The Effect of the Affordable Care Act on Charitable Hospitals [CPA Journal, The]

The New IRC Section 501 (r) and the CPAs Role

On March 23, 2010, President Obama signed the Patient Protection and Affordable Care Act (ACA) into law. Part of the new legislation included the addition of Internal Revenue Code (IRC) section 501(r), "Additional Requirements for Certain Hospitals for Exemption from Tax." Nearly 60% of hospitals in the United States are tax-exempt under the IRC. The new subsection adds additional requirements for current and future tax-exempt hospitals to keep or receive tax-exempt status. Failure to comply with the IRC section 501 (r) requirements can result in monetary penalties, as well as the loss or denial of a hospital's tax-exempt status.

In June 2012, two significant events relating to IRC section 501(r) occurred. On June 28, the U.S. Supreme Court upheld the constitutionality of the ACA, ending litigation that had cast some legal doubt on the law's future, and provided hospitals some assurance of the ACA's existence into the foreseeable future. The week before the Supreme Court's ruling, the Treasury Department issued 94 pages of proposed regulations regarding IRC section 501(r), specifically concerning how tax-exempt hospitals must proceed with respect to the following issues: 1) a new requirement for tax-exempt hospitals to develop a "financial assistance policy" (FAP) that determines whether a patient qualifies for financial assistance related to their healthcare, 2) a limitation on charges that can be assessed to patients, and 3) new requirements for billing and collection procedures. A tax-exempt hospital that fails to meet these requirements may lose its tax-exempt status.

In addition, IRC section 501(r)(3) requires that tax-exempt hospitals provide a Community Healthcare Needs Assessment (CHNA) every three years on the organization's Form 990. The 1RS gave initial guidance for an exempt hospital's CHNA in July 2011, in the form of 1RS Notice 2011-52. The highlights of the recently enacted section 501(r) requirements are discussed below, along with an overview of the 1RS guidance concerning CHNAs and the new proposed regulations regarding the FAP rules, charge limitation rules, and required billing and collection procedures.

Background

In the past decade, several highly publicized news stories highlighted negative issues regarding the provision of care at some tax-exempt hospitals. One article discussed a man whose wife had received care 20 years previously that left him heavily in debt. Although he had been paying his bills since that time, his debt kept growing due to interest charged by the hospital (Lucette Lagnado, "Twenty Years and Still Paying," Wall Street Journal, Mar. 13, 2003). The article also noted that although one tax-exempt hospital reported having $35 million set aside for "free bed funds" to support the uninsured, the hospital was billing many low-income individuals and implementing aggressive collection practices, including wage garnishments, liens, and home foreclosures.

Other articles highlighted related issues, such as the concern that uninsured individuals who did not have access to the deep discounts negotiated by private insurers and government payers were often expected to pay two or three times more than insured individuals for the same healthcare services. In other words, those least able to pay were charged the most for healthcare services (Julie Appleby, "Hospitals Sock Uninsured with Much Bigger Bills, Insurance Companies, Medicare Get Huge Discounts Individuals Can't," USA Today, Feb. 25, 2004).

Healthcare pricing and collection practices became a focus of federal and state investigations. In 2005, the U.S. Government Accountability Office (GAO) issued a report regarding charitable care (free or discounted care for the poor) that revealed no substantial difference in the level of charitable care provided by tax-exempt and for-profit hospitals. The report concluded that tax policy at the time lacked specific standards "that would allow nonprofit hospitals to be held accountable for providing services of benefit to the public commensurate with their favored tax status" ("Non-Profit, For-Profit, and Government Hospitals: Uncompensated Care and Other Community Benefits," Statement of David M. Walker, May 26, 2005, http : //www. gao. go v/ne w. items/ d05743t.pdf).

U.S. Senator Chuck Grassley (R-Iowa) ultimately coauthored the portion of the ACA that became IRC section 501(r). He stated in a press release the day after the ACA was passed in the House:

Tax-exempt hospitals don't have many measures of accountability for their special status. The law hasn't given them much direction, and so they've defined standards for themselves. Sometimes that's resulted in providing very little charitable patient care or other community benefits, failing to publicize charitable care to patients, charging indigent, uninsured patients more than insured patients, and using veiy aggressive collection practices. ... The provisions take steps to differentiate tax-exempt hospitals from for-profit hospitals and provide further transparency about tax-exempt hospitals' fulfilling their charitable mission. Congress, the 1RS, and the public will now have additional tools and information to ensure that charitable hospitals act charitably. (http://www.finance.senate.gov/newsroom/ ranking/release/?id=4bd5e086-ac5f4191-a2c0-302c6ab7d380)

The regulations that have resulted from the ACA have introduced a number of new concepts-outlined in the sidebar, IRC Section 501 (r) Abbreviations, and described in detail below-that CPAs and tax-exempt hospitals must become familiar with.

CHNA: IRC Section 501(i)(3)

In 2011, the 1RS issued Notice 2011-52, which described the requirements under IRC section 501(r)(3) for tax-exempt hos- pitals to adopt and implement a CHNA. This requirement is an effort to have charitable hospitals identify and prioritize their community's health needs. The CHNA process includes the collection and analysis of data, selection of strategic hospital priorities, documentation and com- munication of assessment, planning for action, and monitoring of progress. The most recent Schedule H of Form 990 includes 28 questions regarding CHNAs.

Effective for tax years ending after March 23, 2012, IRC section 501(r)(3) requires that a tax-exempt hospital submit its CHNA with its 1RS Form 990 every three years. (Subsections (r)(4)-(6) below have been in effect since March 23, 2010, although recent proposed regulations issued in June 2012 offer significantly more guid- ance than was previously available.)

Tax-exempt hospitals that do not meet the CHNA requirements for any taxable year face a $50,000 excise tax penalty under IRC section 4959. The $50,000 penalty is also assessed for any succeeding year the CHNA requirements are not met. Notice 2011-52 specifies that the IRC section 501(r) requirements also extend to government hos- pitals seeking exemption under IRC section 501(cX3), even if those hospitals also exclude gross income under IRC section 115.

The CHNA documentation rules require a written report that describes the following:

* The community served by the hospital facility

* The processes and methods used to con- duct the health needs assessment, includ- ing sources and dates of data and infor- mation used, analytical methods applied to identify community health needs, infor- mation gaps that impact the hospital's abil- ity to assess health needs, organizations with which the hospital collaborated in its report, and the identity and qualifications of third parties that assisted the hospital in conducting its CHNA

* How the hospital took into account input from persons who represent the broad inter- ests of the community (including descrip- tions of when and how the organization consulted with such persons)

* A prioritized list of community health needs identified through the needs assess- ment process, as well as a description of the process and criteria used in prioritiz- ing such health needs

* Existing healthcare facilities and other resources within the community that are available to meet community health needs.

A CHNA must also report an imple- mentation strategy for meeting the com- munity healthcare needs it has identified; such a strategy is considered to adequate- ly address a healthcare need identified in the CHNA if its written plan either describes how the tax-exempt hospital plans to meet the need or identifies the health need as one the hospital does not intend to meet (along with an explanation of why the hospital does not intend to meet that need).

In addition, the CHNA must be made widely available to the public. The pro- posed regulations state that this requirement can be met when the tax-exempt hospital puts its CHNA on its website.

Implications. CPAs will play a central role in maintaining records about the com- munity plans that tax-exempt hospitals will be creating. Because the CHNA will be reported to the 1RS every three years on the hospital's annual tax information Form 990, the CHNA will become a key docu- ment to meeting the tax compliance process. CPAs preparing or reviewing Forms 990 for hospitals will need to fully understand the CHNA requirements so that the compliance burden can be satisfied without risk of penal- ty or revoked tax-exempt status.

One practical way that CPAs can help hospitals satisfy the CHNA reporting bur- dens is by reviewing a checklist of docu- mentation requirements, as indicated in 1RS guidance. Through this process, CPAs will be alerted to gaps or weaknesses in the hos- pital's data gathering and retention pro- cesses that will need further attention and preparation. CPAs will likely use Schedule H of Form 990 as a starting point for dis- cussions regarding a hospital's newer com- pliance burdens.

In addition, the 1RS has indicated that it intends to provide more detailed regulations concerning CHNAs-for example, it is anticipated that the 1RS could require some level of director or trustee oversight at tax- exempt hospitals with regard to the CHNA. Clearly, current guidance from the 1RS is subject to modification and added regulations are likely to develop over time. This is especially likely as the 1RS clarifies the ACA's intent with respect to tax-exempt hospitals and provides greater specificity with respect to compliance provisions. Because CPAs have a reputation for objec- tivity and expertise in management and reg- ulatory matters, they are in a unique posi- tion to keep hospital management, directors, and trustees informed as the tax regula- tions relating to IRC section 501(r) are revised and refined going forward.

FAP: IRC Section 501 (r)(4)

As previously mentioned, IRC section 501(r)(4) requires a tax-exempt hospital to establish a written FAP and a written policy relating to emergency medical care. The FAP must include the follow- ing five criteria:

* Eligibility criteria for financial assistance, and whether such assistance includes free or discounted care

* The basis for calculating amounts charged to patients

* The method for applying for financial assistance

* Actions the oiganization may take in the event of nonpayment (but only in cases where the oiganization does not have an appropri- ate separate billing and collections policy)

* Measures to widely publicize the FAP within the community served by the hos- pital facility.

Eligibility criteria and calculation basis. The eligibility criteria have three compo- nents, each designed to ensure that an indi- vidual receiving financial assistance is not paying more for medical care than they would by foregoing financial assistance. The rules attempt to address the concern that a person receiving financial assis- tance may pay more for services than an insured person who benefits from an insur- er's negotiated discounts.

First, although neither the ACA nor the proposed regulations mandate any partic- ular criteria for financial assistance, the pro- posed regulations require that the FAP specify the financial assistance (e.g., all dis- counts and free care) available under the FAP and all of the specific eligibility cri- teria that an individual must satisfy in order to receive a discount, free care, or other level of assistance. Second, the proposed regulations require the FAP to state that once an individual qualifies for financial assistance, that individual will not be charged more than the amount generally billed (AGB) to an insured individual. Third, the FAP must either state the per- centages of gross charges the tax-exempt hospital applies to determine AGB (i.e., AGB percentages) and how these AGB percentages were calculated, or explain how members of the public may readily obtain this information in writing and free of charge. These rules are designed to ensure that financial assistance recipients are not paying more than they would if they had no financial assistance.

Method for applying for financial assistance. The proposed regulations state that the FAP must describe how an indi- vidual may apply for financial assistance; this includes requiring the tax-exempt hos- pital to describe the information or docu- mentation the hospital may require from the individual. The description of infor- mation or documentation required must be in either the tax-exempt hospital's FAP or FAP application form (or form instruc- tions). In addition, the tax-exempt hospi- tal must provide contact information that an individual can use to obtain assistance with the application process. The proposed regulations further state that financial assis- tance cannot be denied based on the omis- sion of documentation that is not specifi- cally required by the FAP or FAP appli- cation form.

Actions taken in the event of nonpay- ment The proposed regulations require the FAP (or a separate written billing and collections policy, if the tax-exempt hos- pital has one) to describe actions that tax- exempt hospitals (or other authorized par- ties) may take with respect to obtaining payment. The FAP must also describe the process and time frames that the tax- exempt hospital will use in taking such actions. In addition, tax-exempt hospitals cannot engage in "extraordinary collec- tions," as defined in IRC section 501(r)(6) (discussed below) until reasonable efforts have been made to determine whether the individual is eligible for financial assis- tance. The FAP must also describe the office or department with the final author- ity to conclude that the tax-exempt hospi- tal has made reasonable efforts to deter- mine whether an individual is eligible under the FAP.

Widely publicizing the FAP. The pro- posed regulations require the FAP to include four types of measures the tax- exempt hospital will take to widely publi- cize its FAP. First, the FAP, its summary, and the FAP application form must be available in English, as well as in the pri- mary language of any populations with limited proficiency in English that consti- tute more than 10% of the residents of the community served by the tax-exempt hospital facility. Second, the FAP must include the measures the tax-exempt hos- pital will take to inform visitors about the FAP through conspicuous display (or other measures calculated to attract attention), such as posting signs and displaying brochures in public locations. Third, the FAP must describe how the tax-exempt hospital will inform those who are most likely to require financial assistance in the community it serves (e.g., the distribution of information sheets summarizing the FAP in local public agencies or nonprofit orga- nizations that address the needs of local low-income populations). The proposed regulations apply a facts-and-circumstances test to determine compliance. Fourth, the FAP must include the measures the tax- exempt hospital will take to post the FAP, FAP application form, and summa- ry of the FAP on the hospital's website (or a website maintained by another entity).

Emergency medical care policy. A tax- exempt hospital must also maintain a writ- ten emergency medical care policy that requires the hospital to provide care for emergency medical conditions without dis- crimination and in compliance with the Emergency Medical Treatment and Labor Act of 1986 (EMTALA). For example, a hospital would violate the EMTALA if it demands payment before providing emer- gency care. Because the proposed regula- tions defer to the EMTALA regulations, it appears that a violation of the EMTALA rules-which most hospitals already com- ply with-would endanger a hospital's tax-exempt status.

Implications. The first set of questions on Schedule H of a hospital's 1RS Form 990 focus on the organization's FAP. As preparers or reviewers of a tax-exempt hos- pital's Form 990, CPAs are typically responsible for determining whether the hospital has an FAP, and reviewing the hospital's FAP for compliance with sec- tion 501 (r) and related 1RS guidance. Although many hospitals likely had some assistance policies in place before the ACA and its accompanying regulations took effect, the new rules will require hospital FAPs to cover broader issues and provide certain details that outdated policies might not have addressed.

As with the CHNA documentation prac- tices noted above, CPAs should consider adopting a checklist for ensuring that FAPs comply with the relevant regulations. In addition to reviewing checklists that could expose gaps and weaknesses in FAP compliance, CPAs should also review doc- umentation required by IRC section 501(r), including-but not limited to-a plain-lan- guage summary of the FAP, the FAP appli- cation form, the FAP application form instructions, the FAP billing and collection policy, and documentation of actions wide- ly publicizing the FAP. In light of the section 501(r)(4) requirements, reviews of such documentation can reassure CPAs and hospitals that the new compliance rules for continued tax-exempt status have been met.

Limitation on Charges: RC Section 501(r)(5)

Both IRC section 501(r)(5) and the proposed regulations require that a tax- exempt hospital limit the amount it charges an individual eligible to receive financial aid under the FAP to no more than the AGB applicable to individuals with insur- ance covering that care. The proposed reg- ulations provide two methods for tax- exempt hospitals to use in determining AGB (i.e., the new limitation on charges to financial assistance recipients): the look- back method and the prospective method.

The look-back method measures AGB based on actual past claims paid to the tax- exempt hospital by both Medicare fee-for- service and all private health insurers (along with any portions paid by patients- Medicare beneficiaries and insured indi- viduals). The prospective method measures AGB by requiring the tax-exempt hospital to estimate the amount it would be paid by both Medicare fee-for-service and the patient Medicare beneficiary for a particular ser- vice. The proposed regulations clarify that Medicare fee-for-service includes Medicare Parts A and B, but not Part C (known as "Medicare Advantage"). After the tax- exempt hospital chooses an AGB method, it must continue to use that method.

IRC section 501(r)(5) prohibits tax-exempt hospitals from using gross charges-that is, the full, established price for medical care that a hospital charges patients before apply- ing allowances, discounts, or deductions- when billing an individual who is eligible for financial assistance. The proposed regu- lations note that including gross charges on a hospital bill is allowable as a starting point, as long as the gross amount is not what an individual eligible for assistance is expected to pay.

Implications. The accounting profession will be fundamentally involved in estab- lishing the prices charged to individuals that a tax-exempt hospital deems eligible for dis- counted care. The ceiling on these prices will be AGB, as defined in IRC section 501(r)(5) and as calculated by accountants.

CPAs are likely to play a pivotal role in assessing a tax-exempt hospital's most beneficial long-term method for calculat- ing AGB (i.e., choosing between the prospective and look-back methods). Because current regulations do not permit a hospital to change its method of calcu- lating AGB in the future, the hospital will want to know what its most beneficial long-term AGB calculation method is from the time of first implementation, based on the hospital's current and projected cir- cumstances.

CPAs can offer analysis and advice regarding which method a hospital should use to maximize its revenue from a pres- ent value perspective. CPAs should work closely with management and other advi- sors as they address any assumptions that can materially alter future calculations of AGB (e.g., a material shift in the ratio of Medicare patients to private insurance patients could affect a hospital's future AGB calculations).

In addition, the capping of healthcare costs for uninsured individuals at AGB will likely have a ripple effect that will increase insurance premiums for individ- uals. As hospitals are required to charge discounted rates to the uninsured, the reduced revenue may incentivize hospi- tals to increase their charges to insurance companies; in turn, insurance companies are likely to charge higher premiums to insured individuals.

Billing and Collection Requirements: RC Section 501(r)(6)

IRC section 501(r)(6) prohibits a tax- exempt hospital from engaging in extraor- dinary collection actions (ECA) before it makes reasonable efforts to determine whether the individual qualifies for finan- cial assistance under the hospital's FAP. Although IRC section 501(r)(6) does not define an ECA, the proposed regulations define it as any action taken with respect to obtaining payment for medical services that requires a legal or judicial process. These actions include-but are not limited to-liens; foreclosures on real property; attachment or seizure of a bank account or other personal property; commencement of a civil action, causing an individual's arrest or subjection to a writ of body attachment; garnishment of wages; and selling of the individual's debt. The proposed regulations also define an ECA to include reporting adverse information about an individual to a consumer credit reporting agency (under the premise that such action can cause sig- nificant financial harm). The proposed reg- ulations do not define ECAs to include refer- ring an individual's debt to a debt collection agent (as long as the debt is not sold).

A tax-exempt hospital is deemed to have made a reasonable determination of whether the individual is FAP eligible if the following elements under the proposed regulations are met:

* The hospital notifies the individual about the FAP

* The hospital provides the individual with information relevant to completing the application (if an incomplete FAP appli- cation is received)

* The hospital makes and documents a determination as to whether the individu- al is eligible for financial assistance (if a complete FAP application is received)

* Both a "notification period" and an "application period" test have been met.

The notification period runs from the date that care is provided to 120 days after the individual is first billed for the care. Once the tax-exempt hospital has met all of its notification requirements and the notification period is over, the hospital may begin ECAs. The application period runs for 240 days after the first billing. A tax- exempt hospital must accept and process applications submitted during this appli- cation period.

Implications. CPAs will be in a position to help a hospital establish or revise billing and collections policies that are compliant with the new ACA regulations. Failure to meet the new billing and collections requirements will establish a failure in compliance and put the organization's tax- exempt status at risk.

CPAs are also able to provide tax- exempt hospitals with advice as they change their existing billing and collections systems and procedures to conform to new regulations. CPAs should discuss these top- ics with management and collect docu- mentation or observe processes in place as the issues are discussed. For example, a CPA may want to review the agreements the hospital has with debt collection agen- cies related to ECAs, as well as discuss the negotiation practices the hospital employs in such agreements in order to ensure com- pliance with the new ECA rules. A checklist of required or barred practices could be used to find gaps or weaknesses in compliance with the new regulations.

A New Regulatory Landscape

Events of the past several years have sig- nificantly affected the regulatory landscape for the healthcare industry in general and tax-exempt hospitals in particular. The ACA's newly enacted IRC section 501(r) has the goal of ensuring that charitable hos- pitals with tax-exempt status earn that favored tax designation through greater transparency and tighter billing policy requirements.

Notably, for tax years ending after March 23, 2012, those hospitals must increase transparency by preparing a CHNA, which requires an implementation strategy for addressing community health needs. The CHNA must be filed every three years with the hospital's 1RS Form 990. CPAs will play a key role in main- taining documents for a hospital's CHNA, as well as advising tax-exempt hospitals on whether their CHNAs meet the regulatory standards of IRC section 501 (r) in order to avoid penalties.

Tax-exempt hospitals also must prepare an FAP and an emergency medical care pol- icy. Because failure to comply with these new requirements could result in financial penalties and the loss or denial of exempt status, CPAs must be aware of the require- ments. Because the CHNA, FAP, AGB, and ECA compliance requirements are report- ed on 1RS Form 990, CPAs are uniquely positioned to help those hospitals with their compliance and planning efforts. A CPA's processes of research, review, dis- cussion, consultation, and assessment of risk add substantial value to tax-exempt hospi- tals as CPAs prioritize their work.

For example, CPAs can provide check- lists of documentation and policies that a hospital must have in place, searching for gaps in compliance. They can also review actual documentation and the processes that tax-exempt hospitals must use to stay com- pliant with the new rules. Discussions and consultations with management and trustees concerning these reviews can help hospitals seek out and correct weak- nesses or deficiencies in regulatory com- pliance, thereby reducing the risk of penal- ties or revocation of tax-exempt status. CPAs will also need to help the manage- ment of tax-exempt hospitals to fully understand the range of possible penalties and then create strategies for avoiding and mitigating penalties wherever possible.

Accountants working for and advising tax-exempt hospitals will play a pivotal role in setting ceiling prices on care for the poor as they calculate AGBs. CPAs can help tax-exempt hospitals choose an AGB cal- culation method that will maximize hos- pital revenues in the long run by making informed method choices early on.

Given the U.S. Supreme Court's recent ruling on the ACA and the current politi- cal landscape, tax-exempt hospitals must prepare for additional reporting require- ments under IRC section 501(r). Clearly, these new rules create a higher burden on tax-exempt hospitals-raising their com- pliance costs and increasing their risk of revoked tax-exempt status. In addition, the capping of healthcare costs for uninsured individuals using AGB could have a rip- ple effect that increases insurance premi- ums for individuals. Because hospitals are required to charge discounted rates to the uninsured, the resulting reduced revenue may incentivize hospitals to increase healthcare charges to insurance companies; insurance companies are likely in turn to charge higher premiums to insured indi- viduals.

Federal regulators have decided that the benefits of these new rules outweigh the compliance and cost burdens, due to the professed need to have charitable hos- pitals communicate more clearly with their communities about healthcare priorities while creating and publicizing policies that help ensure that those of limited means who need medical treatment receive it. Congress ultimately sees these rules as an effort to curb potential abuse at charitable hospitals and maintain the public's faith in those organizations engaged in the char- itable provision of healthcare. ?

IRC SECTION 501 (R) ABBREVIATIONS

CHNA = Community Health Needs Assessment

An assessment which addresses the healthcare needs of the community that the hospital serves, relying on data collected from organizations such as public health agencies and nonprofits. The assessment must receive input from broad community interests, contain an implementation strategy for addressing community health needs, and be made widely available to the public.

FAP = Financial Assistance Policy

This policy must be implemented in order to set the hospital's criteria for financial assistance eligibility and notify individuals of that eligibility.

AGB = Amounts Generally Billed

These are the amounts that tax-exempt hospitals are paid from insured individuals and their insurance (or Medicare beneficiaries and Medicare Parts A and B). Individuals qualifying for financial assistance under the FAP cannot be charged more than this amount.

ECA = Extraordinary Collection Actions

These actions are related to obtaining payment for those medical services that require a legal or judicial process (e.g., liens, foreclosures, civil actions, garnishment of wages, adverse reporting to credit agencies). Tax-exempt hospitals are required to make reasonable efforts to determine whether an individual is eligible under the FAP before engaging in ECAs.

CPAs are in a unique position to keep hospital management, directors, and trustees informed as the tax regulations relating to IRC section 501 (r) are revised and refined going forward.

These rules are designed to ensure that financial assistance recipients are not paying more than they would if they had no financial assistance.

Accountants working for and advising tax-exempt hospitals will play a pivotal role in setting ceiling prices on care for the poor as they calculate AGBs.

William A. Bailey, JD, LLM, CPA, is an assistant professor of accounting at Central Washington University, Ellensburg, Wash.Ronald R. Tidd, PhD, CPA (inactive), is a professor of accounting, also at Central Washington University. Ryan Cahalan, JD, LLM, MBA, is a senior tax consul- tant at Deloitte Tax LLP, Seattle, Wash.