelines that are adopted, monitored, and reviewed regularly by the hospital's board of directors to ensure that its exempt purposes are being served. A committee responsible for medical staff contracts approves the agreement. No benefits other than those stipulated in the agreement are provided.

Situation 2. Hospital B is located in an economically depressed inner-city area of City W and has conducted a community-needs assessment indicating both a shortage of pediatricians in its service area and difficulties Medicaid patients are having obtaining pediatric services. Hospital B recruits a physician to relocate and establish a full-time pediatric practice in its service area, join its medical staff, and treat a reasonable number of Medicaid patients. Again in an arm's-length negotiation approved by its board, the physician is offered payment of moving expenses, professional liability “tail” coverage for the former practice, and a guaranteed level of private practice income for a limited number of years. The amount guaranteed falls within the range of compensation paid to physicians in similar positions according to regional or national surveys.

Situation 3. Hospital C, also located in an economically depressed inner-city area, conducts a community-needs assessment and finds that indigent patients are having difficulty getting access to care because of a shortage of obstetricians in its area willing to treat Medicaid and charity care patients. A member of its current medical staff is recruited to provide these services in return for payment of professional liability insurance during the year the services are provided. The agreement is written and approved in the same fashion as described in Situation 1. The ruling finds that the amount paid to the physician is reasonable and that any private benefit to the physician is outweighed by the public purposes served by the agreement.

Situation 4. Hospital D is located in a medium- to large-size metropolitan area. It maintains a minimum of four diagnostic radiologists to ensure adequate coverage and a high quality of care for its radiology department. When two of its radiologists resign, it recruits a radiologist currently working for another hospital in the city. The hospital agrees in a properly approved and written document to supplement the physician's income to the extent the private practice does not generate a certain level of net income for the first few years.

Situation 5. Hospital F was criminally convicted of knowingly and willfully violating the Medicare and Medicaid anti-kickback statute in its physician recruitment practices. The activities resulting in the violations were substantial.

The examples in the ruling emphasize that the board and duly authorized units operating under the aegis of the board must analyze the institution's ability to accomplish its exempt purpose. With that focus, a board can develop a methodology for meeting its charitable needs and take appropriate steps using reasonable standards for determining fair value and the terms of the arrangements deemed necessary to accomplish the exempt purposes. All exempt organizations, particularly hospitals, are expected to have “contemporaneous documentation of process” to evidence the tax-exempt nature of their financial decisions.¹⁴⁰

Practitioners were pleased when the IRS issued Rev. Rul. 97-21 containing the examples of permissible physician recruitment plans. New circumstances were added when the IRS privately approved bonuses to sway currently practicing physicians to move across town.¹⁴¹ The hospital's hiring decisions were based on community-need assessments. Incentives were given only to physicians whose services were not currently available within its service area or to graduates of a physician-training program. Because the determination of “whether the recruitment incentives cause the organization to violate the operational test is based on all relevant facts and circumstances,”¹⁴² the ruling request also stipulated that the plan further its charitable objectives. The hospital required that the terms be reasonable in regard to each recruit, be set out in a written agreement, and not confer any prohibited private inurement or more than incidental private benefit to any physician. The assistance provided to an existing physician practice for recruiting a physician was limited to no more than 50 percent of the physician's total assistance.

An organization formed to collect health-care data was denied tax-exempt status because the activity was a business providing information available only to its members. Although the data would promote health by improving efficiency of health-care delivery, substantial private benefit would be provided to the members. Therefore, the entity did not operate exclusively for exempt purposes.¹⁴³

(c) Hospital Joint Ventures

While the national and state legislatures, the administration officials in the White House, and the general populace debated the need to reform health-care delivery in the United States during the 1990s, no significant changes in the law were passed at that time, but the health-care industry voluntarily reformed itself. Managed care became the normal method for dispensing health care; mergers, consolidations, and buyouts of nonprofit providers with and by for-profit entities frequently occurred. Combinations of health-care providers happened at such a pace that the IRS was often unable to keep up. Because of reduced staff levels, during the 1990s the Exempt Organization Group could not consider requests for private letter rulings within the timeframe projects required. Significant transactions involving nonprofit hospitals that previously would have been undertaken only after approval by the IRS went without approval.¹⁴⁴ The most significant issue in determining a hospital's qualification as a (c)(3) organization is whether it operates to provide public benefit or yields private inurement to those who manage and operate it.

To finance expansion and improve their health-care facilities, tax-exempt hospitals have opportunities to enter into associations with for-profit companies and investors. When the use and control of hospital assets is altered by entering into a joint venture or partnership, the hospital may maintain its tax-exempt status as long as the venture's activity is primarily charitable and the private interests of the for-profit partners are only incidentally served by the arrangement. Importantly, under concepts of partnership taxation, the activities and income of the venture are treated as those of the partners in the venture. The IRS illustrated the venture terms it considers to serve charitable interests, as compared to those it deems to serve private interests, in Rev. Rul. 98-15.

Charitable Venture. A (c)(3) hospital, in need of additional funding, forms a limited liability company (LLC) with investors. All of the hospital's assets are contributed to the venture in return for an ownership interest proportional to their value. The LLC board has three representatives of the hospital and two chosen by the investors (hospital controls). Governing documents require that the venture operate to further charitable purposes by promoting health for a broad cross-section of its community and the documents can only be amended by the hospital-controlled board. The board must also approve major decisions relating to the venture operations, such as capital and operating budgets, distribution of earnings, selection of key executives, contracts in excess of $X a year, changes in types of services the hospital offers, and renewal or termination of management agreements.

Commercial Venture. A tax-exempt hospital (the “exempt”) in need of capital forms an LLC with a for-profit hospital. Similar to the charitable venture, each venturer receives ownership in proportion to the value of its respective assets contributed. Otherwise the venture agreement evidences to the IRS that ownership of the LLC will not serve the exempt's purposes. The purpose clause of the governing documents does not dedicate the LLC to charitable purposes. The governing body that is empowered to amend the documents and make major decisions consists of three individuals chosen by each venturer (the exempt is not in control). The LLC is to be operated by a management company owned by the for-profit hospital (major decisions delegated to the for-profit). As a part of the agreement, the exempt agrees to approve of two for-profit executives to serve as the LLC's chief executive and financial officers. The IRS found that the absence of a binding obligation on the LLC to serve a charitable purpose meant the venture could “deny care to segments of the community, such as indigents.”¹⁴⁵

The first chapter in the 1999 Exempt Organization Continuing Professional Education (EO CPE) Text is entitled “Whole Hospital Joint Ventures” and states that the IRS, in issuing Rev. Rul. 98-15, “does not seek to curb” all such ventures. When an exempt enters into a venture, the IRS expects charitable purposes to supersede profit maximization purposes, that health-care services benefit the community as a whole, and that the venture does not result in greater than incidental private benefit to the taxable partner or other private parties. The CPE Text contains a list of 24 questions the exempt organization division used in its examinations of such ventures as part of its 1999 work plan. How ventures stray from the acceptable venture in the ruling remains to be seen. What if the charter constrains the operations to be charitable but the for-profit partners control, for example?

The Tax Court agreed with the IRS that Redlands Surgical Services (RSS), through its joint ownership and operation of health-care facilities, served the private interests of its for-profit partners and could not qualify for tax exemption.¹⁴⁶ RSS owned only 46 percent of a general partnership that deprived it of control while allowing it to be exposed to liabilities. Management services were provided by a subsidiary of the for-profit 54 percent partner under terms that were “favorable to the for-profit” and lasted for 15 years, with renewals for 10 more years at the for-profit's option. The entire arrangement was in “direct conflict with achieving charitable goals,” according to the IRS, and the agreements did not contain charitable objectives. Very few Medicaid patients were served, indicating a lack of community benefit necessary to evidence charitable purposes. In keeping with the conclusion in the second example—the “commercial venture” described in Rev. Rul. 98-15—the IRS insists that the charity must be in control for a joint venture to serve charitable purposes. The U.S. Court of Appeals adopted the Tax Court's decision to sustain the IRS's disapproval of exempt status for Redlands Surgical Services. In its brief comments, the court emphasized its objections to the ceding of effective control over the operations of the health-care facility to the for-profit partners, which, in its opinion, conferred impermissible private benefit.

St. David's Health Care System, Inc. initially convinced a Texas district court that, despite the fact that it owned a 45.9 percent interest in the joint venture it formed with a for-profit hospital company, HCA, Inc., there was “absolutely no question” that it was operated for charitable purposes and substantially engaged in charitable activity. The Fifth Circuit Court, however, agreed with the IRS and ruled that St. David's less-than-50-percent-equity interest furthered the private, profit-seeking interests of its for-profit partner.¹⁴⁷ The IRS, in its examination, found that charity care levels could not be measured by the hospital's bad debts. It also insisted that the community board was required to control the joint venture to ensure lack of private interests. The operating agreement's requirement that the hospital operate in accordance with the community benefit standard was insufficient despite the fact that St. David's has the unilateral right to dissolve the partnership if the activity fails to do so. Nor was it persuasive that St. David names the board chair and can remove the chief executive officer. This revocation of the hospital system's exempt status reinforces the IRS view that at least a 50–50 split, and preferably more than 50 percent, of control by the exempt organization is necessary in such a joint venture for it to be considered a charitable activity.¹⁴⁸

The 2002 IRS EO CPE Text contains a 24-factor checklist to use to analyze the impact of joint venture participation on a tax-exempt entity.¹⁴⁹ The long-awaited guidance on so-called auxiliary joint ventures—ones that involve operation of a discrete program rather than the entire operation—was issued on June 1, 2004.¹⁵⁰

An additional issue to consider includes the potential application of §501(r) to all participants in a hospital joint venture.¹⁵¹

(d) Physician Clinics

A clinic providing private medical care to individuals is traditionally owned by doctors, operated for their profit-making purposes, and not qualified for tax exemption, even though it operates for the purpose of promoting health. When a clinic has no private ownership, provides a reasonable level of free or reduced-charge care to members of a charitable class, and otherwise distinguishes itself as a charitable organization, exemption can be sought under the standards previously listed under “Charity Care.”

Clinics operated in conjunction with charity hospitals and medical schools—so-called faculty practice plans—have traditionally been granted exemption, but there are few clear precedents in the area. In one case approving exemption for such a clinic, the physicians were staff members of a teaching hospital and full-time medical school faculty members.¹⁵² About 25 percent of the patients were indigent or students, and medical research was conducted, evidencing a significant element of charitable purpose in addition to the promotion of health.

Leasing of computer systems to a nonexempt faculty practice partnership was deemed an exempt activity for a hospital support organization. Because the doctors were necessary for teaching and supervising residents and interns, the IRS found the leasing activity consistent with the purposes of the teaching hospital and, correspondingly, its support organization, making the revenues related to exempt purposes.¹⁵³

(e) Integrated Health-Care Delivery Systems

Health-care organizations often combine all the service providers—the doctor's clinic, the hospital, the HMO, the pharmacy, and so on—into a consolidated group, called an integrated health delivery system (IDS). The doctors sell their practices to the IDS, become hospital employees, and provide medical services on behalf of one branch, usually the hospital. For management and legal liability reasons, the respective parts of the IDS may remain separately incorporated and individually maintain tax-exempt status. Such a related group of organizations can function as a unit of separate, but integrated, exempt organizations.¹⁵⁴ The IRS had some difficulty originally approving IDSs for charitable status.

A favorable ruling for this type of entity depends on proof that the private doctors do not get favorable treatment in the deal or do not reap private inurement. To give an idea of the policies an organization must adopt to prove it benefits the community¹⁵⁵ rather than the individual doctors, the conditions under which one IDS was granted exemption are described here. Facey Medical Foundation, a newly created holding company that planned to control 12 tax-exempt hospitals and also create a taxable subsidiary to purchase a private medical practice, received a favorable determination that it qualified as a §501(c)(3) organization.¹⁵⁶ The nonexempt sub planned to buy a 48-physician practice, along with the tangible and intangible assets, including trade name, medical service contracts, noncompetition agreements, and patient files. Following IRS policy that the purchase of goodwill is inconsistent with exempt status, there was no compensation for goodwill. Facey leased back the assets and provided management services and nonphysician support for the medical practice. The selling doctors receive a set percentage of Facey's gross income for the first two years only, with their compensation subsequently to be worked out in arm's-length negotiations. The favorable determination was based on the following significant factors that apparently proved to the IRS that there was sufficient community benefit¹⁵⁷ rather than private benefit to the doctors whose practices were being purchased:

• The organization's board of directors will be controlled by members of the community, with no more than 20 percent of the board members being doctors.
• A substantial number of the physicians will give emergency room care without regard to a patient's ability to pay.
• The hospitals will provide at least $400,000 worth, not counting bad debts, of charity care annually.
• Facey will participate in both the Medicare and MediCal insurance program in a nondiscriminatory manner.
• Significant clinical research and public education programs will be conducted.
• Facey will comply with anti-kickback provisions of the Social Security Act.¹⁵⁸ Essentially, the terms of the buyout and compensation arrangements with physicians would not induce or reward referrals.

The published determination letters of other integrated delivery systems issued since that time can be studied to further clarify the IRS's thinking on this subject.¹⁵⁹

For instance, a pair of professional service organizations, operated in conjunction with the State University of New York at Buffalo's medical and dental schools to assign residents to local teaching hospitals, was denied tax-exempt status. The court found that the organizations were “appendages rather than integral parts” of the educational or hospital organizations they serve (organizational documents themselves stated that the service organizations were ancillary to the primary purpose of the school's graduate medical and dental education). Because they serve the university, as well as the hospitals, they also could not qualify as cooperative hospital service organizations under IRC §501(e).¹⁶⁰

(f) Health Maintenance Organizations

Health maintenance organizations providing prepaid medical care to members can be exempt if a large enough charitable class is benefited and the HMO provides the care itself.¹⁶¹ HMOs providing commercial-type insurance as a substantial part of their activities are not, however, tax-exempt under §501(m), which was enacted as a part of the Tax Reform Act of 1986. Insubstantial insurance activity that does not prevent exemption is subject to unrelated business income tax.

Due to the significant controversies discussed here, the IRS on May 27, 2003, announced it was suspending revocation of HMO exemption for 18 months and intended to issue proposed regulations defining “commercial-type insurance.”¹⁶² Comments were solicited to aid them in proposing those new regulations. Examination guidelines were revised in 2008 but as of 2011, regulations had not yet been proposed.¹⁶³ Matters involving HMOs were to be referred to EO Technical (Washington office). Readers therefore should review the following discussion for historical reference but check for updated guidance on this subject.

In September 1990, the IRS issued a memo setting forth the criteria it would follow for issuing exemptions to HMOs.¹⁶⁴ The standards were designed to ensure that HMOs operate to benefit the community and were similar to those applied for exemption of hospitals. The criteria are as follows:

• Health-care services and facilities are provided.
• Emergency treatment is available without regard to ability to pay, and this fact is communicated to the public.
• Membership organizations must make efforts to expand the number of members to spread the cost among more persons, seek individual members, have no age or eligibility barriers, and charge individuals rates similar to those charged groups.
• Nonmembers are served on a fee-for-service basis.
• Medicare, Medicaid, and other publicly assisted patients are accepted, and care is provided at reduced rates for indigents.
• Health education and research programs are provided.
• Health-care providers are paid fixed compensation (no incentive pay).
• Operating surpluses are dedicated to improving facilities and health-care programs.
• The community is broadly represented on the governing body.

A court agreed with the IRS that an HMO that did not itself provide direct medical services and conducted no programs to satisfy the community benefit standards previously outlined could not qualify as charitable.¹⁶⁵ Although the HMO at issue, Geisinger Health Plan, could conceivably qualify as charitable if it were an integral part of a parent health-care system, its primary activity—the provision of insurance-like contract medical services for private patients—did not qualify for charitable status. Likewise, because its primary focus was serving private patients in addition to those of the hospitals, it could not qualify as an exempt feeder under the integral part test. The decision should be read in detail by any proposed HMO not meeting most of the nine IRS criteria previously listed. The Third Circuit revisited the Geisinger Health Plan and again decided that it failed to qualify for exemption.¹⁶⁶ A two-pronged test was applied to determine whether the organization qualified under the integral part test:

1. It is not carrying on a trade or business that would be an unrelated trade or business if regularly carried on by the parent.
2. The relationship to its parent somehow enhances the subsidiary's own exempt character to the point that, when the boost provided by the parent is added to the contribution made by the subsidiary itself, the subsidiary would be entitled to (c)(3) status.

Nonprofit HMOs exclusively providing services to Medicaid recipients can also qualify for (c)(3) status if the standards described here are satisfied. Such organizations are formed to serve managed care systems established by states following the example of other health-care providers.¹⁶⁷

IHC Health Plans and its two affiliated organizations were denied exemption under §501(c)(3) because they did not provide sufficient community benefits.¹⁶⁸ Despite the fact that the organizations provided Medicaid managed care services to nearly 50 percent of eligible persons in Utah and health-care coverage to about 20 percent of the state's total population, the court agreed with the IRS that the organizations essentially provided commercial-type insurance. IHC did not have its own facilities, emergency care, subsidized coverage to the needy, or a health education program. Also, the fact that plan enrollees received nearly 80 percent of their services from physicians with no direct link to IHC indicated it could not qualify as a health-care provider.

(g) Health/Fitness Centers

An increasingly important component of the health-care industry is alternative therapies and regimes that encourage wellness to prevent illness. Most everyone in America today agrees that physical fitness and dietary prudence promote health. Nonprofit organizations as well as private industry address this concern. For both, the activity itself is essentially charitable: to promote health. What distinguishes a nonprofit fitness center is the absence of private ownership and operational practices that distinguish it from its commercial counterparts, following the standards outlined in Chapter 2. A nonprofit created to provide alternative forms of entertainment to persons to promote adult sobriety was denied tax exemption. The free and low-cost tabletop games that constituted the recreation, provided in addition to the therapy, were deemed to have an “inherently commercial nature.” Additionally, the organization had ties to the for-profit recreational gaming industry and did not limit activities to addicts with low incomes.¹⁶⁹

The provision of a fitness facility to the healthy, however, may not always be considered a charitable activity. A community center that restricts its availability to less than an entire community, for example, cannot be classified as charitable.¹⁷⁰ In contrast, the operation of a health and fitness center providing access to handicapped persons and offering reduced daily rates for persons of limited financial means serves a health-care organization's exempt purposes.¹⁷¹ As a part of a new medical complex, a sports and physical medicine facility was designed to serve patients referred by the center's hospitals and physicians, as well as the general public. What primarily distinguished this center as a charitable facility was its provision of services to patients and employees of the medical center. It provided availability to the general public in a noncommercial manner and was found to contribute to the center's exempt purpose of providing health care to the community in which it was located.

A similar conclusion was reached regarding a wellness center created as a joint venture of an acute-care hospital, its parent, and an orthopedic hospital. The facilities were designed to provide physical rehabilitation services to patients and to the general public. The membership fee structure would permit access to the general public, and the facility would serve the creators' exempt health-care purposes. The center was therefore found to be exempt.¹⁷² A heart health center operating as an integral part of an acute-care hospital was also deemed distinguishable from commercial health centers. Its fees were low enough to be within financial reach of a significant segment of its community, and scholarships were granted to those in need of cardiovascular rejuvenation but unable to pay.¹⁷³ An organization sponsoring general fitness programs for youths, by operating a track, gymnasium, swimming pool, and courts for racquetball, handball, and squash, was also found to be accomplishing an exempt purpose.¹⁷⁴ Access to most of its facilities was available upon payment of a nominal annual fee. Its operation of a health club program providing use of a spa, exercise rooms, whirlpool, sauna, and such, was, however, considered an unrelated activity not contributing to its exempt purposes. Club members paid an advance annual fee that was comparable to that charged by a commercial health club and sufficiently high to restrict participation in the facility.

(h) Professional Standards Review Organizations

Under Social Security legislation in 1972, Congress authorized the creation of professional standards review organizations (PSROs). PSROs monitor and establish cost and quality controls for hospitals in their area with the intention of reducing overutilization of government-financed health programs. PSRO members must be licensed physicians. The exemption issue is again whether the PSRO serves the public or the individual doctor members and the medical profession. A PSRO must possess the following attributes to qualify for exemption as a charity—otherwise, it may qualify as a business league:¹⁷⁵

• It must operate to ensure quality and care utilization for Medicare and Medicaid patients.
• Membership is open to all physicians without charge.
• The governing body cannot be controlled by or tied to a medical society.
• The PSRO is authorized to act under the federal statutes.

An organization that reviewed the propriety of hospital treatment provided to Medicaid recipients was also found to be exempt because it relieved the burden of government and promoted the health of persons eligible for Medicare and Medicaid.¹⁷⁶

(i) Homes for the Elderly

Until 1972, homes for senior citizens were required to provide free or low-cost services.¹⁷⁷ Today, a charitable home may charge full cost for its services so long as it provides for the primary needs of the elderly—housing, health care, and financial security—and is operated in a nonprofit manner. In seeking approval for exemption, a home must furnish detailed information about its proposed or actual operation on Schedule F of Form 1023.¹⁷⁸ The 2004 IRS EO CPE Text chapter entitled “Elderly Housing” updated the IRS's policies regarding housing for senior citizens and also updates previous articles. The questions address the following specific policies that a home must maintain to qualify as charitable:¹⁷⁹

• Have a commitment to maintain in the residence any person who becomes unable to pay his or her regular charges, or do all that is possible to make other suitable arrangements for such person's care.
• Provide its services at the lowest feasible cost, taking the facts and circumstances of the home into account (for example, cost of facility or wages in the area).
• Charge fees affordable by a significant segment of the elderly population so as to evidence benefit to the community in which it is located.
• Adopt policies to protect itself financially and enable it to meet its obligation not to expel elderly residents who become unable to pay.

A home may require its applicants to make a deposit upon admission of an amount of assets calculated to secure their care.¹⁸⁰ A home might also permit residents to establish trusts, the income of which is payable to the home during the resident's life. Income from trusts is exempt function income to the home because it is paying the fees. Charitable status can be allowed for a senior citizen home that allows full-paying elderly to keep their assets, subject to a requirement that such assets could be used, if necessary, to supplement income to meet the monthly charges.¹⁸¹

An exempt organization created by a cancer institute to provide a pet therapy program for its patients was approved. The program would provide playful interaction between registered therapy dogs and hospital patients, particularly children, and also nursing home residents. Animals would be trained as well as the handlers who would accompany them. The ruling spoke of benefit to those away from home in a health or elderly facility and opined that the animals would promote improved mental well-being and physical comfort and therefore constituted a charitable activity.¹⁸²

A pharmacy organized to furnish discount drugs to senior citizens was denied exemption because it operated for commercial purposes and had no charitable attributes such as low-cost or free drugs to the indigent.¹⁸³

(j) §501(r) Requirements for Hospitals

The IRS began a Hospital Compliance Project in May of 2006 in order to study nonprofit hospitals and community benefits, and to determine how such hospitals establish and report executive compensation. The project involved mailing out questionnaires to 544 nonprofit hospitals and analyzing their responses. The questionnaire requested information regarding each hospital's activities, governance, expenditures, and executive compensation practices. The IRS issued its final report in 2009, stating the following results:

• There was considerable diversity in the demographics, activities, and financial resources among the respondent hospitals.
• The average and median percentages of total revenues reported as spent on aggregate community benefit expenditures were 9 percent and 6 percent, respectively. These percentages generally increased with revenue size.
• Uncompensated care was the largest reported community benefit expenditure overall and across all demographics. Medical education and training, medical research, and community programs followed in descending order.
• Uncompensated care and aggregate community benefit expenditures were unevenly distributed among hospitals and concentrated in a relatively small group. Overall, 21 percent of the hospitals reported community benefit expenditures constituting less than 2 percent of total revenues.
• On an aggregate basis, revenues exceeded expenses by 5 percent. Overall, 21 percent of the hospitals reported a deficit.
• The study did not find a correlation between community benefit expenditure levels and per-capita income levels of the area surrounding the hospital. The study did observe that community benefit expenditures increased as uninsured rates of the area surrounding the hospital increased.
• Nearly all hospitals in the study reported complying with key elements of the rebuttable presumption procedure available to establish compensation of certain executives and disqualified persons.

In 2010, the Patient Protection and Affordable Care Act was signed into law, establishing four additional requirements for nonprofit hospitals to maintain exempt status under § 501(c)(3) (codified in § 501(r)) and instituting a requirement that the IRS review the community benefit activities of each hospital at least once every three years. The §501(r) requirements include conducting community needs assessments, communicating financial assistance policies, limiting charges for indigent patients, and following certain billing and collection practices. The IRS has significant information on their website at irs.gov/eo.¹⁸⁴ On June 21, 2012, the Treasury Inspector General for Tax Administration (TIGTA) issued a report regarding its review of the IRS's progress in establishing controls to determine whether tax-exempt hospitals comply with §9007 of the Patient Protection and Affordable Care Act (and corresponding IRC §501(r)). The report was titled “Affordable Care Act: While Much Has Been Accomplished, the Extent of Additional Controls Needed to Implement Tax-Exempt Hospital Provisions Is Uncertain.” According to the report, the IRS has made progress toward establishing controls, but it is difficult to determine how much additional work will be required because legal guidance (in the form of regulations) has not yet been published.

The report noted that prior to the passage of the Affordable Care Act (ACA), the IRS did not maintain a database that identified all tax-exempt hospitals. Through the labor-intensive efforts of seven IRS employees who reviewed information gleaned from Forms 990 and websites listing hospital facilities, after 1½ years, the IRS has now identified 3,377 tax-exempt hospitals. IRS management plans to add an indicator to the Business Master File to make identification of tax-exempt hospitals easier in the future.

A review of each tax-exempt hospital is required to be conducted once every three years. Phase 1 of this review has been completed and covered approximately 1,700 organizations. As part of the review, the examiner may recommend an ACA-related or non–ACA-related compliance check or examination. TIGTA's report noted that at the conclusion of its audit, there had been no recommendations for compliance checks or examinations related to ACA provisions during Phase 1.

An automated process was developed to identify Forms 990 that are filed with incomplete information on Schedule H. When incomplete forms are received, IRS employees will correspond with the hospitals to obtain the missing data. IRS employees in the EO Division who are responsible for conducting community benefit reviews of hospitals will also manually review the data entered on Schedule H and check publicly available sources.

IRC §501(r) is applicable only to an organization that either (1) operates a “facility which is required by a State to be licensed, registered, or similarly recognized as a hospital”¹⁸⁵ or (2) has “the provision of hospital care as its principal function or purpose constituting the basis for its exemption under subsection (c)(3).”¹⁸⁶ Facilities located outside the United States are not subject to the provisions of §501(r); however, governmental hospitals, which have recognition under §501(c)(3), are subject. Additionally, the requirements of §501(r) are applied on a facility-by-facility basis rather than on an organization-by-organization basis.

Community Health Needs Assessment. Each nonprofit hospital is required to conduct a community health needs assessment (CHNA) at least once every three years.¹⁸⁷ A hospital organization may take into account all of the relevant facts and circumstances in defining the community its facility serves as long as it does not circumvent the requirement to assess the health needs of certain members of the community, such as medically underserved persons, low-income persons, minority groups, or those with chronic disease needs.

To conduct a CHNA, a hospital facility must complete the following steps:¹⁸⁸

1. define the community it serves;
2. assess the health needs of that community;
3. in assessing the health needs of the community, solicit and take into account input received from persons who represent the broad interests of that community, including those with special knowledge of or expertise in public health;
4. document the CHNA in a written report (CHNA report) that is adopted for the hospital facility by an authorized body of the hospital facility; and
5. make the CHNA report widely available to the public.

The CHNA will be considered to have been conducted on the date on which all these steps have been completed.¹⁸⁹ The written CHNA report must include the following:¹⁹⁰

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 interest 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;
5. a description of the resources potentially available to address the significant health needs identified through the CHNA; and
6. an evaluation of the impact of any actions that were taken since the hospital facility finished conducting its immediately preceding CHNA, to address the significant health needs identified in the hospital facility's prior CHNA(s).

A hospital organization with multiple facilities must document the CHNA for each of its hospital facilities in separate written reports that include the aforementioned information.¹⁹¹

The second component of the requirement to conduct a CHNA is the adoption of an implementation strategy to meet the needs identified in the CHNA. The strategy is a written plan that addresses each significant health need identified in the CHNA for such facility and either describes how the facility plans to meet the health need or identifies the health need as one the facility does not intend to meet and explains why the facility does not intend to meet the need.¹⁹² Again, similar to the separate CHNA requirement for hospital organizations maintaining multiple facilities, each facility must adopt a separate implementation strategy based on its separate CHNA.¹⁹³ The implementation strategy will be considered to be adopted on the date the strategy is approved by an authorized governing body of the hospital organization. Importantly, the implementation strategy must be adopted on or before the 15th day of the fifth month after the end of the taxable year in which the hospital facility is considered to have conducted the CHNA (i.e., when the last step was completed regardless of when the process was begun).¹⁹⁴ A hospital organization must attach to its Form 990 a copy of the most recently adopted implementation strategy for each hospital facility it operates, or provide on the Form 990 the URL of the web page on which it has made the implementation strategy widely available.¹⁹⁵

Section 4959 imposes a $50,000 excise tax on a hospital organization that fails to meet the CHNA requirements with respect to any taxable year. This tax is applied to each facility separately, so that an organization maintaining two hospital facilities which fail to meet the requirements would be subject to a $100,000 tax.

Financial Assistance Policy. Each nonprofit hospital must adopt, publicize, and make available to the public its financial assistance policy (FAP).¹⁹⁶ The policy must apply to all emergency and other medically necessary care provided by the hospital facility and include:¹⁹⁷

1. Eligibility criteria for financial assistance, and whether such assistance includes free or discounted care.
2. The basis for calculating amounts charged to patients.
3. The method for applying for financial assistance.
4. In the case of a hospital facility that does not have a separate billing and collections policy, the actions that may be taken in the event of nonpayment.
5. If applicable, any information obtained from sources other than an individual seeking financial assistance that the hospital facility uses, and whether and under what circumstances it uses prior FAP eligibility determinations.
6. A list of any providers, other than the hospital facility itself, delivering emergency or other medically necessary care in the hospital facility that specifies which providers are covered by the hospital facility's FAP and which are not.

Eligibility Criteria. Consistent with the statute, the regulations do not mandate any particular eligibility criteria.

Basis for Calculating Amounts Charged to Patients. The FAP must state that following a determination of FAP eligibility, an individual will not be charged more than the amounts generally billed (AGB) to individuals who have insurance covering such care for emergency or medically necessary care.¹⁹⁸ The FAP must also state which of the following permitted methods the hospital facility uses to determine AGB.

• The first method is a “look-back” method¹⁹⁹ based on actual past claims paid to the hospital facility by either Medicare fee-for-service only; Medicare fee-for-service together with all private health insurers paying claims to the hospital facility; or Medicaid, either alone or in combination with Medicare fee-for-service, and private health insurers.
• The second method for determining AGB is “prospective”²⁰⁰ in that it requires the hospital facility to estimate the amount it would be paid by Medicare or Medicaid (along with the amount the patient would be personally responsible for paying in the form of co-payments, co-insurance, and deductibles) for the emergency or other medically necessary care at issue as if the FAP-eligible individual were a Medicare fee-for-service or Medicaid beneficiary.

These two methods of determining AGB are mutually exclusive, and a hospital facility may only use one method to determine AGB. Different hospital facilities operated by the same hospital organization may use different methods, and a hospital facility may change the method it uses to determine AGB at any time.²⁰¹

Method for Applying for Financial Assistance. The FAP must describe how an individual may apply for financial assistance.²⁰² The FAP or FAP application form must describe the information or documentation the hospital facility may require an individual to submit as part of his or her application and provide certain contact information that an individual can use to obtain assistance with the application process. Financial assistance may not be denied based on the omission of information or documentation if such information or documentation is not specifically required by the FAP or application form.

Actions That May Be Taken in the Event of Nonpayment. The FAP, or a separate written billing and collections policy, must describe the actions that the hospital facility (or other authorized party) may take related to obtaining payment of a bill for medical care provided by the facility, including, but not limited to, any extraordinary collection actions described in Treasury Regulation §1.501(r)-6(b).²⁰³ In addition, either the FAP or the billing and collections policy must also describe the process and time frames the facility will use in taking these actions, including any reasonable efforts the facility will make to determine whether an individual is eligible for financial assistance under the facility's FAP.²⁰⁴ In addition, the policy must describe the body with the final authority and responsibility for determining that the facility has made reasonable efforts to determine whether an individual is eligible for financial assistance and therefore may engage in extraordinary collection actions against the individual.²⁰⁵ If the requirements of this section are satisfied by a separate billing and collections policy, the FAP must indicate that such is the case and explain how members of the public may readily obtain a free copy of this separate policy both on a website and upon request.²⁰⁶

Widely Publicizing the FAP. The hospital facility must take the following four measures to widely publicize the FAP.²⁰⁷ First, the facility must make the FAP, application form, and a plain language summary²⁰⁸ of the FAP widely available on a website. The documents must be in English and in the primary language of any populations with limited English proficiency that constitute more than the lesser of 1,000 individuals or 5 percent of the community served by the facility.²⁰⁹ Second, the facility must make paper copies of the FAP, application form, and the plain language summary of the FAP available upon request and without charge, both by mail and in public locations in the hospital facility. Third, the facility must notify and inform members of the community served by the facility about the FAP in a manner reasonably calculated to reach those members of the community who are most likely to require financial assistance. For example, the facility could distribute information sheets summarizing the FAP to local public agencies and nonprofit organizations that address the health needs of the community's low-income populations. Last, the facility must notify and inform visitors to the facility about the FAP by offering a paper copy of the plain language summary to patients as part of the intake or discharge process, including a conspicuous written notice on billing statements about the availability of financial assistance, and setting up in the facility a conspicuous display or other measure reasonably calculated to attract the attention of visitors.

Additionally, a hospital facility must establish a written policy that requires the facility to provide, without discrimination, care for emergency medical conditions to individuals regardless of whether they are eligible for financial assistance.²¹⁰ Any hospital policy or procedure that discourages individuals from seeking emergency medical care, such as demanding that emergency patients pay before receiving treatment or permitting debt collection activities in the emergency department, may jeopardize a facility's compliance with this requirement.²¹¹ Therefore, the facility's policy must prohibit debt collection activities in the emergency department or other hospital venues where such activities could interfere with emergency medical treatment.

A hospital organization is considered to have adopted the required financial assistance policy, billing and collections policy, and emergency medical care policy only if an authorized body of the hospital facility has adopted the policy for the facility and the facility has implemented (i.e., consistently carried out) the policy.²¹²

Limitation on Charges. The facility may not charge for emergency or medically necessary care provided to individuals covered under its financial assistance policy more than it charges individuals who have insurance covering such care.²¹³ In the case of all other medical care covered under the FAP, the facility must limit the amount it charges to less than the gross charges for such care.²¹⁴

Billing and Collection Requirements. Before initiating extraordinary collection actions (ECAs), the organization must make a reasonable effort to determine whether the patient qualifies for financial assistance under the organization's financial assistance policy.²¹⁵ This includes making ECAs against any other individual who has accepted or is required to accept responsibility for the patient's hospital bills.²¹⁶ In addition, the facility will be considered to have engaged in an ECA against an individual if any purchaser of the individual's debt or any debt collection agency or other party to which the facility has referred the debt to has engaged in an ECA against the individual.²¹⁷

ECAs are defined as the following actions taken by a facility against an individual related to obtaining payment of a bill for care covered under the FAP:²¹⁸

1. Selling an individual's debt to another party.²¹⁹
2. Reporting adverse information about the individual to consumer credit reporting agencies or credit bureaus.
3. Deferring or denying, or requiring a payment before providing, medically necessary care because of an individual's nonpayment of one or more bills for previously provided care under the hospital facility's FAP.
4. Actions that require a legal or judicial process, including, for example, placing a lien on an individual's property²²⁰ or causing an individual's arrest.

A facility is considered to have made reasonable efforts to determine whether an individual is eligible for financial assistance if the facility (1) notifies the individual about the FAP before initiating any ECAs and refrains from initiating such ECAs for at least 120 days from the date the facility provides the first post-discharge billing statement for the care; (2) in the case of an individual who submits an incomplete FAP application during the application period,²²¹ provides the individual with information relevant to completing the application and gives the individual a reasonable opportunity to do so; and (3) in the case of an individual who submits a complete FAP application, makes and documents a determination as to whether the individual is FAP eligible (and meets certain other specified requirements described later).²²² For these purposes, “notification” is deemed to occur only if the facility does the following at least 30 days before initiating one or more ECAs to obtain payment for the care:²²³

1. Provides the individual with a written notice that indicates financial assistance is available for eligible individuals, that identifies the ECA(s) that the facility intends to initiate to obtain payment for the care, and states a deadline after which such ECA(s) may be initiated that is no earlier than 30 days after the date the written notice is provided.
2. Provides the individual with a plain language summary of the FAP.
3. Makes a reasonable effort to orally notify the individual about the FAP and about how the individual may obtain assistance with the FAP application process.

If an individual submits an incomplete FAP application during the application period, the facility must suspend any ECAs to obtain payment for care and provide the individual with a written notice that describes the additional information and/or documentation required under the FAP or FAP application form that must be submitted to complete the FAP application, and includes the contact information of the facility office or nonprofit organization/government agency that can provide assistance with the FAP application process.²²⁴ If an individual submits a complete FAP application during the application period, the facility must suspend any ECAs to obtain payment for care, make a determination as to whether the individual is FAP eligible and notify the individual in writing of this eligibility determination, and if the individual is eligible, must also do the following:²²⁵

1. If the individual is determined to be eligible for assistance other than free care, provide the individual with a billing statement that indicates the amount the individual owes for the care as a FAP-eligible individual and how that amount was determined, and that states how the individual can get information regarding the AGB for the care.
2. Refund to the individual any amount he or she has paid for the care that exceeds the amount he or she is determined to be personally responsible for paying as a FAP-eligible individual, unless such amount is less than $5.
3. Take all reasonably available measures to reverse any ECA taken against the individual to obtain payment for the care.

A hospital facility will not have made reasonable efforts to determine whether an individual is FAP eligible if the facility bases its determination that the individual is not FAP eligible on information that the hospital facility has reason to believe is unreliable or incorrect, or on information obtained from the individual under duress or through the use of coercive practices.²²⁶ For this purpose, a coercive practice includes delaying or denying emergency medical care until the individual has provided information requested to determine whether the individual is FAP eligible for the care being delayed or denied.

In order to ensure that individuals have sufficient opportunity to consider whether they might be eligible for assistance under the facility's FAP, a facility will not be considered to have made reasonable efforts to determine whether an individual is FAP eligible simply because it obtains a signed waiver from the individual.²²⁷ Thus, a signed statement that the individual does not wish to apply for assistance under the FAP or to receive certain notifications about the FAP will not constitute a determination of FAP eligibility or satisfy the requirement to make reasonable efforts to determine eligibility before engaging in ECAs against the individual.

Failures to Satisfy the Requirements of Section 501(r). Except as provided in the following, a hospital organization failing to meet one or more of the requirements of § 501(r) with respect to one or more hospital facilities it operates may have its § 501(c)(3) status revoked as of the first day of the tax year in which the failure occurs.

Minor and inadvertent omissions and errors:²²⁸ A hospital facility's omission of required information from its CHNA, financial assistance policy, or emergency medical care policy, or error with respect to the implementation or operational requirements described in §1.501(r)-3 through §1.501(r)-6, will not be considered a failure to meet a requirement of §501(r) if the omission or error was minor and either inadvertent or due to reasonable cause and the hospital facility corrects such omission or error as promptly after discovery as is reasonable given the nature of the omission or error. Such correction must include establishment of practices or procedures reasonably designed to promote compliance.

Excusing Certain Failures if a Hospital Facility Corrects and Makes Disclosure. ²²⁹ A hospital facility's failure to meet one or more of the requirements described in §1.501(r)-3 through §1.501(r)-6 that is neither willful nor egregious shall be excused if the facility corrects and makes disclosure in accordance with future guidance such as a Revenue Procedure or Notice. For purposes of this provision, the term “willful” would include a failure due to gross negligence, reckless disregard, or willful neglect. An egregious failure includes only a very serious failure, taking into account the severity of the impact and the number of affected persons.

Facts and circumstances considered in determining whether to revoke §501(c)(3) status include:²³⁰

1. Whether the organization has previously failed to meet the requirements of §501(r) and, if so, whether the same type of failure previously occurred;
2. The size, scope, nature, and significance of the organization's failure(s);
3. In the case of an organization that operates more than one facility, the number, size, and significance of the facilities that have failed to meet the §501(r) requirements relative to those that have complied with the requirements;
4. The reason for the failure(s);
5. Whether the organization, had prior to the failure, established practices and procedures reasonably designed to promote and facilitate overall compliance with the §501(r) requirements;
6. Whether the practices and procedures had been routinely followed and the failure(s) occurred through an oversight or mistake in applying them;
7. Whether the organization has implemented safeguards that are reasonably calculated to prevent similar failures from occurring in the future;
8. Whether the organization corrected the failure(s) as promptly after discovery as is reasonable given the nature of the failure(s); and
9. Whether the organization took the measures described in 7 and 8 above before the IRS discovered the failure(s).

Taxation of Noncompliant Hospital Facilities. ²³¹ If a hospital organization operating more than one hospital facility fails to meet the §501(r) requirements with respect to a facility but continues to maintain its exemption under §501(c)(3), then the income from the noncompliant facility will be subject to income tax (either corporate or trust, depending on how the exempt organization was formed) and reported on Form 990-T. The gross income and allowed deductions of a noncompliant hospital facility may not be aggregated with the gross income and allowed deductions of another noncompliant hospital facility, nor may it be aggregated with the organization's unrelated trade or business activities.