August 11, 2017 IRS revokes 'dual status' hospital's Section 501(c)(3) status for failure to comply with Section 501(r) requirements The IRS has made public the first revocation of a hospital's Section 501(c)(3) status for failure to comply with Section 501(r). (The revocation letter is cited according to IRS convention as PLR 201731014, although this was the result of an examination, not a private letter ruling request.) The basis of the revocation included failure to conduct a community health needs assessment (CHNA), failure to make a CHNA widely available to the public and failure to adopt an implementation strategy. Section 501(r) background Section 501(r) and its accompanying regulations (see Tax Alert 2015-29) impose a variety of requirements on Section 501(c)(3) hospitals, including: — Conducting a CHNA at least once every three years Failure to comply with these requirements can result in revocation of a hospital's Section 501(c)(3) status, temporary taxation of the income from the hospital facility, and a $50,000 excise tax specific to CHNA failures. In determining whether to revoke Section 501(c)(3) status or impose tax, the IRS will consider all relevant facts and circumstances, including the significance of the failure, the reason for the failure, and any practices and procedures the organization had in place prior to the failure or safeguards it implemented afterwards. The regulations and Revenue Procedure 2015-21 contain some provisions to mitigate these consequences (see Tax Alert 2015-553). Minor errors or omissions that are (1) inadvertent or due to reasonable cause and (2) corrected, are not treated as Section 501(r) failures. If an error or omission is more than minor, but not willful or egregious, it will be excused for purposes of revocation or facility taxation (but not the CHNA excise tax) if the hospital corrects it and discloses the issue on its annual information return (the Form 990), in accordance with Revenue Procedure 2015-21. Some hospitals are exempt from taxation both because they are governmental and also because they have obtained separate IRS recognition of Section 501(c)(3) status. These are referred to as "dual-status" hospitals, which must comply with the Section 501(c)(3) requirements, including Section 501(r), to maintain their Section 501(c)(3) status. However, they may not need to file the Form 990 under the provisions of Revenue Procedure 95-48. Facts The revoked hospital was a dual-status entity that had obtained recognition of tax-exempt status under Section 501(c)(3). It was previously operated by a management company before a local county governmental agency took over control of the facility after the management company ran into difficulties. The hospital prepared a CHNA, but this was done to meet Medicare requirements rather than to comply with Section 501(r). The hospital did not make the CHNA widely available to the public via a website. However, it did have paper copies available upon request. The hospital indicated to the IRS that it might have acted on some of the recommendations included in the Implementation Strategy Report, but that a separate written implementation policy was neither drafted nor adopted. The hospital also stated that, as a small rural facility, it lacked the staffing to comply with the Section 501(r) regulatory requirements and that it "really did not need, actually have any use for, or want their tax-exempt status under Section 501(c)(3)." The hospital maintained that the tax-exempt status prevented the hospital facility from becoming involved in some of the various Medicare reimbursement or payment arrangements. The hospital further stated that its Section 501(c)(3) status was maintained only in case any liabilities arose relating to the prior management company that had originally obtained that status from the IRS. Ruling The IRS concluded that the hospital failed to meet the requirements of Section 501(r) and the corresponding regulations. Specifically, the IRS stated that the hospital failed to adopt an implementation strategy as required by Section 501(r)(3)(A)(ii), and it failed to make the CHNA report widely available to the public as required by Section 501(r)(3)(B)(ii). The IRS determined that these failures were egregious and, based on the hospital's statement that it had neither the resources nor the will to follow the CHNA requirements, the IRS concluded that the failure was willful. Thus, the IRS concluded that the hospital's Section 501(c)(3) status should be revoked. Implications This revocation letter provides an important example of Section 501(r) failures that will be considered willful and egregious and, therefore, not "excusable" under Revenue Procedure 2015-21. Notably, the lack of an implementation strategy and the failure to post the CHNA on a website were considered egregious (and, therefore, would not be eligible for forgiveness under Revenue Procedure 2015-21). All Section 501(c)(3) hospitals should review their compliance with the Section 501(r) requirements, particularly those in the final regulations that require posting of documents on hospital websites. The IRS reviews the community benefit activities of each Section 501(c)(3) hospital at least once every three years. These compliance reviews include looking at the hospital's website and other publicly available information in addition to Form 990 data (see Tax Alert 2017-1035). If the IRS sees evidence of noncompliance with Section 501(r) as part of this review, such as a document missing from the website, this will likely cause the hospital to be referred for examination. The IRS has identified over 300 hospitals for examination so far as part of this process. Dual-status hospitals should be aware that the IRS is examining them for Section 501(r) compliance as well, and is willing to impose sanctions upon them despite their status and despite the absence of Form 990 data (such hospitals are likely identified for examination primarily based on a review of the hospital's website and other publicly available information). This specific hospital's professed lack of interest in retaining its Section 501(c)(3) status may have played a role in the IRS's decision to revoke that status, but other dual status hospitals that wish to retain such status (often for employee benefit purposes) should review their compliance just like other Section 501(c)(3) hospitals. Reviewing and ensuring compliance with Section 501(r) is vital, because if a hospital loses its Section 501(c)(3) exemption, it loses the ability to use certain employee benefit plans and, absent governmental status, will likely be subject to income, property and other taxes and be unable to receive tax-deductible contributions or utilize tax-exempt bonds. Please contact your Ernst & Young LLP professional for further information. ——————————————— — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg ———————————————
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