The IRS has recently released "Issue Snapshots" on three issues relating to charitable hospitals: (1) information regarding financial assistance policies (FAPs), (2) information regarding the definition of a hospital under Section 170(b)(1)(A)(iii) versus Section 501(r), and (3) information regarding entities engaged in the corporate practice of medicine. The "Issue Snapshots" are aids created for IRS employees on certain technical issues, and they include analysis of the covered issue and corresponding examiner guidance.

Financial assistance policies (FAPs)

The FAPs Issue Snapshot, dated April 3, 2018, addresses certain requirements under Section 501(r)(4). In general, Section 501(r)(4), added by the Affordable Care Act, requires tax-exempt hospital organizations and their hospital facilities to adhere to certain requirements regarding FAPs. The IRS issued final regulations under Section 501(r), including 501(r)(4), on December 31, 2014 (the Final Regulations). These regulations became effective on December 29, 2015. For years beginning on or after that date, a hospital facility must establish a FAP that meets the requirements of Section 501(r)(4). For a detailed discussion of the Final Regulations and Section 501(r)(4) requirements, see Tax Alert 2015-0029.

The Issue Snapshot provides some background on the relevant resources (e.g., statutes, regulations and IRS guidance) and applicable requirements under Section 501(r)(4). It reviews the FAP minimum requirements and the rules relating to widely publicizing the FAP, including translating the documents into the primary language(s) spoken by the population for those with limited English proficiency that are served by the hospital facility.

The Issue Snapshot further includes some detailed examiner guidance in the form of "issue indicators or audit tips." Specifically, the Issue Snapshot instructs IRS examiners to:

1. Ensure that organizations have established a FAP for the first tax year beginning after March 23, 2010

2. Pay attention to the year at issue in each case, keeping in mind that the Final Regulations apply for tax years beginning on or after December 29, 2015

3. Review organizations' audited financial statements (which must be submitted with Form 990) for useful information

4. Verify that each hospital facility has a written FAP (for organizations with multiple hospital facilities)

5. Ensure that the FAP covers emergency and medically necessary care provided by the hospital

6. Check for a list of providers providing care in each facility and ensure that the list specifies which providers are covered by the hospital's FAP (see Notice 2015-46, Tax Alert 2015-1252)

7. Check the organization's website to ensure that the FAP, FAP application and plain language summary are available

8. Check whether the hospital facility is notifying and informing members of the community about the FAP in a manner reasonably calculated to reach those who are likely to require financial assistance from the hospital facility

9. Verify that the FAP is translated, as appropriate (under 501(r)(4), a hospital facility must translate all FAP documents into a language if that language is spoken by the lesser of 1,000 individuals or 5% of the community served by the hospital facility)

10. Watch for examples of actions indicating that the hospital is discouraging individuals from seeking emergency medical care (e.g., requiring patients to pay or make deposits before receiving treatment for emergency medical conditions, or permitting debt collection activities that interfere with the provision of emergency care)

Hospital definition under Sections 509(a)(1) and 170(b)(1)(A)(iii) versus Section 501(r)

The hospital definition Issue Snapshot, dated April 3, 2018, compares the definitions of "hospital" under Sections 170(b) and 501(r). It notes that, in general, Section 170(b)(1)(A)(iii) identifies hospitals by their principal purpose, whereas Section 501(r) identifies hospitals with reference to state law. An organization that is required under state law to be licensed or registered as a hospital would fall under Section 501(r) of the Code. The definition of hospital organization under Section 501(r) triggers the additional requirements of Section 501(r), which must be satisfied for a hospital organization to obtain and maintain exempt status under Section 501(c)(3).

The Issue Snapshot reviews in some detail the differing definitions under the two Code Sections before proceeding to set forth the corresponding issue indicators and audit tips for IRS employees. It divides the employee guidance into two categories: determinations and examinations. With respect to determinations, the Issue Snapshot instructs IRS employees to:

1. Check to see if state law requires the facility to be licensed, registered or similarly recognized as a hospital

2. Review the organization's exemption application, and, if it does not provide information on whether it is licensed as a hospital by the state, perform internet research to check for a state license or request a written statement from the organization

3. Examine the organization's narrative statement provided in Form 1023, Part IV, to determine if the organization's principal purpose or function is to provide medical or hospital care, medical education or medical research

4. Review the organization's responses to Form 1023, Part VIII, line 20 and Part X, line 5c

Regarding examinations, the Issue Snapshot instructs IRS employees to:

1. Review Form 990 Schedule H for documentation on all aspects of Section 501(r) compliance

2. Refer to Internal Revenue Manual (IRM) 4.75.9.3 (Affordable Care Act Hospital Review) for additional guidance on Section 501(r) compliance

Entities engaged in corporate practice of medicine

The Corporate Practice of Medicine Issue Snapshot, dated November 9, 2017, includes guidelines for analyzing Professional Service Corporation (PSC) cases involving the Corporate Practice of Medicine (CPOM). It explains that corporations employing physicians to provide medical services are engaged in the CPOM. Several states (CPOM states) restrict the practice of medicine by "lay controlled corporations" (i.e., organizations controlled by laypersons, as distinguished from corporations run by physicians). These CPOM states do notallow lay controlled corporations to employ physicians to provide medical services, but do permit PSCs — a special type of corporation that must be owned by physicians — to do so.

The IRS will recognize PSCs as exempt if they meet certain requirements, including meeting the organizational and operational tests. The Issue Snapshot also describes certain process requirements for PSCs to qualify for exemption under Section 501(c)(3), and reviews guidance on articles of incorporation and bylaws, shareholder control agreements, management services agreements and employment agreements.

For IRS employees, the Issue Snapshot sets forth separate issue indicators and audit tips. The issue indicators instruct IRS employees to:

1. Carefully review all organizational documents for the presence or absence of the appropriate agreements (shareholder control agreement, management service agreement or employment agreement)

2. Consider whether the applicant described in detail the methods and procedures through which an exempt parent controls the shareholder (e.g., whether there are indicators of a lack of control by the exempt parent)

With respect to audit tips, the Issue Snapshot instructs IRS employees to:

1. Review the organization's Section 501(c)(3) exemption application to confirm that it established adequate control by the exempt parent

2. Review the state law when performing a field examination of an entity that is engaged in the CPOM

Implications

I. Section 501(r)

The changes brought by Section 501(r) of the Code began a new era for hospital facilities and their related hospital organizations. These regulations have shown tax-exempt hospitals that the IRS is now closely scrutinizing these organizations and their contributions to the community. The snapshot can help an organization to ensure compliance with the challenging rules and regulations regarding its exempt status. Here, all three snapshots provide helpful insight into what the IRS is looking at when auditing or reviewing an exempt organization's Form 990.

a. Financial assistance policies

In general, organizations have had difficulty in determining what the final regulations require. More specifically, hospital organizations have struggled with the requirements necessary for an entity to comply with the regulations issued under Section 501(r)(4) related to FAPs. This IRS guidance provides a simplified version of the steps a hospital organization (and all of its related hospital facilities) need to take to comply with these new requirements. It provides a list of the minimum requirements, a definition of "widely publicizing" the FAP, and requirements related to translating the FAP, FAP application and plain language summary to other languages.

b. Hospital definition under Section 170(b) versus Section 501(r)

This snapshot helps organizations understand that application of the Section 501(r) requirements does not depend on being a Section 170(b) organization, because the definition of a hospital differs between the two Code sections. An organization can be described as a Section 170(b) organization, but not be required to comply with Section 501(r), and vice versa.

The definition of a hospital facility under Section 501(r) is tied to whether the entity must be licensed or registered with the state. Each state's regulations differ, which means that a variety of healthcare organizations could be classified as a hospital facility under Section 501(r). For example, the guidance references rehabilitation centers, hospice in-patient units, psychiatric hospitals, and diagnostic treatment centers as potential hospital facilities. If the organization does not fall under the state's definition of a licensed hospital, then compliance with Section 501(r) is not necessary. Therefore, an organization must be well versed in the laws of each state in which it has a facility that could potentially qualify as a licensed hospital.

Again, the IRS guidance helps an organization to identify what criteria and resources the IRS is using to determine whether an organization has complied with the provisions of Section 501(r).

II. Entities engaged in the corporate practice of medicine

The primary information from this IRS snapshot is that the IRS is willing to accept a PSC as an organization exempt from tax under Section 501(c)(3). Here, the IRS notes the primary issues that a PSC must address when seeking tax exemption. The three main issues that the IRS has seen related to issuing determination letters for a PSC include: (1) whether the PSC's activities are being performed exclusively in furtherance of an exempt purpose within Section 501(c)(3); (2) whether there is any inurement to stockholders in the form of dividends or profits on transfers of their stock, distributions in the event of dissolution, or excessive compensation; and (3) whether compensation paid to the physician employees is reasonable. Furthermore, the PSC must show that it is an integral part of the parent exempt organization, which means that it must provide services for, or carry on a function for the benefit and convenience of, the parent organization.

The IRS further notes that a PSC can qualify for exemption even if the parent does not hold title to the stock of the PSC or the state does not permit the parent to appoint the PSC's board. However, there are some details that will disqualify a PSC from exemption, including any state law requiring the stockholder to have beneficial as well as legal title to the stock.

In sum, a PSC can qualify for exemption and should be considered by a parent organization that uses these types of corporations to provide care to its patients. This snapshot provides a list of considerations and issues that an organization should review before choosing to create a PSC.

III. Conclusion

In sum, organizations should be aware of the IRS snapshots on the IRS website, as these can be used as resources regarding the IRS's review procedures and requirements for previously issued rules and regulations.

Please contact your Ernst & Young LLP tax professional with any questions.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg

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