Tax-Exempt Hospital Compliance With Sec. 501(r): No Violation Is Too Small to Ignore

By Michelle Michalowski, CPA, Washington

Editor: Annette B. Smith, CPA

Exempt Organizations

On Dec. 29, 2014, the IRS issued final regulations under Sec. 501(r) regarding exemption requirements for nonprofit hospitals (T.D. 9708). The IRS supplemented the final regulations in early March 2015 by Rev. Proc. 2015-21, which provides guidance on correction and disclosure for certain failures to meet the Sec. 501(r) requirements. Tax-exempt hospitals must generally be in compliance with the final regulations for tax years beginning after Dec. 29, 2015, for their hospital facilities to remain exempt from federal income tax.

The final regulations establish detailed procedural and process requirements in four areas:

  • Financial assistance policies (FAPs);
  • Amounts charged to FAP-eligible individuals;
  • Billing and collection practices; and
  • Community health needs assessments (CHNAs).

These requirements affect almost every aspect of a tax-exempt hospital's operations, including patient intake, financial counseling, the emergency room, information technology, billing, collections, public relations, community outreach, finance and accounting, legal, and tax reporting. Noncompliance can trigger sanctions ranging from a simple correction of a minor error to, in the most extreme cases, revocation of exempt status. This item focuses on what a facility must do when a violation occurs.

With such detailed rules and so many hospital facility employees involved in their implementation, even at the most careful facility something can go wrong. The current guidance makes clear that no violation is too small to be ignored. Even violations some might consider trivial—such as signage briefly falling off a wall or a patient's accidentally being overcharged by $2—are significant enough to be addressed.

Responding to Violations

A tax-exempt hospital must identify every Sec. 501(r) violation and ensure that each violation is addressed by properly trained staff responsible for Sec. 501(r) compliance. The staff should classify violations into one of the three categories set forth in the final regulations:

  • Minor errors or omissions, which are not considered "failures" if they are inadvertent or due to reasonable cause—but only if promptly corrected;
  • Willful or egregious failures, which are subject to the full array of sanctions; and
  • Any failure in between those two categories, which will be "excused" as long as it is "corrected and disclosed."

Proper classification requires knowledge of the specific incident and other similar incidents, past or present. Each category has its own requirements for resolution, but all require correction, and correction arguably is the most important element.

Identification, classification, and resolution require a hospital to implement detailed practices and procedures that guide employees through each step in addressing a violation. The final regulations stress the establishment of these practices and procedures and their frequent monitoring to minimize the risk of sanctions.

Example: A patient who recently applied for and qualified under the facility's FAP returns to the facility and receives medically necessary care. The patient is provided all required FAP information but does not indicate that he previously has qualified. Hospital facility employees fail to realize that the patient is qualified under the FAP, and the patient is billed at the facility's rate for noninsured patients, which exceeds amounts generally billed (AGB) and the FAP amount. He pays in full.

The example raises the following issues:

1. Identification: The hospital facility should adopt practices and procedures that allow it to identify patients it has previously identified as FAP-eligible and subject to AGB limits. Periodic compliance checks also may be a best practice and could identify errors in billing. Charging a patient who has been identified as FAP-eligible more than would be charged under the FAP policy and more than AGB is a potential violation.

2. Classification: There is no indication that this violation is willful or egregious, although Rev. Proc. 2015-21 seems to indicate that overcharging a FAP-eligible patient is not a minor violation. The violation would appear to be a type of failure that the IRS will excuse with proper correction and disclosure.

3. Resolution: Under the guidance, correction must include a refund of any payments made in excess of the amount owed after the FAP discounts are applied (if $5 or more), even if such payments were made in prior years (including closed years). Correction also might include providing the individual with an explanation of the error and a corrected bill. Disclosure requires reporting on IRS Form 990, Return of Organization Exempt From Income Tax, descriptions of (a) the failure, (b) correction of the failure, (c) how the affected individual was restored to his or her prefailure position, and (d) updates to practices and procedures or an explanation of why no changes were necessary.

Unanswered Questions

Despite the guidance, many questions remain, and how those issues are resolved may significantly affect application of the law to various violations. For example, Rev. Proc. 2015-21, Section 6.01, requires that the correction of failures must be made according to certain principles, one of which is that a correction includes restoration of any affected individual to the position in which he or she would have been had the failure not occurred, even if the harm he or she suffered was in a prior "closed taxable year." How far back must a facility correct? Would prior tax years include dates prior to the effective date of the final regulations or of Rev. Proc. 2015-21?

If a facility has a violation that otherwise might be excused but misses one or two required elements of correction or disclosure, what is the consequence? Also, does a framework of guidance built on self-identification of violations that, once identified, trigger public disclosures create a disincentive to self-identify and address areas of noncompliance? As facilities and practitioners delve into the details of the guidance and its practical application, more questions will arise.


Rev. Proc. 2015-21 and the final regulations seek to provide hospital facilities a road map to promote compliance and relief from harsh sanctions when noncompliance is minor or not due to culpable behavior on the hospital's part. The guidance is intended to encourage hospital facilities to take corrective steps when any noncompliance is discovered. The complexity of the final regulations likely will result in discoveries of violations, many of which may seem insignificant. However, the current guidance suggests that a tax-exempt hospital may not ignore even insignificant violations. Each discovered violation under Sec. 501(r) will require some action by the hospital facility. The policies and procedures put in place by a hospital facility to promote compliance, as well as the steps taken to correct mistakes once they occur, will affect the sanctions that the IRS could impose on a facility for noncompliance.


Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington.

For additional information about these items, contact Ms. Smith at 202-414-1048 202-414-1048 or

Unless otherwise noted, contributors are members of or associated with PricewaterhouseCoopers LLP.

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