The IRS has published an Issue Snapshot that reviews the rules and describes audit tips for two taxes that apply to charitable hospitals that fail to meet the requirements under Section 501(r): (1) the excise tax under Section 4959 for failure to meet the requirements of Section 501(r)(3), and (2) the tax on Noncompliant Facilities Income (NCFI). An IRS "Issue Snapshot" is an aid created for IRS employees on certain technical issues that includes analysis of the covered issue and corresponding examiner guidance.

Background

Section 501(r) and its accompanying regulations (see Tax Alert 2015-0029) impose a variety of requirements on Section 501(c)(3) hospitals. These requirements must be met by each hospital facility that is operated by a Section 501(c)(3) hospital organization.

Section 501(r)(3) includes requirements for the community health needs assessment (CHNA), and requires Section 501(c)(3) hospitals to conduct a CHNA at least once every three years, make the CHNA publicly available, and adopt an implementation strategy to meet the needs identified in the CHNA.

Additional Section 501(r) requirements include:

 — Adopting a written financial assistance policy (FAP) and a written emergency medical care policy and publicizing them, including posting the policies on a website

 — Limiting the amounts charged for emergency or other medically necessary care to individuals eligible for financial assistance

 — Making individuals aware of, and determining if individuals are eligible for, assistance under the FAP before engaging in certain collection actions

Failure to comply with the Section 501(r) requirements can result in a $50,000 excise tax for failure to meet certain CHNA requirements under Section 4959, temporary taxation of the income generated by a non-compliant hospital facility (NCFI taxation), and, ultimately, revocation of a hospital's tax-exempt status under Section 501(c)(3).

Revenue Procedure 2015-21 includes correction and disclosure procedures under which certain failures to meet the Section 501(r) requirements for charitable hospital organizations can be excused (see Tax Alert 2015-0553).

The IRS has previously published Issue Snapshots relating to Section 501(c)(3) hospitals (See Tax Alert 2018-0874). The FAP Issue Snapshot, dated April 3, 2018, addresses certain requirements under Section 501(r)(4) relating to a hospital organization's FAPs and the hospital definition Issue Snapshot, also dated April 3, 2018, compares the definitions of "hospital" under Sections 170(b) and 501(r).

Issue Snapshot

Before setting forth "Audit tips" for examiners, the Issue Snapshot reviews the statute and regulations pertaining to the Section 501(r) requirements, Section 4959 excise tax, and NCFI taxation. It also highlights the regulations pertaining to the potential correction of failures.

The Issue Snapshot states that, before imposing sanctions (i.e., Section 4959 excise tax, NCFI taxation, revocation of tax-exempt status), the IRS will consider all facts and circumstances. The IRS will determine whether the failure is a minor error or omission that is either inadvertent or due to reasonable cause and, therefore, not considered a failure under relevant guidance, or whether the failure is excusable. The IRS added, however, that the Section 4959 excise tax applies even if a failure to meet the requirements of Section 501(r)(3) is considered excusable.

The Issue Snapshot instructs examiners to determine if each hospital facility conducted a timely and adequate CHNA and made the CHNA widely available to the public. Similarly, the Issue Snapshot instructs examiners to determine if each hospital facility has timely adopted an adequate implementation strategy addressing the needs identified in its CHNA. If either requirement is not met, the Issue Snapshot states that the Section 4959 excise tax should be imposed, unless the hospital organization's failure to meet these requirements involved an omission or error that is described and corrected in accordance with Treasury regulations and, therefore, is not considered a failure.

The Issue Snapshot further instructs examiners to:

1. Ascertain each hospital facility's reason(s) for its failure(s)
2. Review Form 990-T
3. Determine whether there is a minor error or omission that is not considered a failure to meet the requirements of Section 501(r) under Reg. Section 1.501(r)-2(b)
4. For non-minor errors or omissions, determine whether the failure may be excused under Reg. Section 1.501(r)-2(c) if the failure is corrected and disclosed
5. If the hospital facility's failure was neither willful nor egregious, determine whether the hospital facility corrected and disclosed the failure in accordance with Revenue Procedure 2015-21
6. If appropriate, determine the applicable sanction(s) (i.e., Section 4959 excise tax, NCFI taxation, and/or revocation of tax-exempt status)
7. Review activities that generate NCFI

Implications

The Section 501(r) and 501(r)(3) regulations apply to tax years beginning after March 23, 2010, and March 23, 2012, respectively. Because the final regulations have been in place for some time, most hospital organizations subject to the requirements of Section 501(r) should already be taking steps to comply. This Issue Snapshot highlights, however, that Section 501(r) is a continuing compliance matter for all Section 501(c)(3) hospital organizations. Section 501(c)(3) hospital organizations that operate one or more hospital facilities must also remember that each respective facility is required to meet the Section 501(r) requirements separately.

The Issue Snapshot provides Section 501(c)(3) hospital organizations with a strong reminder of the risks associated with non-compliance. The risks can range from the administrative expense of correcting a minor omission or error to revocation of tax-exempt status. If a hospital organization operates more than one hospital facility, the IRS indicates that it will often apply other types of sanctions before revoking tax-exempt status, such as applying the NFCI tax to all income from the violating hospital facility. Further, even if a hospital organization loses its tax-exempt status, it can still be subject to the excise tax under Section 4945 for failure to properly complete a CHNA. Although this excise tax can only be applied once per year, it can be applied to each individual facility that failed to satisfy the requirements of Section 501(r)(3).

Hospital facilities should continue to improve and maintain their practices, policies and procedures related to Section 501(r) compliance. As highlighted by the Issue Snapshot, hospital organizations should ensure that each hospital facility: (1) conducted a timely and complete CHNA that is available to the public, (2) adopted a timely and adequate implementation strategy that addresses the health needs identified during the CHNA process, (3) ensured that there is a written FAP and emergency medical care policy and that the policy is made available to the public, (4) limited the amounts charged to individuals eligible for financial assistance, and (5) did not engage in extraordinary collection actions until determining the individual's eligibility under the FAP. Lastly, Section 501(c)(3) hospital facilities should check that all documents contain the information required by the final regulations and that updates are timely made to those documents to meet those requirements.

The Issue Snapshot is another reminder to hospital organizations that the IRS expects compliance with the Section 501(r) regulations. Further, it indicates that the IRS continues to monitor Section 501(c)(3) hospital facilities and their compliance with Section 501(r). The Issue Snapshot, along with the previously issued Issue Snapshot discussing FAPs, can be used as a guide to understanding what examiners will be looking for if the organization is subject to a Section 501(r) examination.

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

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