STRATEGIC PERSPECTIVES: No Good Deed Goes Unpunished-Charitable Hospitals Should Watch Congress
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September 26, 2017
STRATEGIC PERSPECTIVES: No Good Deed Goes
Unpunished—Charitable Hospitals Should Watch
Congress
By Travis Jackson, Partner, King & Spalding LLP
Congress returns from its summer break with a far-reaching agenda that includes raising the debt ceiling, reforming the
tax code, and potentially revisiting health reform. The health care industry as a whole faces economic and regulatory
uncertainty as Congress tackles its to-do list. Charitable hospitals find themselves particularly vulnerable in this legislative
season as questions resurface about whether these hospitals do enough to justify the tax breaks and other benefits they
enjoy. Charitable hospitals should pay close attention to these questions, demonstrate their compliance with existing
regulatory requirements, and advocate for the vital role they play in their communities. Ignoring these questions could
make it easier for Congress, the Internal Revenue Service (IRS), or other agencies to change tax-exemption standards,
restrict the 340B Drug Pricing Program, or cut Medicaid funding.
Increasing Scrutiny over How Charitable Hospitals Benefit Their Communities
Just a few quick Google searches show that reporters, advocacy groups and scholars have resurrected questions about
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the role charitable hospitals play in their communities. Sensational headlines cry out from pieces like How Hospitals Got
2 3
Richer Off Obamacare, How Hospitals Turn Community Care and Taxpayer Subsidies into Capital, and Very Profitable
4
Nonprofit Hospitals . . . But Where Are the Profits Going? These articles present a consistent, but misleading theme:
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charitable hospitals do not benefit their communities in a way that justifies the tax breaks they receive. This recurring
message discounts the regulatory framework within which charitable hospitals must operate, and it distorts the benefit
charitable hospitals provide to their communities. These pieces provide an incomplete view of charitable hospitals for the
public and, perhaps more concerning, for Congress, the IRS, and other regulatory agencies.
Charitable hospitals come in many shapes and sizes, fulfilling distinctive missions, with different resources in communities
with disparate needs. Some are small, critical access hospitals in sparsely populated rural towns dedicated to operating
the only emergency department or inpatient facility for miles. Other charitable hospitals might devote their resources to
serving densely populated urban areas. Still others may be academic facilities committed to teaching and training the next
generation of physicians and nurses while also conducting research in the hope of discovering breakthrough treatments
for cancer, heart disease, HIV, or other pressing health issues. These inherent differences make it impossible to establish
a one-size-fits-all approach for determining what a hospital must do to receive charitable status.
1
See, e.g., Shefali Luthra, Nonprofit Hospitals Focused More on Community Needs under the ACA: That May Change, Washington
Post, March 14, 2017.
2
Dan Diamond, Politico, July 17, 2017.
3
David Williams, President of the Taxpayers Protection Alliance, The Daily Caller, July 26, 2017.
4
Bruce Y. Lee, Contributor, Forbes, May 8, 2016, (citing Ge Bai and Gerard Anderson, A More Detailed Understanding of Factors
Associated with Hospital Profitability, Health Affairs,).
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See, e.g., Diamond (“The ACA did nothing more to force the hospitals to share their revenue with their neighbors or taxpayers
generally.”); Williams (“Lawmakers may be reticent to turn a critical eye on such large employers, but these facilities are taking
advantage of taxpayer dollars without providing the promised community care.”); and Lee (“However, if the study results are a sign
that innovation-stimulating competition is being suppressed and that profits are being steered into maintaining the status quo, then
change is needed so that more people, patients and businesses throughout society can actually ‘profit.’”).The IRS has struggled with how to distinguish for-profit from charitable hospitals for more than 60 years. In 1956, the IRS
focused on the amount of free care a charitable hospital provided by requiring it to operate “to the extent of its financial
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ability for those not able to pay for the services rendered . . ..” The IRS followed this broad pronouncement with an
immediate caveat: “The fact that its charity record is relatively low is not conclusive that a hospital is not operated for
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charitable purposes to the full extent of its financial ability.” This standard proved difficult for charitable hospitals to
interpret and impractical for the IRS to administer, particularly when set against the enactment of Medicare and Medicaid
in 1965, which brought health care to millions of elderly and indigent patients.
The IRS acknowledged the diversity among charitable hospitals in 1969 when it shifted its focus from charity care and
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developed the “community benefit standard.” In drawing the line between charitable and for-profit hospitals, the IRS said
it would look for facts demonstrating a hospital benefited its community, such as being led by a community board of
directors, making staff privileges available to all qualified physicians, operating a full-time emergency department open to
all regardless of ability to pay, and using any financial surplus to expand and replace facilities, improve patient care, and
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provide medical training, education, and research. Significantly, the IRS noted a hospital could qualify as charitable even
if it “ordinarily limits admissions to those who can pay the cost of their hospitalization, either themselves, or through
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private health insurance, or with the aid of public programs such as Medicare.” Not surprisingly, the IRS expressly
disavowed its previous focus on charity care by stating the new standard removed “the requirements relating to caring for
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patients without charge or at rates below cost.”
Ultimately, the community benefit standard proved just as difficult as the prior test for charitable hospitals to understand
and the IRS to apply. In 1983, the IRS determined that operating an emergency room was not necessarily required for
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charitable status. The IRS realized imposing such a requirement might preclude exemption for eye, cancer, and other
specialty hospitals and, therefore, removed that constraint on those provider types. In 2001, the IRS revived its focus on
charity care by emphasizing in advice to its agents the “provision of free or subsidized care to the indigent is a significant
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indicator . . . that a hospital promotes health for the benefit of the community.”
The IRS further defined the community benefit standard in 2008 when it redesigned the federal informational return (Form
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990) that charities and other tax-exempt organizations must file. The redesigned Form 990 did not itself make any new
law, but it identified factors the IRS looks for in quantifying the community benefit a hospital provides. The IRS did not let
charitable hospitals establish the rules for calculating community benefit themselves. Instead, the IRS determined
charitable hospitals could only count the following activities as community benefit:
financial assistance, including the cost of charity care and dollars lost serving Medicaid patients;
community health improvement services and community benefit operations;
health professions education;
subsidized health services;
research; and
cash and in-kind contributions for community benefit activities.
15
In creating these categories, the IRS ensured hospitals benefitted the community as a whole, rather than the hospital
itself. For example, charitable hospitals cannot count training programs available exclusively to its employees and medical
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staff as “health professions education.”
Additionally, many activities a charitable hospital may undertake—or critics may expect them to undertake—do not count
as community benefit for exemption purposes. The IRS specifically excludes worthwhile activities that may enhance the
6
Rev. Rul. 56-185, 1956-1 C.B. 202.
7
Id.
8
Rev. Rev. 69-545, 1969 C.B. 1969-2 C.B. 117.
9
Id.
10
Id.
11
Id.
12
Rev. Rul. 83-157, 1983-2 C.B. 94.
13
Field Serv. Adv. 200110030, March 9, 2001.
14
See, e.g., https://www.irs.gov/charities-non-profits/form-990-redesign-for-tax-year-2008-filed-in-2009.
15
2016 Form 990, Schedule H, Part I, at Lines 7a to 7i.
16
Instructions to Schedule H, at p.18.
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2communities or neighborhoods in which charitable hospitals operate, such as investments in housing, economic
17
development, environmental improvements, and workforce development, although hospitals may report the cost of
engaging in these activities on their Forms 990, which are publically available. However, because such activities do not
count as “community benefit,” the contributions many charitable hospitals make to their communities are shortchanged in
the eyes of the public or, perhaps worse, discouraged by these restrictions.
At the same time the IRS worked to define the community benefit standard more rigorously, Sen. Chuck Grassley (R-
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Iowa) and other members of Congress became concerned over reported abuses by charitable hospitals. Many of
Grassley’s proposals to reform charitable hospitals found their way into the Patient Protection and Affordable Care Act
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(ACA) as the new Section 501(r) of the Internal Revenue Code. Now, in addition to satisfying the community benefit
standard, charitable hospitals must assess the health needs of their communities at least once every three years; develop
a strategy for addressing high priority health needs; adopt and publicize a financial assistance policy; implement an
emergency care policy; limit charges for emergency and medically necessary care if a patient qualifies for financial
assistance; and refrain from taking certain collection actions before making reasonable efforts to determine whether a
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patient qualifies for financial assistance.
Section 501(r) did not provide charitable hospitals a free pass. It has bite. One hospital has lost its charitable status for
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failing to comply with Section 501(r), and more penalties and revocations are likely on the way as the IRS fulfills its
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obligation to review each charitable hospital for compliance with Section 501(r) at least once every three years. The IRS
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has even trained 30 additional agents to assist in this task.
Ultimately, the community benefit standard and the additional requirements of Section 501(r) create a complex framework
that hospitals must navigate to receive and retain their tax-exempt status. This complexity—coupled with the public
availability of Form 990—invites criticism about the actions or inactions of charitable hospitals. Charitable hospitals often
have difficulty responding to these criticisms because explaining technical IRS rules, including the types of benefits that
count as “community benefit,” does not lend itself to a catchy sound bite. Nonetheless, charitable hospitals must be
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mindful of these critics because they often call on Congress to take “a hard look at our nation’s nonprofit hospitals,” and
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Grassley and others have historically shown a desire to answer these calls.
Potential 340B Program Changes Could Affect Many Charitable Hospitals
Questions about the amount of community benefit charitable hospitals provide are not the only criticisms some hospitals
have encountered. Many also face scrutiny over their participation in the federal 340B Drug Pricing Program (340B
Program). Congress established the 340B Program 25 years ago to provide greater access to health care services
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without spending additional federal funds. The 340B Program requires pharmaceutical manufacturers who desire
Medicaid coverage for their products to sell outpatient drugs to certain safety net providers, including many charitable
hospitals, at discounts of up to 50 percent. Participating providers may then dispense drugs purchased at these discounts
to their patients, including those who have Medicare or commercial insurance. Congress expanded the types of providers
27
that qualify for the 340B Program in the ACA. This expansion created a white-hot political issue, as some estimate that
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annual outpatient drug sales under the 340B Program will exceed $23 billion by 2021.
17
2016 Form 990, Schedule H, Part II, at Lines 1 to 10.
18
See, e.g., John Carreyrou and Barbara Martinez, Grassley Targets Nonprofit Hospitals on Charity Care, Wall Street Journal,
December 18, 2008.
19
Press Release, Grassley’s Provisions for Tax-exempt Hospital Accountability Included in New Health Care Law March 24, 2010 see
also Section 9007 of the Patient Protection and Affordable Care Act (ACA) (P. L.111-148).
20
26 U.S.C. §501(r).
21
Final Adverse Determination Letter 201731014, dated February 14, 2017, released August 4, 2017.
22
ACA Sec. 9007(c) .
23
See, e.g., Michael Cohn, IRS Revokes Hospital’s Tax Exemption, Accounting Today, August 21, 2017.
24
David Williams, President of the Taxpayers Protection Alliance, The Daily Caller, July 26, 2017
25
Joe Carlson, Grassley, Bingaman Push Charity Care Standards, Modern Healthcare, February 6, 2009.
26
See, e.g., https://www.hrsa.gov/opa/index.html (stating, “The 340B Program enables covered entities to stretch scarce Federal
resources as far as possible, reaching more eligible patients and providing more comprehensive services.”).
27
ACA Sec. 7101.
28
Berkeley Research Group, 340B Program Sales Forecast: 2016 – 2021.
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3The Health Resources and Services Administration (HRSA) administers the 340B Program, but after a well-publicized
lawsuit with the Pharmaceutical Research and Manufacturers of America, the U.S. District Court for the District of
Columbia found HRSA lacks the statutory authority necessary to issue binding regulations on key aspects of the 340B
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Program. Without the ability to establish clear rules, HRSA has attempted to govern the 340B Program largely through
vague, occasionally contradictory guidance for hospitals and manufacturers alike. Many in Congress and elsewhere are
now asking whether HRSA’s inability to implement binding regulations for the 340B Program has allowed participating
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hospitals to enrich themselves at the expense of drug manufacturers and ineligible providers. Rep. Joe Barton (R-
Texas) echoed these concerns on July 18, 2017, during a Congressional hearing by stating, “We all support the program,
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but it has grown topsy-turvy.”
CMS did not wait for Congress to act on these criticisms and threw a curve ball at participating 340B hospitals in its
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Proposed rule for the 2018 Outpatient Prospective Payment System (OPPS). CMS proposed reducing Medicare Part B
reimbursement for separately payable, non-pass-through outpatient drugs and biologicals purchased under the 340B
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Program from a current rate of average sales price (ASP) plus 6 percent to ASP minus 22.5 percent. Translated into
practical terms, if a drug costs $50,000, Medicare would pay a 340B Program hospital $38,750 under the OPPS instead of
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the $53,000 the hospital receives now. CMS estimates these reductions would decrease Medicare payments to 340B
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Program hospitals by approximately $900 million. On August 21, 2017, after hearing from many charitable hospitals and
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their allies, a CMS advisory panel voted against finalizing this proposal, but whether CMS will heed the advice of this
panel remains to be seen.
Health Reform May Also Disproportionately Impact Charitable Hospitals
Charitable hospitals also face questions with significant operational consequences arising from whether Congress will
ultimately repeal and replace or retain but fix the ACA. The Senate’s failure to pass the Better Care Reconciliation Act of
2017 does not necessarily mean Congress will steer clear of health reform this fall. President Trump has indicated a
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strong desire for the House and Senate to “get back to work” on health reform, and the Senate Health, Education, Labor
and Pensions Committee has announced it will hold two hearings in September on stabilizing the individual insurance
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market.
Congress’s answers to questions about how individuals obtain health coverage and who pays for it may have a
disproportionate impact on charitable hospitals. For example, the Congressional Budget Office estimated 49 million
people would be uninsured by 2026 if the Better Care Reconciliation Act of 2017 had been enacted, due in large part to
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changes in Medicaid financing and removal of the individual insurance mandate. This is approximately 21 million more
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people than are projected to be uninsured under the current health care law. According to a 2015 study, the burden of
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caring for these individuals would primarily fall on charitable hospitals. Such hospitals “fill the gaps in the existing social
health insurance system to a degree that is not true of for-profit hospitals,” challenging the perception that charitable
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hospitals are just “for-profits in disguise.”
29
Pharmaceutical Research and Mfrs. of Am. v. U.S. Dep’t of Health and Human Servs., No. 13-1501-RC (D.D.C. 2014).
30
Andrew Pollack, Dispute Develops Over Discount Drug Program, New York Times, February 12, 2013.
31
Kaiser Health News, Congressional Hearing Examines Concerns about Oversight, Abuse of 340B Drug Discount Program, July 19,
2017.
32
Proposed rule, 82 FR 33558, July 20, 2017.
33
Id. at 33632.
34
See also Virgil Dickson, CMS Proposes Slashing 340B Rates, Paying for Joint Procedures at Outpatient Facilities, Modern
Healthcare, July 13, 2017.
35
Proposed rule, 82 FR 33558 at 33711, July 20, 2017.
36
Virgil Dickson, Influential Advisory Panel Asks CMS to Reject $1.65 Billion in Cuts to 340B, Modern Healthcare, August 21, 2017.
37
Jessica Taylor, Trump to McConnell: 'Get Back To Work' On Health Care, Washington Post, August 9, 2017.
38
Robert Schroeder, Senate Health Committee to Hold Hearings on Insurance Market Stabilization in September, MarketWatch.
39
Congressional Budget Office, Cost Estimate H.R. 1628 Better Care Reconciliation Act of 2017, June 26, 2017.
40
Id.
41
Who Bears the Cost of the Uninsured? Nonprofit Hospitals, Kellogg Insight, June 22, 2015 (based on the following research: Craig
Garthwaite, Tal Gross, and Matthew J. Notowidigdo, Working Paper, Hospitals as Insurers of Last Resort, National Bureau of
Economic Research, at p. 6.
42
Id.
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4Responding to Uncertainty with Compliance, Watchfulness and Advocacy
Charitable hospitals can navigate the current economic and regulatory environment best by complying fully with existing
legal requirements, paying close attention to issues that may affect their operations such as tax-exemption standards or
340B Program requirements, and engaging Congress and other regulatory officials as needed to ensure their voices are
heard.
Charitable hospitals should embrace the requirements of Section 501(r), engaging with their communities on identifying
health needs and developing strategies for addressing those needs. Regularly monitoring for compliance with Section
501(r)’s financial assistance, billing and collection requirements and charge limits should be high on the to-do list of
attorneys, tax directors, and compliance officers. Charitable hospitals also should examine their Forms 990 carefully to
see how the public might perceive their community benefit expenditures and ask themselves critically whether the
reported amounts fully demonstrate the value they add to their communities. Similarly, if charitable hospitals participate in
the 340B Program, they should take proactive compliance measures such as performing self-audits and regularly
reviewing outpatient drug purchasing policies and procedures. In addition, they should document how participating helps
them fulfill the oft-stated purpose for the 340B Program of stretching “scarce federal resources as far as possible,
43
reaching more eligible patients and providing more comprehensive services.”
Finally, charitable hospitals should not shy away from advocating for themselves when confronted with these questions.
Working with their own government affairs officers and outside consultants in conjunction with state and national hospital
associations provides an opportunity to ensure charitable hospitals have a seat at the table as Congress and regulatory
agencies address these issues.
The views set forth in this article are those of Mr. Jackson and do not reflect the views of King & Spalding LLP.
Attorneys: Travis Jackson (King & Spalding LLP).
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43
See, e.g., Proposed rule, 81 FR 53381, August 12, 2016.
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