Sweeping reforms implemented by the IRS and Treasury in 2009 have pulled back the veil surrounding the community benefit investments required of all nonprofit hospitals seeking federal tax exempt status.  Will this new transparency, in combination with important tax law reforms enacted by Congress as part of the Affordable Care Act, lead to greater hospital investment in community health?

The Evolution Of Community Benefit Law

Since the 1950s, federal tax law has recognized that in order to qualify for tax-exempt status, nonprofit hospitals owe certain duties to the communities they serve.  IRS Revenue Ruling 56-185 (1956) established a “financial ability” standard that required charitable hospitals to be “operated to the extent of [their] financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay.”  In 1969, this early ruling was amended by Revenue Ruling 69-545, which substituted a more amorphous “community benefit” standard that has essentially survived into the present time, although with important modifications under the Affordable Care Act.

As noted by the Joint Committee on Taxation, the express purpose of Revenue Ruling 69-545 was to eliminate any enforceable obligation on the part of tax-exempt hospitals to furnish financial assistance to indigent inpatients.  Following an unsuccessful legal challenge to the validity of the ruling (Eastern Kentucky Welfare Rights Organization v Simon, 370 F. Supp. 325, 338 (D.D.C. 1973), rev’d, 506 F.2d 1278 (D.C. Cir. 1974), vacated on other grounds, 426 U.S. 26 (1976)), the community benefit standard remained moribund and essentially went unexplored for decades.

Beginning in 2006, chiefly as a result of the intense interest of Senator Charles Grassley (R-IA), lawmakers began to devote increasing attention to the question of how much specificity tax law should impose where the conduct of nonprofit hospitals claiming tax-exempt status is concerned.  Part of the impetus for this increased scrutiny was cost estimates underscoring the sizable value of the benefits derived by hospitals from their tax-exempt status.  (CBO placed the value of the exemption at $12.2 billion in revenues foregone in 2002; today’s figure clearly would be significantly higher).  A further impetus for heightened scrutiny came from widely publicized articles, including pieces in the Wall Street Journal, detailing highly troubling billing and collection practices by nonprofit hospitals aimed at uninsured patients.

This interest culminated in two important developments:  the creation of a special mandatory reporting system for nonprofit hospitals seeking federal tax-exempt status, and amendments to the Internal Revenue Code under the Affordable Care Act that broaden and clarify hospitals’ community benefit obligations. Together these two reforms usher in far greater transparency in hospital community benefit investments and a stronger community voice in how these investments should be used to improve community health.

Schedule H

What qualifies as a community benefit?  The mandatory reporting system takes the form of a special report, known as Schedule H, that must be filed as an addendum to hospitals’ annual 990 Forms submitted to the IRS.   Launched formally in 2009, Schedule H contains detailed instructions that define the term “community benefit” and delineate its parameters. As with the 990 form, hospitals’ Schedule H forms are transparent and fully available for review and analysis.

Under Schedule H (2011), financial assistance basically takes three forms.

  1. prospective discounts for uninsured patients in need of assistance,
  2. participation in Medicaid and other means-tested programs, and
  3. community health improvement investments in research, training and education; certain “community-building” activities that can be shown to improve health; and community-based health services that are furnished outside the four walls of the hospital and that are not billable by the hospital.

The third set of activities is particularly important.  As the number of uninsured declines as a result of the Affordable Care Act, hospitals may be able to augment activities such as risk-reduction in homes, abatement of environmental hazards, community-based prevention programs in workplaces and schools, and early childhood education efforts.  These may be essential to health but fall well outside insurable events.

What does not quality as a community benefit?  Schedule H goes further than simply delineating what does constitute a community benefit.  It also defines what does not.  Under Schedule H, the definition of community benefit excludes losses attributable to Medicare as well as bad debts that go unpaid after collection efforts.   Schedule H thus creates a far sharper framework for community benefit; not surprisingly, hospitals have vigorously protested the reporting system for both its detail and transparency through both agency comments and Congressional oversight hearings.

Hospitals’ unhappiness is not surprising: Schedule H effectively creates a nationwide data base that can be used to create information about hospitals’ community benefit investments; merged with other data, Schedule H would permit the creation of a national benchmarking system enabling communities to understand hospital community benefit activities in relation to key variables such as the characteristics of hospitals, patients, and communities themselves.

The importance of the clarity and detail brought to the subject of community benefit investment by Schedule H is evident from studies that have begun to use Schedule H to measure and report on the extent of hospitals’ community benefit investment.  One of the authors of this blog post (Kindig) was the senior author of the first peer-reviewed study using the first year (2009) of Schedule H data, just published in the Wisconsin Medical Journal.  The authors posed the question of whether hospital community benefit investments are primarily charity care, and found that, by far, this is not the primary investment reported to the IRS.

Of the more than $1 billion in community benefit expenditures reported by Wisconsin’s hospitals, over half was attributable to hospital losses associated with their participation in Medicaid and other means-tested entitlements.  Less than 10 percent, or $98 million, of total hospital community benefit reported was attributed to financial assistance (termed “charity care” in the article).  More than this amount ($121 million) was reported for subsidizing discounts for other money losing services. About 4 percent, or $47 million, of the total (ranging from zero to slightly more than 7 percent of individual hospitals’ total community benefit expenditures) was invested in community health improvement activities.

The ACA Amendments

The Affordable Care Act builds on the transparency and definitional advances made by Schedule H.   Under the Internal Revenue Code as amended, hospitals must undertake four specific actions as a condition of tax-exempt status. First, they must conduct triennial “community health needs assessments” that provide for community and public health input and that result in implementation strategies tying community investments to community needs. A 2011 Notice issued by the IRS and the Treasury Department offers an extensive interpretation of this requirement, which took effect for tax years beginning March, 2012.

Second, hospitals must adopt specific financial assistance policies that better assure prospective assistance to patients unable to pay for care.  Proposed rules (77 Fed. Reg. 38148, June 26, 2012) similarly provide a detailed and comprehensive interpretation of this requirement.  Third, hospitals must limit charges imposed on persons eligible for financial assistance to levels no greater than they generally bill insurers.

Fourth, hospitals must meet federal billing and collection requirements and must maintain written policies clarifying their compliance with EMTALA. These issues are also addressed in the 2012 notice of proposed rulemaking and – not surprisingly – also have been the subject of widespread hospital protest. Yet events continue to underscore the importance of the ACA amendments — in particular, recent news reports detailing outrageous and potentially unlawful hospital collection practices in the emergency department.

Looking Down The Road

The advent of Schedule H, coupled with the ACA amendments, potentially ushers in a new era of transparency for nonprofit hospitals’ community benefit investments.  One reform clearly may help spur the other, since the needs assessment and public input requirements of the ACA amendments may lead to some shift in community benefit investments.  As public involvement grows, it is possible that more emphasis will be placed on community health improvement.

The Wisconsin study shows the major community benefit role played by Medicaid losses. While claiming Medicaid losses is consistent with federal tax policy, the degree to which these losses dominate the community benefit expenditure picture (at least in Wisconsin) is jarring.  It raises questions regarding the degree to which one government program (IRS) should subsidize another (Medicaid), why these discounts are appropriate for non-profits only, what the appropriate accounting baseline for the discounts should be, and what the auditable standards for other money loosing “subsidized services” should be. As Uwe Reinhardt, one of the more trenchant analysts of health care financing, has observed, hospital pricing is “chaos behind a veil of secrecy.”

If the Wisconsin figures hold nationally, then fully half of the more than $12 billion spent by U.S. taxpayers on nonprofit hospitals in 2002 went to cover claimed Medicaid losses.  Whether U.S. taxpayers are well served in this regard — or would be better served were hospitals to instead invest their community benefit financing in broad prevention activities that could help avert these conditions — is essentially what the transparency of Schedule H and the community health needs assessment amendments of the ACA are all about.