Risk of losing tax-exempt status could be disruption for many nonprofit hospitals

REAL ECONOMY BLOG | June 02, 2023

Authored by RSM US LLP

The tax-exempt status of nonprofit hospitals faces legislative scrutiny as members of Congress discuss the tax-exemption benefit and whether it equates to the value these organizations provide to their local communities.

In April, the House Committee on Ways and Means addressed the matter with a hearing and proposed bill titled the “Holding Nonprofit Hospitals Accountable Act.” The legislation intends to amend the definition of the so-called community benefit standard, a measure the IRS uses to determine if hospitals with tax-exempt status are operated for the charitable purpose of promoting health in their community.

How we got here

The value of tax-exempt status for hospitals is substantial and financially one of the main arteries tapped for many tax-exempt hospitals to remain solvent. According to a recent Kaiser Family Foundation study, in 2020, the total value of tax exemption for hospitals was approximately $28 billion, a 45% increase since 2011.

Since 1956, the community benefit standard has evolved under various tax code amendments. The latest update was in 2010 under the Affordable Care Act, which among other requirements, established compliance standards for nonprofit hospitals to maintain their tax-exempt status. They include conducting a community health needs assessment every three years, developing an implementation plan to address the identified needs of the community, and providing free or discounted medical services and other initiatives to improve the health and well-being of the local population.

Community benefit activities may vary depending on the type and size of the hospital, as well as the specific health needs of the community. According to the American Hospital Association’s witness statement from the April hearing, ‘’One of the greatest accomplishments of the community benefit standard is the flexibility it gives to hospitals and health systems to meet the needs of their communities. A small rural community in Montana will not have the same needs for support and services as a hospital in downtown Atlanta. And it always should be up to those communities to decide if the amount, range and focus of their hospital’s community benefit activities meets their needs.’’

Since hospitals and health systems began reporting an amount attributable to community benefits, between $894 billion to $1.3 trillion has been spent on them, the AHA’s witness statement said. Additionally, based on AHA data, from 2013 through 2020, tax-exempt hospitals’ uncompensated care costs as a percent of total hospital expenses ranged from 12% to 16% and those providers have continued to generate operating losses. As tax-exempt hospitals are beleaguered from challenges such as the combined impact of higher incidences of influenza and respiratory syncytial virus, as well as ongoing cases of COVID-19, inflation and elevated interest rates, losing tax-exempt status could be the final blow that leads to further consolidation or worse, closing the doors for some hospitals.

The proposed House bill outlines new policies, including expansion of charity care eligibility, establishment of quantitative standards for a minimum amount spent on community benefits, community involvement in hospital decision making such as requiring hospital boards to have community representation, and more.

Such a policy may affect the quality of care to patients and lead some hospitals to question whether they have the financial resources and labor capacity to implement new standards.

The takeaway

In an environment where hospitals already operate on thin or negative margins and continue to battle elevated inflation and ongoing labor shortages, the risk of losing tax-exempt status could prove to be a major disruption to long-term viability. To remain solvent, some hospitals will likely reassess critical procedures offered, and, in some instances, access to certain care may be lost. Tax-exempt providers should ensure they have the appropriate data analytics and financial tools available to provide data-driven transparency focused on the benefits they provide to their communities to protect their tax-exempt status.

Contributor: Rebekuh Eley, Partner and National Tax-exempt Health Care Industry Practice Leader