Cash flow squeeze: 2012 IRS rule will withhold some Medicare pay

With health system and payment reform issues dominating discussion this year, physicians might be forgiven if they overlooked yet another planned decrease to Medicare pay.

A little-known provision tucked into a 2005 tax bill requires the Internal Revenue Service, starting in 2012 at the earliest, to withhold 3% of payments to any contractor doing work for federal, state or local governments. The Medicaid program is excluded because it provides services based primarily on patient need. But Medicare, which is age-based, is not exempt.

That means physicians, hospitals and others who bill the government could receive only 97% of what they are owed from Medicare, starting in 2012. That 3% hit would be on top of any across-the-board cuts required by the Medicare physician payment formula.

The IRS would apply the withholding to physicians' tax obligations for the year. The remainder would be refunded after doctors file their tax returns the following spring, but in the meantime, the federal government would hold that money, interest-free.

A temporary 3% reduction may not seem like a major problem to many physicians who spent 2009 worrying about an upcoming 21% cut to Medicare pay. But for solo practitioners and smaller practices who count on Medicare pay to generate razor-thin profit margins, the policy change, if not repealed before 2012, could represent a significant squeeze to their cash flow, doctor organizations and practice managers warned.

"Practices now have difficult cash-flow problems as small businesses," said Patrick Smith, senior vice president of government affairs for the Medicare Group Management Assn. "The more pressure something like this puts on will clearly have an affect on payments as well as beneficiary access."

Physicians say the prospect of such a serious interruption to payment operations is particularly unsettling because doctors have faced several rounds of significant Medicare reductions from the sustainable growth rate formula that determines the fee schedule. Even with Congress stepping in to head off cuts, pay has not come close to keeping up with costs, physicians say.

"Cuts of this magnitude, on top of physician payment rates that, to date, have fallen well behind medical practice cost inflation, will impact Medicare beneficiary access to care," American Medical Association Executive Vice President and CEO Michael D. Maves, MD, MBA, warned in a March 5 letter to the IRS. The Association strongly opposes the Medicare withholding provision in the tax statute and continues to call on Congress to repeal it.

Fighting for a repeal

Physicians, hospitals and other health care entities say they aren't going to take the 3% withholding laying down. They've joined other government contractors in their fight.

The MGMA, the Federation of American Hospitals and America's Health Insurance Plans are members of the Government Withholding Relief Coalition, formed solely to oppose the tax provision and argue for a repeal.

Coalition members argue that the government, as well as physicians, hospitals and other contractors, will need to rework accounting systems to incorporate the withholding policy. The IRS, which is expected to issue its final rule on the statute sometime in early 2010, has not yet explained how it will keep track of the money and refund any overpayments. CMS also would need to change its Medicare claims systems.

"This is a bureaucratic nightmare not only for contractors, but the government as well," said Jeff Micklos, the hospital federation's general counsel and the executive vice president of management and compliance. "I'm not sure there have been any public statements from the IRS that are fully supportive of the policy goals of this, because they recognize the burden it's going to put on their systems."

Contractors have had some success in making their case. Reps. Kendrick Meek (D, Fla.) and Wally Herger (R, Calif.) introduced legislation in January that would repeal the tax provision. The bill had 133 co-sponsors as of Dec. 1. Sen. Arlen Specter (D, Pa.) introduced companion legislation in the upper chamber.

The House actually passed a repeal earlier this year as part of its version of the economic stimulus package. But the Senate balked at the move, and lawmakers eventually agreed to a one-year delay, pushing the effective date from January 2011 to January 2012.

Because the withholding would generate an estimated $7 billion in revenue over 10 years, largely through accelerated tax receipts, new revenue would be needed to pay for a repeal, explained Chris Braddock, senior director of procurement policy for the U.S. Chamber of Commerce. "There's significant support on the Hill to repeal this, but that, unfortunately, is proving to be difficult due to the revenue effects and other high-profile issues dominating Congress' time," said Braddock, who also manages the withholding relief coalition.

Supporters of the withholding concept say it is a necessary response to widespread failures by contractors both to pay their taxes and to render good service.

"The government has been getting less than what has been requested on some of their services, and they are tired of this pay-and-chase mechanism," said Patrick Burns, director of communications for Taxpayers Against Fraud, a watchdog group based in Washington, D.C.

The tax policy was prompted by a Government Accountability Office report released in June 2005. It projected that about 33,000 government contractors owed about $3 billion in unpaid federal taxes.

The GAO issued another report in March 2007 finding that approximately 5% of physicians and others who billed for Medicare Part B services continued to receive money from the program, despite having significant outstanding federal payroll and income tax liabilities.

Seeking alternatives

Opponents of the withholding policy are hoping to convince Congress that continuing with the 2012 plan, even with the best intentions in mind, is in nobody's best interest.

Physicians participating in Medicare don't have the luxury of being able to increase service bids by 3% to make up for the loss, but other contractors do.

The Dept. of Defense estimated it would cost more than $17 billion over the first five years alone to comply with the 3% withholding requirement. The withholding repeal coalition estimates the total costs to federal, state and local governments would be much more.

"We do not think that people should not pay their federal taxes -- just the opposite. Tax compliance is important for all levels of governments," said Susan Gaffney, director of the Federal Liaison Center for the Government Finance Officers Assn., which is representing state and local governments on this issue. "However, the withholding of 3% of payments mandate on state and local governments is not a fair or effective way of ensuring federal tax compliance."

The AMA and coalition members argue that the Federal Payment Levy Program is a better way to deal with those who fail to pay taxes. Federal officials may reduce Medicare payments for tax delinquent contractors by 15%, a levy that would stay in place until the overdue taxes are paid in full or a payment arrangement is made.

The Centers for Medicare & Medicaid Services started using the levy program in mid-2008, and it has collected $44.6 million to date, officials said.

"We have implemented it, we are doing it, and I think we're pretty successful at it, unfortunately," said Jerry Walters, director of the CMS financial services group. "Medicare does not want to be a tax collector here."

Still, Walters said CMS would be ready for the 3% withholding despite some expected challenges.

Physicians may be able to escape the withholding, even if the provision remains in place by 2012. The MGMA's Smith said defense contractors, not the medical community, appear to be the intended target of the 2005 policy. He remains hopeful that physician practices will be exempted.

But Congress might not bite when it comes to carving out an exemption, delaying the effective date further or repealing the provision outright.

In that case, physician practices eventually will need to prepare for the reality of the 3% withholding, said Mark Scroggins, principal for Clayton L. Scroggins Associates, a practice management consultation company based in Cincinnati.

"As disheartening as it would be for physicians to hear, we would have to talk about this and ask some hard questions," Scroggins said. Some practices might have to look at taking more painful steps, such as decreasing benefits for employees.