Nonprofit hospitals under scrutiny: The IRS cracks down

A spotlight is shining on nonprofit hospitals, but the attention is probably unwanted. Some of these hospitals are the unwitting co-stars in a handful of investigations and legal actions that aim to see whether they are meeting their expectations as charitable organizations.

The Internal Revenue Service has launched an investigation into whether executives at various nonprofits, including hospitals, are being paid too much in violation of their tax-exempt status. Numerous lawsuits have been filed accusing nonprofit hospitals of overcharging the uninsured. And state and local authorities, feeling that hospitals are not fulfilling their charitable missions, have cracked down on some property tax exemptions.

Bill Monnig, MD, a urologist in the Cincinnati area and chair of the Organized Medical Staff Section of the AMA, said physicians have a stake in what happens to nonprofit hospitals.

In particular, Dr. Monnig said physicians need assurances that nonprofit hospitals won't use the money they save in taxes to invest in for-profit facilities that would compete with physician practices.

"That's the threat. What needs to be made certain in these nonprofit hospitals is that they are in fact using their funds appropriately, and that there are auditing mechanisms."

"I don't think we need necessarily more laws, we just have to use the laws that are there now to hold these people accountable," he added. The AMA has taken no formal position on any of the recent investigations, lawsuits or actions directed against nonprofit hospitals.

Rick Wade, spokesman for the American Hospital Assn., said the pressure on nonprofit hospitals varies with each community.

"I think some people are trying to put them under the gun," he said. "There's a new era of public accountability coming to everybody in health care. ... I think as the public comes to look at this, they'll look in their own communities."

Abandoning their heritage?

About 85% of the nation's 5,000 hospitals are nonprofit, Wade said. He said the figure has remained fairly stable even during the 1990s, when for-profit hospital chains such as HCA and Tenet Healthcare grew their roots.

Nonprofit hospitals originally were created as extensions of religious missions, community charitable missions, universities and local governments -- entities that were typically tax-exempt, which is why they gained their own exempt status. Nowadays, virtually all nonprofit hospitals enjoy some sort of tax exemption, Wade said.

But critics charge that some nonprofit hospitals, many of which struggle with razor-thin operating margins, have lost sight of their charitable heritage. As proof, they point to the higher rates that some hospitals have charged uninsured patients. And they say the growing number of nonprofit hospitals that have engaged in business deals with for-profit entities to create ancillary services are proof that nonprofit hospitals are acting more like for-profit businesses.

For an entity to get a tax break, the IRS requires that the entity must be organized and operated exclusively for one or more of the purposes that the agency has defined, including charitable purposes, and it must not have shareholders or tie its earnings to the benefit of an individual. The IRS said "charitable purposes" could include serving the poor, distressed or underprivileged.

In July, the IRS opened an investigation into whether some nonprofits paid excessive compensation to their executives and officers.

The agency said it was contacting nearly 2,000 organizations nationwide to find out more about their compensation practices. IRS spokeswoman Nancy Mathis confirmed that nonprofit hospitals were part of the probe.

Hospital leaders had the highest salaries paid to chief executives among the nation's largest nonprofit organizations in a survey released in September by The Chronicle of Philanthropy. Salaries went as high as $1.7 million, according to the survey.

Lisa Petkun, an attorney in Philadelphia with Pepper Hamilton, LLP, who works with tax-exempt organizations, said nonprofit hospitals are big businesses that have to pay their executives "big compensation" to get the kind of talent that they need.

"I think compensation has to be competitive," she said. "I just don't see how you can get quality people if you say we need you to take a pay cut to be the CEO of a hospital."

Annual compensation surveys by a national professional services firm, the Hay Group, showed steady, modest increases over three years with all hospital CEOs earning a median base pay of $231,000 in 2001, $237,700 in 2002 and $238,500 in 2003.

Whether the IRS investigation will result in some nonprofits losing their tax exemptions or having to change the way they compensate their executives is unclear. The investigation is ongoing and is expected to continue into 2005, Mathis said.

On another front, since June, numerous lawsuits have been filed accusing hospitals of charging uninsured patients too much and engaging in unfair debt collection practices. At least one hospital, North Mississippi Health Services, reached a legal agreement to restructure its billing practice to avoid a potential lawsuit.

Mark Nagle, a health care fraud and abuse attorney with Sheppard, Mullin, Richter & Hampton LLP in Washington, D.C., said he had counted about three dozen lawsuits filed against various hospitals so far and expects to see more in coming months.

He said the lawsuits are "a very difficult thing for a charitable hospital to deal with" and could force some to enter into settlements rather than endure trials.

State and local taxing authorities also could shape how nonprofit hospitals do business.

For example, in February, the Illinois Dept. of Revenue denied a request for a charitable property tax exemption for Provena Covenant Medical Center, a nonprofit, 270-bed acute care hospital that had been operating as a charitable entity in Urbana for decades, said Patrick S. Coffey, an attorney with Gardner, Carton & Douglas, LLP, in Chicago, who represents the hospital.

The state's ruling concerning the 2002 tax year meant that Provena owed about $1.3 million to $1.4 million in property taxes, which it has started paying, Coffey said.

The ruling followed recommendations from a local review board that concluded in a report that the hospital shouldn't be granted the tax exemption because it allowed outside for-profit entities, including some physician groups, to use its facilities for generating profits, among other things.

Provena has appealed the Illinois Revenue Dept.'s decision and was expecting a hearing on the issue before the end of the year.

Defining a charity

It can be difficult to define precisely what a nonprofit hospital can do to fulfill its duty as a charitable organization to provide community benefits, said Rev. Michael D. Place, president and chief executive officer of the Catholic Health Assn. of the United States, a leadership organization for the nation's Catholic health ministry.

"You have to step back and look at what is the relationship of a health care provider to patients and a community," he said. "[But] what would be appropriate in one community may not be appropriate for another."

For example, Place said, a hospital in an urban environment with a high percentage of patients who were addicted to crack cocaine would serve the community well by having a neonatal intensive care unit with staff trained in helping babies with addictions. But the same program might not be appropriate for a hospital with a large geriatric population and few drug users, he said.

Being able to prove that they are providing tangible benefits to the community might some day help nonprofits if their tax exemptions are challenged further.

Lois Richardson, vice president and legal counsel for the California Healthcare Assn., a state hospital organization, said the IRS considers the fact that a community has a hospital to be a community benefit.

"You are benefited by the mere fact that a hospital is there," she said. "And assuming the hospital has an emergency room, that's probably enough" to fulfill the obligation of providing community benefits.

Indeed, the nation's hospitals say they offer substantial community benefits by providing billions of dollars worth of uncompensated care each year. And some of the hospitals offering that care and other community benefits are for-profit. Wade said nonprofits do more along these lines, largely because there are more of them out there.

"Our view is that every hospital in America ought to be able to stand up in public and justify what they are doing," he said. "And they should be constantly listening to their communities."