Chapter 4 Federal Income Tax Learning Objectives Benefits of tax-exempt status Ways that tax-exempt status may be lost IRS pressure on tax-exempt hospitals How a hospital can provide community benefit Problems with “excess benefit transactions” Legally-safe physician recruitment incentives Tax-exempt status in a joint venture Tax-exempt status compliance program Introduction Tax-exemption for health care entities is available under section 501(c)(3) of the Internal Revenue Code. The largest segment of the health care industry composed of non-profit entities are hospitals. Tax-exempt status of non-profit hospitals has become a hot issue, legally and politically. Benefits of Tax-Exempt Status Need not pay federal income taxes Generally need not pay state income taxes, state/local sales taxes, and property taxes Donations to exempt entities are tax deductible Exempt entities may receive foundation and government grants May use tax-exempt bond financing Free from pressure of shareholders Indications That a Hospital Does Not Deserve Tax-Exempt Status Few free or discounted care patients Minimal dollar value of free care Unpaid bills immediately sent to collections Uninsured patients charged full rates Failure to publicize indigent patient policies Failure to provide community benefits No allocation of revenue surplus to research, education, and medical training Requirements for Hospital Tax-Exempt Status Community benefits Excess benefit transactions Unrelated business income Transparency requirements under PPACA Physician recruitment and retention Mergers and acquisitions, joint ventures Tax-exempt bond financing Community Benefit Standard Activities the IRS looks for in determining if a non-profit organization has met its community benefit standard. Community-oriented governing board Open staff privileges Emergency medical care Non-emergency medical care Use of surplus funds Charity care Health promotion 7 Excess Benefit Transactions Providing economic benefit to a “disqualified person” without receiving something of equivalent fair market value in return. Definition of “disqualified person”. Recipient of excess benefit pays excise tax. Managers approving the transaction liable for 10% tax on excess amount. Compensation tied to % of net earnings. Unrelated Business Income Money-making activities unrelated to an entity’s charitable purpose. Hospital gift shops and parking garages. Income generated by an activity “regularly carried on” and not substantially related to charitable purpose is taxed at normal corporate rates. New Transparency Requirements Under PPACA Community health needs assessment every 3 years Written financial assistance policy and emergency care policy Avoid abusive billing and collection practices Hospital emergency care charges for uninsured patients no higher than for insured patients Every 3 years, IRS review of hospital’s community benefit activities Physician Recruitment & Retent ...

1. Chapter 4
Federal Income Tax
Learning Objectives
Benefits of tax-exempt status
Ways that tax-exempt status may be lost
IRS pressure on tax-exempt hospitals
How a hospital can provide community benefit
Problems with “excess benefit transactions”
Legally-safe physician recruitment incentives
Tax-exempt status in a joint venture
Tax-exempt status compliance program
Introduction
Tax-exemption for health care entities is available under section
501(c)(3) of the Internal Revenue Code.
The largest segment of the health care industry composed of
non-profit entities are hospitals.
Tax-exempt status of non-profit hospitals has become a hot
issue, legally and politically.
Benefits of Tax-Exempt Status
Need not pay federal income taxes
Generally need not pay state income taxes, state/local sales
taxes, and property taxes

2. Donations to exempt entities are tax deductible
Exempt entities may receive foundation and government grants
May use tax-exempt bond financing
Free from pressure of shareholders
Indications That a Hospital Does Not Deserve Tax-Exempt
Status
Few free or discounted care patients
Minimal dollar value of free care
Unpaid bills immediately sent to collections
Uninsured patients charged full rates
Failure to publicize indigent patient policies
Failure to provide community benefits
No allocation of revenue surplus to research, education, and
medical training
Requirements for Hospital
Tax-Exempt Status
Community benefits
Excess benefit transactions
Unrelated business income
Transparency requirements under PPACA
Physician recruitment and retention
Mergers and acquisitions, joint ventures
Tax-exempt bond financing
Community Benefit Standard
Activities the IRS looks for in determining if a non-profit
organization has met its community benefit standard.
Community-oriented governing board
Open staff privileges
Emergency medical care

3. Non-emergency medical care
Use of surplus funds
Charity care
Health promotion
7
Excess Benefit Transactions
Providing economic benefit to a “disqualified person” without
receiving something of equivalent fair market value in return.
Definition of “disqualified person”.
Recipient of excess benefit pays excise tax.
Managers approving the transaction liable for 10% tax on
excess amount.
Compensation tied to % of net earnings.
Unrelated Business Income
Money-making activities unrelated to an entity’s charitable
purpose.
Hospital gift shops and parking garages.
Income generated by an activity “regularly carried on” and not
substantially related to charitable purpose is taxed at normal
corporate rates.
New Transparency Requirements Under PPACA
Community health needs assessment every 3 years
Written financial assistance policy and emergency care policy
Avoid abusive billing and collection practices

4. Hospital emergency care charges for uninsured patients no
higher than for insured patients
Every 3 years, IRS review of hospital’s community benefit
activities
Physician Recruitment & Retention
In order to offer physician recruitment incentives, hospitals
must do the following:
Demonstrated community need for physician
Or located in Health Professional Shortage Area
Formal written physician recruitment policy
Recruitment package negotiated at arm’s length
Market-reasonable financial incentives
Each package approved by board of directors
Mergers and Acquisitions
These transactions must be conducted at FMV.
Hospital buys physician practice at inflated price, or sells assets
at below FMV.
Be able to demonstrate FMV of the exchange; professional
valuation is key.
Risk of anti-kickback and Stark violations.
For-profit entity buys a non-profit entity.
Joint Ventures
Tax-exempt entity partners with non-tax-exempt entity.
Venture serves hospital’s charitable purpose.
Venture gives priority to exempt purposes over maximizing
profits.
Hospital does not yield control of its activities to its non-tax-

5. exempt partner.
Tax-Exempt Bond Financing
Must use bond proceeds to advance the hospital’s charitable
purposes.
Put to a “qualified use” not a “private use”.
Management & service contracts present special risk; IRS has
defined 6 safe harbors.
Reasonable contract compensation, not based on share of
profits, qualified user free to terminate contract, and contract
term limits.
Employment Taxes
Are medical directors and clinic physicians employees of a
hospital?
Hospital’s degree of control over the physician’s work activities
is key.
Physician has no private practice, paid a fixed salary, hospital
provides supplies and support, submits claims for physician’s
work, and is on duty at the hospital during specified hours.
Steps to Protect Tax-Exempt Status
Incorporate exempt status measures in overall compliance
program.
Concentrate on high risk areas, use checklists to keep
transactions and arrangements within legal limits.
Document employee training, compliance reviews and other
measures, and procedures for identifying & resolving violations.