Endangered species? Not-for-profit hospitals face tax-exemption challenge: How can you maintain your organization's tax-exempt status? One way is to participate in the debate over how to measure charity care and community benefits

Healthcare Financial Management, Sept, 2004 by Lisa Simonson Maiuro, Helen Schneider, Nicole Bellows

The service you do for others is the rent you pay for the time you spend on earth.

--Muhammad Ali

In February 2004, the Illinois Department of Revenue revoked the tax-exempt status of Provena Covenant Medical Center, a Catholic-affiliated not-for profit hospital in Urbana, because local tax authorities determined that it was not a charitable institution--a decision that the February 19 Wall Street Journal described as an "unusual move that is sending shock waves across the hospital industry." Not-for-profits across the country may be wondering, "Am I next?"

Not-for-profit hospitals have been under increased scrutiny as local and state governments have become more concerned about holding these hospitals accountable to their communities for their tax exempt benefits. With states facing severe budget deficits and the uninsured population totaling more than 43.6 million nationwide in 2002 (according to the U.S. Census Bureau), state policymakers have begun to debate more than ever the question "Are we getting enough in return for the tax exemptions granted to not-for-profit hospitals?" Not-for-profits that wish to preserve their tax-exempt status should make a strong effort to play an active role in this policy debate, because the definition of "community benefit" that policymakers use as a basis for answering this question could influence their decisions about whether hospitals are meeting their obligation to retain tax exemption.

More than 20 states have community-benefit reporting requirements designed to tackle the question of whether not-for-profit hospitals are worthy of tax exemption. Yet even in these states, the requirements vary in nature and scope, and determining whether a given not-for-profit hospital's tax exemption is "safe" may be impossible because the methods for economic valuation tend to be unclear and the criteria for providing adequate charity care are often not defined.

To understand the ramifications of these differences and ambiguities, the authors conducted a multivariate study of the effect of market conditions on the provision of charity care over a three-year period (1998-2000). Data for the study were obtained from the California Office of Statewide Health Planning and Development (OSHPD) Annual Disclosure Reports. The California data were used to examine and quantify the potentially variable nature of charity care reporting by addressing the following questions:

* What are the alternate ways that charity care may be defined given the flexibility available to hospitals in reporting this measure?

* To what degree do these alternate definitions differ?

* What policy changes may be considered to make not-for-profit hospitals more accountable?

The findings described here are excerpted from the larger study. Although the research is based on California data, the general findings are applicable to hospitals across the country.

Charity Care: What Are the Legal Requirements?

In accordance with the "community benefit standard" established by the IRS in 1969, federal tax law requires not-for-profit healthcare organizations to provide services in a way that benefits their community in return for federal tax exemption. The IRS's current position on charitable obligations is reflected in a revised and updated ruling issued by the agency in 1983. The ruling states, "the promotion of health ... is deemed beneficial to the community as a whole," and on the basis of this premise, it sets forth a number of criteria for tax exemption. These criteria include the requirements that care be provided to all uninsured patients, including government sponsored patients, and that a full-time emergency department be maintained in which no one requiring emergency care can be denied treatment (although this condition may be waived).

However, the IRS did not clearly define community" benefits expected of not-for-profit hospitals. This imprecision has prompted researchers to investigate the commitment of not for profit hospitals to their communities and states. (See, for example, Reinhardt, Uwe E., "Economics of For-Profit and Not-for-Profit Hospitals," Health Affairs, Nov.-Dec. 2000, pp. 178-185; and Nicholson, Sean; Pauly, Mark V.; Burns, Lawton R.; Baumritter, Agnieshka; and Ash, David A., "Measuring Community Benefits Provided by For-Profit and Nonprofit Hospitals," Health Affairs, Nov.-Dec. 2000, pp. 168-177.)

In 1985, the Utah Supreme Court ruled in Utah County v. Intermountain Health Care that two not-for-profit hospitals did not qualify for property tax exemption based on a six-part test established by that court. The court's criteria focused narrowly on charity care rather than the federal view that recognized community health promotion, in addition to uncompensated care, as an important tax exempt function.

The 1985 decision prompted numerous tax challenges against not-for-profit healthcare organizations, with the result that many states began to develop standards for tax exemption involving requirements ranging from voluntary process-oriented reporting to more prescriptive, mandatory reporting. By 2001, 21 states had enacted legislation to address hospital charity care through state community benefit planning and reporting laws.