March 10, 2009
Previously published on March 2, 2009
On February 12, 2009, the Internal Revenue Service (IRS) issued its Final Report on the agency’s Hospital Compliance Project (Project), a study on tax-exempt hospitals. The Project began in 2006 and was conducted by the IRS in order to better understand tax-exempt hospitals and their practices regarding community benefit expenditures and payment of executive compensation. The IRS sent a Project questionnaire to 544 hospitals across the United States and closely examined 20 tax-exempt hospitals regarding their executive compensation practices. The Final Report analyzed the responses to the questionnaire to determine the provision of community benefits by surveyed hospitals, and the processes that tax-exempt hospitals use to determine executive compensation.
The IRS uses a facts and circumstances analysis to assess whether a hospital meets the community benefit standard for tax exemption under Section 501(c)(3) of the Internal Revenue Code. The questionnaire requested specific information from the hospitals relating to patient mix, medical staff privileges, medical research, uncompensated care and community programs to help assess whether the respondents met the community benefit standard.
Tax-exempt hospitals must pay no more than reasonable compensation to their officers, directors, trustees and other disqualified persons. Organizations generally rely on the rebuttable presumption standard in order to establish that compensation paid to their executives is reasonable. Under that standard, an organization may place the burden of proving excess compensation on the IRS by using independent third parties to compare compensation at similar entities and establish compensation guidelines for salary and benefits paid to officers, directors and other key individuals of a tax-exempt organization.
The study divided the hospitals surveyed into four community types based on location of the particular hospital and census data. The organizations were further classified by revenue size based on annual revenues as reported on IRS Form 990. Regarding community benefits, the IRS found that:
- Community benefit expenditures by the reporting hospitals averaged nine percent of revenue. Expenditures were lowest for rural hospitals and highest for high population hospitals.
- The largest category of reported community benefit expenditure for all hospitals was uncompensated care. The average uncompensated care as a percentage of total revenues was approximately seven percent over all hospitals.
- Hospitals reported average excess revenues of approximately five percent of their total revenues. Generally, the percentage of excess revenues increased with hospital size. However, 21 percent of all responding hospitals reported that total expenses exceeded total revenues.
- There was no correlation between community benefit expenditures and per capita income levels of the hospital’s geographic service area. However, community benefit expenditures generally increased as the rate of uninsured patients in the particular hospital’s geographic area increased.
The IRS found in the executive compensation portion of the Project that:
- Average annual total compensation paid to the top management official (CEO or president) by survey respondents was $490,000. The largest total compensation amounts were reported by high population hospitals. Critical access hospitals in rural areas reported the smallest amounts.
- Nearly all hospitals in the study reported compliance with the rebuttable presumption process.
- Of the 20 closely examined hospitals (specifically selected for their high compensation amounts), total compensation to top management officials averaged $1.4 million.
Although seemingly high compared to the national averages, the IRS reported that these amounts generally complied with the rebuttable presumption and fell within the range of reasonable compensation for hospitals when size and circumstances were considered.
In the Final Rule, the IRS set forth its observations concerning the Project and highlighted the variability of community benefit reporting across responding hospitals. Importantly, the IRS felt that a significant percentage of hospitals reported uncompensated care and total community benefit expenditures below federal exemption standards. The agency also found that a large concentration of uncompensated care was found in a relatively small number of hospitals.
The IRS further admitted that, in hindsight, many inquiries on the questionnaire were ambiguous or difficult to answer without supplemental explanation. It pledged to work closely with experts in the design of future questionnaires. The IRS expressed pleasure with the overall questionnaire response rate and noted that the quality of responses was generally “very good.” It promised to study ways to assure that response rates remain high in future tax-exempt reporting initiatives. Finally, hospitals were reminded that the Form 990, Schedule H, report will begin in the 2009 tax year. The IRS believes more accurate and complete data on community benefit expenditures will be available after implementation of the new Form 990.
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