This is to advise you of a series of significant developments this week relating to continued Internal Revenue Service (IRS) scrutiny of tax-exempt hospitals and compliance with the standards for tax-exempt status, and to offer some related planning suggestions.
The first development was Wednesday's announcement by the IRS of its 2006 Exempt Organizations (EO) Implementing Guidelines (a/k/a "Workplan"), together with release of an explanatory letter from Martha Sullivan, IRS Director for Exempt Organizations. These two documents reflect the materially increased level of attention that nonprofit, tax-exempt hospitals can expect from the IRS in the coming year.
It is clear from the Workplan that the IRS will continue to monitor executive compensation issues beyond the scope of its current "soft contact audit" initiative, which is to be completed in 2006. The IRS still intends to issue a report of its initial findings from the audits. Based upon those findings, the IRS expects to "target additional examinations and compliance checks." Query whether the recent controversies involving American University, Getty Museum and executive discretionary expenditures will expand the IRS' focus in the compensation area.
Perhaps more noteworthy is the potential for an Exempt Organization Compliance Unit compliance project to determine how hospitals meet the community benefit standards for purposes of IRC Section 501(c)(3). This project would involve sending compliance check letters to a "significant number" of hospitals (at least 600) requesting that they answer certain questions regarding satisfaction of the community benefit standards, executive compensation and potentially other issues.
Also of note is the continued effort by the IRS to collaborate with the National Association of State Charity Officials ("NASCO"), "to identify areas of mutual interest and explore ways to integrate our activities and strategies." Of course, state charity officials in most cases claim jurisdiction under state nonprofit corporation statutes and possibly charitable trust laws to pursue similar issues of executive compensation (i.e., "waste of charitable assets") and charitable status.
The Workplan also references the previously announced audit initiative addressing issues of private use and private benefit related to IRC Section 501(c)(3) bonds.
The second development was the several speeches given early in the week by Senator Charles F. Grassley, Chair of the Senate Finance Committee. In these speeches, Sen. Grassley emphasized that he still expects his Committee to introduce, perhaps in several phases, the long-awaited federal nonprofit governance oversight legislation. The first phase, which he expects to be introduced before the end of the year, would address matters of transparency, improved corporate governance, self dealing and excessive compensation – issues of great importance to nonprofit hospitals. The balance of the legislation would be introduced in 2006 and would deal with other perceived abuses in charitable organizations.
Significantly, Sen. Grassley also stated the Committee's intention to continue to examine issues of hospital tax-exempt status, which began in the early summer with the controversial letters sent to 10 hospitals and health systems, inquiring about community benefit and charity care practices, as well as executive compensation and expenses. Sen. Grassley indicated that the Committee was unsatisfied by the initial responses to those letters and may issue follow-up letters seeking clarification. An additional round of letters, to other hospitals, may also be sent by the Committee. Sen. Grassley's interest continues to be with the lack of a common policy/common approach in the nonprofit, tax-exempt hospital industry concerning charity care and community benefit.
Also noteworthy from Sen. Grassley's presentations was his concern with respect to alleged abuses at both the American University and the Getty Museum, and what he referred to as the lack of criticism from the nonprofit community about these controversies. [Note: Both American University and Getty Museum have been the subject of substantial recent national media coverage, and McDermott Will & Emery will be issuing an "On the Subject" client memo next week discussing exempt organization tax and corporate issues arising therefrom.]
In responding to these new developments, tax-exempt, nonprofit hospitals may wish to consider the following course of action:
First, it may make sense to continue to emphasize the application of identified "best practices" to the executive compensation process, with new focus on the issue of discretionary executive expenditures. Clearly, each of Congress, the IRS and state regulators intends to maintain sharp focus on perceived executive compensation abuses.
Second, it will be important to review and monitor the continued effectiveness of hospital policies and practices on the provision of charity care, and related billing and collection practices, from a community benefit perspective. This will be especially important in the event that the IRS proceeds with its intended compliance initiative in the area.