AHLA Tax Primer Tricia M. Johnson, CPA Executive Director Ernst & Young LLP Cincinnati, OH Cynthia Leon Vice President, Transactions and Tax Catholic Health Initiatives Denver, CO Tax Issues for Health Care Organizations October 20-22, 2013
PRIMER: TAX EXEMPTION AND TAX ISSUES AHLA Tax Issues for Healthcare Organizations October 20-22, 2013 Tricia M. Johnson Executive Director Ernst & Young LLP Cincinnati, Ohio Cynthia Leon VP Legal -Transactions and Tax Catholic Health Initiatives Denver, Colorado tricia.johnson1@ey.com cindyleon@catholichealth.net 1 Notice This content is for educational and discussion purposes only, and is not intended, and should not be relied upon, as accounting advice. Any US tax advice contained herein is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. 1
Overview Overview of types of healthcare organizations Qualification as a Section 501(c)(3) organization Public charity versus private foundation status Section 501(c)(4) exemption Interacting with the IRS exemption applications or selfselection of status, annual information returns, and rulings Maintaining exemption -- audits, enforcement and revocations Intermediate sanctions Unrelated business income tax Other Considerations 3 Types of Healthcare Organizations 4 2
Types of Healthcare Organizations May or may not qualify for tax-exemption Hospitals Physician groups Physician faculty practice plans Integrated delivery systems/joa entities/regional parents Home health agencies Homes for the aged/assisted living centers Fitness centers Medical research organizations HMOs IPA/staff model v. arrangers Information technology organizations ACOs 5 Basics of Section 501(c)(3) Status 6 3
Basics of Section 501(c)(3) Status Advantages of tax exemption may include: Income taxes Deductibility of contributions Qualification for grants Tax-exempt financing Employee benefit programs Federal unemployment taxes Postal rate savings Property tax exemption Sales/use tax exemption 7 Basics of Section 501(c)(3) Status (cont d) Qualification as a 501(c)(3) organization Organizational test Permissible purposes (and no more) Form of entity Purposes set forth in organizational document Dissolution clause Operational test Exclusively versus primarily Private benefit and inurement Political activities Lobbying activities 8 4
Public Charity vs. Private Foundation 9 Nonprofit v. tax exempt l Non-Profit Corporation Tax-Exempt Organization State Corporation Law Federal Tax Law 10 5
Tax Exempt v. Charitable Charitable Organizations 501(c)(3) Tax-Exempt Organizations 11 Public Charity v Private Foundation Charitable Organizations Public charities 509(a)(1), (2) Charitable or (3) Organizations Private foundations Tax Exempt Organizations 12 6
Public Charity v. Private Foundation Disadvantages of private foundation status rigid rules Default to private foundation status unless can meet a public charity status Private Foundations Subject to Excise Taxes on Investment Income (2% or 1%) Failure to distribute 5% or more of average value of assets annually Engaging in Self-Dealing (prohibited transactions) Excess Business Holdings (owning too much of another entity various tests and aggregation required) Jeopardy investments (too risky) Taxable Expenditures (items not within PF purposes) Limitation on deductibility of contributions 30%/20% of AGI 13 Public Charity v. Private Foundation Public Charities Subject to Excise Taxes on Excess Benefit Transactions - (similar to intermediate sanctions) On Taxable Expenditures political and lobbying activity Limitation on deductibility of contributions 50%/30% of AGI Most common Stated status e.g. hospital or a school Receipt of substantial and broad-based contributions Receipt of program service revenue (exempt function income) Supporting relationship with other charitable organization(s) 14 7
Public Charity 170(b)(1)(a)(iii) Section 509(a)(1)/170(b)(1)(A)(iii) Status based on nature of organization who it is, or what it does Classification as hospital Principal purpose or function is to provide hospital or medical care or either medical education or medical research May include rehabilitation institution, outpatient clinic, community mental health or drug treatment center, physician practice, or skilled nursing facility if its principal purpose or function is providing hospital or medical care Medical research organization operated in conjunction with a hospital Note: Definition of hospital differs from those used for Form 990 Schedule H and IRC Section 501(r) 15 Public Charity 509(a)(1) Section 509(a)(1)/170(b)(1)(A)(vi) Status based on receipt of substantial support in the form of contributions from governmental units or the general public 1/3 support test mechanical calculation Normally Alternative facts and circumstances (10%) test 16 8
Public Charity 509(a)(2) Section 509(a)(2) Status based on receipt of substantial support in the form of revenue from conduct of activities in furtherance of exempt purposes ( program service revenue ) 1/3 support test mechanical calculation, but different Normally Negative 1/3 test investment income and UBI 17 Public Charity 509(a)(3) Section 509(a)(3) Status based on relationship in support of one or more other publicly supported organizations, i.e., those described in 509(a)(1) or (2) Relationship test Organizational test Operational test Control test Types I, II and III (functionally integrated or not) 18 9
Old Hospital Requirements Qualification as a 501(c)(3) organization from Rev Rul 69-545 Purpose: promotion of health community benefit standard Open emergency room Care to Medicare/Medicaid beneficiaries Use of surplus funds Open medical staff Community board Charity care? 19 New Hospital Requirements Hospitals Health reform (PPACA) New Section 501(r) Applicable to hospitals (as defined) Compliance determined on facility-by-facility basis New requirements in four areas: Community health needs assessment (Notice 2011-52 and Proposed Regs from April 2013) Financial assistance policies (Proposed Regs from June 2012) Limitations on patient charges (Proposed Regs from June 2012) Limits on collection practices (Proposed Regs from June 2012) Must provide audited financial statements with Form 990 20 10
Section 501(c)(4) Qualification 21 Section 501(c)(4) Qualification Alternative status for organizations unable to qualify under Section 501(c)(3) Avoids federal and maybe state income taxation, but does not entail other benefits of 501(c)(3) status No receipt of deductible contributions No tax-exempt bond financing Recent IRS enforcement blip regarding gift tax implications of donations made to 501(c)(4)s Congressional scrutiny re: political activities (donors not disclosed, really an exempt purpose?) Fast track for certain cases 22 11
HMOs and Exemption Section 501(c)(3) Staff v. Arranger models Medicaid Section 501(c)(4) Prior IRM guidance (pulled a few years ago) Community Benefit Intermountain Health Care good characteristics Vision Services Plan not so good characteristics Recent IRS Community Benefit discussions How does the IRS view HMOs today? Medicare HMOs Recent PPO ruling Interaction with IRS and Obtaining Exemption 24 12
Organization of the IRS and its Offices Reorganization TE/GE 1999 As of summer 2013, there are discussions regarding another reorganization Four units of TE/GE: Customer education and outreach Washington DC Rulings and agreements Washington DC Determinations - Cincinnati Examinations Dallas 25 Form 1023 Form 1023 - Section 501c3 Board quals to serve, compensation of officers Financial projections Copies of contracts and agreements Physician groups likely to get a hospital status, but not same as a hospital for 501r Form last updated June 2006 IRS will request items upon review that are not within the form itself Hospitals 501r compliance questions (not in the form, but sent by IRS during their review) Follow-up questions for things that look like an ACO 26 13
Form 1024 Form 1024 - Section 501c4 and other 501c s Open ended questions to describe activities and how they occur Community benefit is not specifically addressed/requested Closest question in the 501c4 section to an HMO is: Does the organization perform or plan to perform (for members, shareholders, or others) services, such as maintaining the common areas of a condominium; buying food or other items on a cooperative basis; or providing recreational facilities or transportation services, job placement, or other similar undertakings? Form last updated September 1998 Self selection considerations 27 Interaction with the IRS Obtaining recognition of exemption Exemption application (IRS Form 1023/1024) Schedule C (Hospitals and Medical Research Organizations) Merit close via screening or further case development Effective date of exemption IRS determination letter Group exemption rulings Special projects and automatic referrals to National Office; examples include: Credit unions 501(c)(4)s with potential for political activity HMOs 28 14
Maintaining exemption Audits, enforcement and revocations 29 Annual Filing Annual information returns (IRS Form 990) Filing requirement Comprehensive scope not just numbers Schedule H for hospitals Due date 15 th day of 5 th month following close of tax year May extend to 15 th day of 11 th month Public disclosure prior 3 years returns (www.guidestar.org) May also have state filing requirements Annual registration Solicitations 30 15
PPA of 2006 Small organizations (under $50,000 revenue) Previously not subject to annual filing requirement PPA of 2006 Mandated minimal annual reporting (Form 990-N e- Postcard) Provided that failure to file for 3 years results in automatic loss of exemption On June 6, 2011, the IRS announced start of auto-revocation of exemption; to date over 450,000 organizations Preliminary list had been posted spring 2011 Updated monthly, based on year-end as organizations miss their third filing since PPA was passed List of organizations published on irs.gov Reinstatement Dealing with revocation Specified procedures for reinstatement, via IRS TE/GE in Cincinnati Guidance to assist in reinstatement Notice 2011-44 YouTube video File a new Application for reinstatement (Form 1023 or 1024) Retroactive reinstatements were available on limited basis; most not available anymore (post 12/31/12) 16
Maintaining Exemption Confirming continued exempt status Report on Form 990 Seek informal advice/confirmation (though can t rely on it) Written notification to Cincinnati TE/GE Redetermination to Cincinnati TE/GE (see Form 8940) Seek private letter ruling from IRS National Office Confirming public charity status IRS Master File via Cincinnati TE/GE See SelectCheck on irs.gov new tool 33 IRS Examination/Enforcement Historically, limited enforcement resources for TE/GE IRS alternatives: Examinations (audits) Correspondence Field TEP General Compliance checks not an examination, but referred to exam if did not participate 34 17
Challenges to Exemption Key theme since 2008 return: Good governance + Transparency = Better exempt organization Prior IRS initiatives Executive compensation Community benefit Exempt bonds Governance College and University report 4/2013 National research program employment taxes 35 Congressional Scrutiny Spring/summer 2013 - Grassley attention to 340B program and executive bonuses May 16, 2012 - House Ways and Means Subcommittee on Oversight Hearings re: the operations and oversight of tax-exempt organizations for consideration as part of overall tax reform Purpose - to ensure that the sector is operating efficiently and that the laws governing it are being applied fairly and evenly October 2011 - Boustany (Chair House W&M) letter to IRS Commissioner Douglas Shulman asking for detailed information regarding the Service s administration and oversight of exempt entities April 2011 - Oversight Subcommittee hearing on the activities of AARP (Section 501(c)(4)) and its exempt purpose 36 18
Intermediate Sanctions 37 Intermediate Sanctions Concept Penalty taxes, thus a remedy short of revocation Taxes on disqualified person (insider) First tier at 25% of excess benefit amount Second tier at 200%, if not timely corrected Taxes on organizational manager(s) 10% of excess benefit amount, up to $20,000 Definitions critical 38 19
Intermediate Sanctions (cont d) Excess benefit transaction Non-FMV transaction with a disqualified person Compensation above reasonable market levels Transaction at other than FMV Prohibited revenue-sharing transaction (yet to be defined) Prohibited transactions involving supporting organizations Automatic excess benefits 39 Intermediate Sanctions (cont d) Disqualified persons Persons having substantial influence over the affairs of the organization, either currently or within past 5 years Deemed disqualified persons Others subject to facts and circumstances test Now includes persons who are disqualified in relation to supporting organization Physicians? 40 20
Intermediate Sanctions (cont d) Rebuttable presumption of reasonableness Approved by independent board or committee Relied on appropriate data as to comparability Adequately and contemporaneously documented Protection for organization managers Obtained rebuttable presumption Relied on reasoned written opinion 41 Intermediate Sanctions (cont d) Twists: May arise through controlled affiliates Automatic excess benefits are often inadvertent, arising by failure to properly approve and report a payment, perk or benefit as compensation Form 990 disclosure Revocation still a possibility 42 21
Unrelated Business Income Tax 43 Unrelated Business Income Tax If an activity is unrelated to exempt purposes, it should be taxable Generates tax revenue Prevents unfair competition Three-part test Trade or business Regularly carried on Not substantially related to exempt purposes 44 22
Unrelated Business Income Tax (cont d) Modifications Dividends, interest, royalties, rents, gains, research income Unrelated debt-financed income Controlled subsidiaries Exclusions Volunteer exception Convenience exception Sale of items received as gifts or contributions Small hospital exception 45 Unrelated Business Income Tax (cont d) Deductions Ordinary and necessary business expenses Proximate and primary relationship to the revenue Direct v. indirect costs Net operating losses year over year Reporting on Form 990-T Impact of substantial UBI how much is too much? Revenue v. net income 46 23
Unrelated Business Income Tax (cont d) Common applications to healthcare organizations Pharmacy sales and lab testing 340B Medicare drug programs? DME Sales of blood and blood products Fitness centers Cafeterias and gift shops Parking facilities and transportation services Lease of MOB space Management/administrative services and services to unrelated entities Joint ventures Alternative investments 47 Other Tax Considerations 48 24
Other Tax Considerations State filings Property taxes Gross receipts/net income UBI Foreign filings see Schedule F of Form 990 Excise taxes CHNA MDET Reinsurance premium excise tax 9010 health insurance tax PCORI fee (started July 2013) ACA Reinsurance fee (starts 2014) 25