Not-For-Profit/Exempt Organizations Blog : Non-Profit Lawyers & Attorneys : Proskauer Rose Law Firm : Tax & Corporate Law for 501(c), 501(3) Organizations

As we reported earlier in March of this year, the IRS announced that it would concede and pay outstanding claims for periods before April 1, 2005.  The significance of the April 1, 2005 date is that new regulations went into effect on that date providing that the student exception from FICA tax does not apply if the individual works full-time.

Last summer, the Eighth Circuit Court of Appeals held that this regulation was valid in the Mayo Foundation for Medical Research and Education and the University of Minnesota cases.  These institutions petitioned the Supreme Court for certiorari.

Yesterday, the United States Supreme Court granted the certiorari petition and will hear the appeal concerning the availability of the student FICA exception for medical residents after April 1, 2005.  As a practical matter, the grant of certiorari means that this issue is still up in the air for the time being and institutions should consider whether they should still continue to file protective refund claims for recent years.

In a plurality opinion, three of the seven Supreme Court justices concluded that Provena Covenant hospital, located in Urbana, Illinois, was not a charitable institution for tax purposes.  (Two justices did not participate in the case.)  Their opinion reasoned that the primary use of the hospital property was providing medical services for a fee, while charity means providing a gift to the community.  The opinion further pointed out that (i) charity care being provided was subsidized by payments for patients; (ii) patients granted partial charity care still paid enough that the hospital might cover its costs; and (iii) the hospital's community benefit activities -- such as a residency program and an education program for emergency responders -- benefited the hospital as well as the community and thus were not truly gifts by the hospital.  Thus, the hospital property was not in charitable use.

Most not for profit hospitals today are, of course, primarily supported by payments for services rather than by charitable contributions.  Under the opinion's reasoning, hospital property tax exemption may well be hard to maintain.  However, a partial concurrence and partial dissent by two justices suggests that this case is not the end of the story.  They concur that Provena did not carry its burden of proof to show that it was entitled to exemption.  They dissent, however, on the rationale. The dissent indicates that the plurality opinion impinges on the legislative function of setting specific standards for tax exemption. It further points out that the plurality opinion's charitable use discussion is not joined by a majority of the court and, therefore, is not binding precedent.

The dissent indicates that this may not be the end of this issue in Illinois.  For example, the legislature could take action to set minimum standards to qualify for exemption.  A different case with a different record might generate a different conclusion.  The decision is important nationally, however, in two respects.  First, the opinion's language is likely to drive more property tax exemption challenges.  Second, it emphasizes, along with the health reform proposals concerning requirements for income tax exemption for hospitals, the higher level of accountability to which not for profit hospitals are being held nationally.

The IRS is not conceding this issue for periods on and after April 1, 2005.  On that date, new regulations went into effect providing that the student exception from FICA tax does not apply if the individual works full-time, which of course residents do.  The Eighth Circuit decided last year that the new regulation was valid and precluded FICA tax refunds for residents after its effective date.  This case is the only appellate case on the issue to date.  The employers in that case, Mayo Foundation for Medical Education and Research and the University of Minnesota, have filed a cert. petition with the US Supreme Court; the Court has yet to act on that petition.

The IRS will, within 90 days of its announcement, begin contacting hospitals, universities, and medical residents who filed FICA refund claims for these periods with more information and procedures.

Employers and individuals with pending claims do not need to take any action at this time.

Taxpayers with currently pending suits should contact the Department of Justice attorney assigned to the case.

Organizations that employ residents and wish to keep their FICA claims for 2006 alive need to file refund claims by April 15, 2010.

For additional information about medical resident refund claims, please visit the IRS's Questions and Answers section.

For the past 40 years, the availability of tax exemption for hospitals and other health care organizations has been judged by the “community benefit” standard articulated by the IRS.  We have previously described the history of the community benefit standard.  If Congress adopts a health reform bill and the Senate provisions are included, hospitals will have greater transparency and public accountability requirements.  Because the House health reform bill passed in November had no provision concerning this issue, it is unlikely that the hospital tax exemption provisions will change significantly in the process of agreeing upon a final bill.

Section 9007 of the bill, in essence, codifies and elaborates on certain key aspects of the “community benefit” standard.  The penalty provisions and focus on ongoing charity care trends should prompt hospital governance and management to pay much closer attention to these particular requirements and the broader distinctions between tax-exempt and for-profit hospitals.

The legislation contains the following four specific requirements, which hospitals must satisfy in order to qualify for tax-exempt status under Section 501(c)(3):

·        Community health needs assessment.  Each hospital must conduct or participate in a community health needs assessment at least every three years and report on its implementation.  A hospital not meeting this standard would be subject to an excise tax.

·        Financial assistance policy.  Each hospital must adopt a financial assistance policy spelling out its criteria for free or discounted care and make the policy widely available.

·        Limitations on charges.  Each hospital must charge those who are eligible for partial financial assistance no more than the amount generally billed (that is, the “list price” cannot be charged for the balance).

·        Billing and collection.  Each hospital must make reasonable efforts to determine whether a patient is eligible for assistance under its financial assistance policy before taking extraordinary collection actions.

Interestingly, the legislation would also require the IRS to review each hospital’s community benefit activities at least once every three years – the level and manner of scrutiny is not specified.  The IRS has not indicated how it would conduct such reviews.  Finally, the Departments of Treasury and Health and Human Services would be required to report each year to Congress on levels of charity care and other activities of tax-exempt, public, and taxable hospitals.

Many tax-exempt hospitals have already adopted most of the practices set forth in the health reform legislation.  Even if the hospital tax exemption provisions (or health reform itself) do not pass, however, hospitals that currently do not engage in these practices should consider adopting some or all of them to stay current with the practices that the public and the government expect.