Final Regulations for Tax-Exempt Hospitals

By Laura Kalick, J.D., LL.M., Bethesda, Md.

Editor: Kevin D. Anderson, CPA, J.D.

Exempt Organizations

Final regulations (T.D. 9708) under Sec. 501(r) (regarding additional requirements charitable hospitals must meet to be treated as tax exempt under Sec. 501(c)(3)) were recently issued and apply to a hospital's tax year that begins after Dec. 29, 2015. For tax years beginning on or before that date, the final regulations provide that a hospital may rely on a reasonable, good-faith interpretation of Sec. 501(r) and that a hospital will be deemed to have operated in accordance with a reasonable, good-faith interpretation of that section if it has complied with the provisions of the proposed regulations issued in 2012 (REG-130266-11) and 2013 (REG-106499-12) or the final regulations. To avoid the potential revocation of their tax exemptions and the resulting taxation of their income, charitable hospitals should make sure that any errors or omissions in their procedures are only minor, inadvertent, and due to reasonable cause and should take steps to adopt and carry out the proper procedures.


In 1969, the IRS published Rev. Rul. 69-545 to set forth the community benefit standard with which a tax-exempt hospital must comply to be a Sec. 501(c)(3) organization. Rev. Rul. 69-545 required a community-based board of directors, an open medical staff, an open emergency room, and acceptance of patients who had insurance, including Medicare. However, the lines between tax-exempt hospitals and for-profit entities continued to be blurred, especially in light of "whole-hospital" joint ventures, management company arrangements, and multientity complex health care organizational structures.

Rev. Rul. 98-15 clarified how the community benefit standard would be enforced with some of these combinations, but the debate still continued as to whether the characteristics of the tax-exempt hospital differed sufficiently to justify the revenue subsidy that tax exemption provides and whether there should be a charity care requirement. Also, concerns were raised about tax-exempt hospitals that took extraordinary collection actions against individuals who could not pay their bills, pushing them into even more dire financial straits. In many instances, the amounts billed to the patients who had no insurance were the full gross charges, much higher than the lower, negotiated rates that patients with insurance or Medicare enjoyed.

Sec. 501(r)

As a result of these events, the 2010 Patient Protection and Affordable Care Act, P.L. 111-148, provided that a Sec. 501(c)(3) hospital would have to meet the requirements of Sec. 501(r) to keep its exemption. Sec. 501(r) provides that a tax-exempt hospital must:

  • Conduct a community health needs assessment (CHNA) at least once every three years and adopt an implementation strategy to meet the needs identified through the CHNA;
  • Establish a written financial assistance policy (FAP) and a written policy relating to emergency medical care;
  • Not use gross charges and limit the amounts charged for emergency or other medically necessary care provided to individuals eligible under the FAP to not more than the amounts generally billed (AGB) to individuals who have insurance covering such care; and
  • Make reasonable efforts to determine whether an individual is FAP-eligible before engaging in extraordinary collection actions.

These requirements are in addition to meeting the general requirements of Sec. 501(c)(3) and the community benefit standard of Rev. Rul. 69-545. Noncompliance with the requirements can result in revocation of the hospital's tax-exempt status and taxing all the income as unrelated business income (UBI).

Sec. 501(r) applies to organizations that operate licensed hospitals in any of the 50 states or the District of Columbia, including government hospitals that have Sec. 501(c)(3) status. Where a hospital has an ownership interest in a passthrough entity, such as a partnership or limited liability company that is treated as a partnership or disregarded entity, the activities of that entity are treated as the activities of the hospital. Therefore, a department operated by the partnership or disregarded entity must comply with Sec. 501(r), or the income from the department will be considered UBI.

A hospital operated through a passthrough entity where the hospital has a stake must be in compliance with Sec. 501(r), or else the hospital can lose its 501(c)(3) status. Regs. Sec. 1.501(r)-1(b)(22) provides a limited exception to this rule where (1) the hospital does not have sufficient control over the partnership to ensure that it is conducted in a Sec. 501(c)(3) manner and treats the operation of the facility as an unrelated trade or business; or (2) at all times since March 23, 2010, the organization is primarily engaged in educational or scientific purposes, has no more than a 35% interest in the partnership, does own a general partner interest, managing-member interest, or similar interest in the partnership, and does not have control over the operation of the hospital facility sufficient to ensure that the hospital facility complies with the requirements of Sec. 501(r).

Under Regs. Sec. 1.501(r)-4(b)(1)(iii)(F), a hospital's FAP must list the providers, other than the hospital itself, delivering emergency or other medically necessary care in the hospital and must specify which providers are covered by the hospital's FAP (and which are not). The preamble to the final regulations notes that if a hospital outsources the operation of its emergency room to a third party and the care provided by that third party is not covered under the hospital's FAP, the hospital facility may not be considered to operate an emergency room for purposes of the factors in Rev. Rul. 69-545 that describe community benefit.

"Establishing" the Policies

A hospital should review its written policies and procedures to make sure that they comply with the existing guidance on Sec. 501(r) and should work to come into compliance with any new requirements in the final regulations. The policies must be "established." Regs. Sec. 1.501(r)-4(d) clarifies that a policy that is simply adopted by an authorized body of a hospital but not followed in any regular fashion has not been "established"; the policy must be "consistently carried out." Therefore, the hospital should provide reasonable resources for, and exercise due diligence regarding, the implementation of the policies to meet the standards required by the statute and regulations.

The Sec. 501(r) Requirements

Community health needs assessments: Tax-exempt hospitals must conduct a community health needs assessment at least once every three years and adopt an implementation strategy to meet the needs identified through the CHNA. The CHNA must be made widely available to the public and should take into account input from representatives of a broad cross section of the community, including those with public health expertise. Once the CHNA has identified the needs, an implementation strategy must be approved that indicates which needs will be addressed and why other needs will not be addressed.

Widely available to the public: The CHNA report must be made "widely available to the public" (Sec. 501(r)(3)(B)(ii)). This communication is a less stringent requirement than "widely publicizing," which is the communication requirement for the FAP. "Widely available" is the same standard that is used for making Form 990, Return of Organization Exempt From Income Tax, available to the public. This means that the CHNA must be posted on a webpage. Although private organizations such as GuideStar make the Forms 990 of all organizations available, no private company currently is known to provide this service for the CHNA. In addition, a hospital facility must make a paper copy of the CHNA report available for public inspection upon request and without charge (Regs. Sec. 1.501(r)-3(b)(7)(i)(B)).

If an organization fails to meet the CHNA requirements of Sec. 501(r)(3), Sec. 4959 imposes a $50,000 excise tax for any tax year for which there is such a failure.

The FAP: A hospital must establish a written FAP and a written policy relating to emergency medical care and "widely publicize" the FAP. Regs. Secs. 1.501(r)-4(a) and -4(b) provide that a hospital meets this requirement if it establishes a written FAP that includes:

  • 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;
  • In the case of an organization that does not have a separate billing and collections policy, the actions the organization may take in the event of nonpayment, including collections action and reporting to credit agencies;
  • If applicable, any information obtained from sources other than an individual seeking financial assistance that the hospital facility uses, and whether and under what circumstances it uses prior FAP eligibility determinations, to presumptively determine that the individual is FAP-eligible; and
  • A list of any providers, other than the hospital facility itself, delivering emergency or other medically necessary care in the hospital facility that specifies which providers are covered by the hospital facility's FAP and which are not.

Widely publicizing the FAP: Communication of the FAP is key. Regs. Sec. 1.501(r)-4(b)(5)(ii) goes beyond the comparable provisions of the proposed regulations that required the FAP documents to be translated into languages of persons with limited English proficiency (LEP) in the community that constituted 10% of the population. The final regulations require translation of the FAP for LEP populations that constitute the lesser of 5% or 1,000 persons.

Regs. Sec. 1.501(r)-4(b)(5) provides that to "widely publicize" the FAP, the hospital must:

  • Make the FAP, FAP application form, and plain-language summary (Regs. Sec. 1.501(r)-1(b)(24)) of the FAP widely available on a website;
  • Make paper copies of the FAP, FAP application form, and plain-language summary of the FAP available upon request and without charge, both by mail andin public locations in the hospital, including, at a minimum, in the emergency room (if any) and admissions areas;
  • Notify and inform members of the community served by the hospital about the FAP in a manner reasonably calculated to reach those members most likely to require financial assistance from the hospital; and
  • Notify and inform persons who receive care from the hospital about the FAP by:
    • Offering a paper copy of the plain-language summary of the FAP to patients as part of the intake or discharge process;
    • Including a conspicuous written notice on billing statements about the FAP that includes hospital department phone numbers for information about the FAP and FAP application process and the website address where copies of the FAP, FAP application form, and plain-language summary of the FAP may be obtained; and
    • Setting up conspicuous public displays to inform patients about the FAP, in at least the emergency room (if any) and admissions areas.
Charges Policy

The charges policy is an important element of Sec. 501(r) and provides that persons who are eligible for the FAP cannot be billed the hospital's gross charges and that the hospital must limit the amount charged for any emergency or other medically necessary care it provides to a FAP-eligible individual to not more than the AGB to individuals with insurance covering that care. Medically necessary care can be defined by state law, by reference to generally accepted standards of medicine in the community, or by reference to an examining physician's determination (Regs. Sec. 1.501(r)-5(e)).

Two methods are provided for hospitals to determine AGB: the lookback method (Regs. Sec. 1.501(r)-5(b)(3)) and the prospective Medicare or Medicaid method (Regs. Sec. 1.501(r)-5(b)(4)). A hospital may use only one of these methods to determine AGB at any one time, but different hospital facilities operated by the same hospital organization may use different methods, and a hospital facility may change the method it uses to determine AGB at any time (Regs. Sec. 1.501(r)-5(b)(1)).

Billing and Collections Policy

A hospital meets this requirement only if it does not engage in "extraordinary collection actions"(ECAs) before it has made "reasonable efforts" (Regs. Sec. 1.501(r)-6(c)) to determine FAP eligibility. Essentially, the regulations provide an eight-month period (240 days) after the first post-discharge bill for a hospital to give a patient time to apply for financial assistance to be considered to have made reasonable efforts to determine whether the patient is FAP-eligible.

Regs. Sec. 1.501(r)-6(b) provides that ECAs include:

  • Selling an individual's debt to another party (other than those that meet an exception—see below);
  • Reporting adverse information about the individual to consumer credit reporting agencies;
  • Deferring or denying, or requiring a payment before providing, medically necessarycare because of an individual's nonpayment of one or more bills for previously provided care covered under the hospital's FAP; and
  • Actions that require a legal or judicial process.

Exception for certain debt sales: Regs. Sec. 1.501(r)-6(b)(2) provides an exception for certain debt sales. If a hospital sells an individual's debt, it will not be considered an ECA if, prior to the sale, the hospital enters into a legally binding written agreement where:

  1. The purchaser is prohibited from engaging in any ECAs to obtain payment for the care;
  2. The purchaser is prohibited from charging interest on the debt in excess of a certain rate set by the Internal Revenue Code;
  3. The debt is returnable to the hospital if the hospital determines that the individual is FAP-eligible; and
  4. If the individual is determined to be FAP-eligible and the debt is not returned, then procedures are put in place so that the individual does not pay more than he or she is responsible for paying under the FAP.
Failures to Satisfy the Requirements of Sec. 501(r)

A hospital that fails to meet the requirements of Sec. 501(r) may have its Sec. 501(c)(3) status revoked. Regs. Sec. 1.501(r)-2 provides that the IRS will consider all relevant facts and circumstances including: previous failures; the size, scope, nature, and significance of the organization's failures; reason for the failures; whether the organization had established practices or procedures reasonably designed to promote compliance; whether the procedures had been routinely followed; whether the organization has implemented safeguards that are reasonably calculated to prevent similar failures from occurring in the future; and whether the organization corrected the failures as promptly after discovery as is reasonable, given the nature of the failures and whether the organization implemented the safeguards and corrected the failures before the IRS discovered them.

Reasonable cause: Regs. Sec. 1.501(r)-2(b)(4) provides that a hospital facility's establishment of practices or procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with the Sec. 501(r) requirements prior to the occurrence of an omission or error is a factor tending to show that the omission or error was due to reasonable cause. The IRS published Rev. Proc. 2015-21 on March 10 to provide guidelines regarding correction and disclosure procedures for hospitals to follow so that certain failures to meet the requirements of Sec. 501(r) will be excused.

Taxation of Noncompliant Hospital Facilities

A hospital organization will be subject to tax on gross income from its noncompliant hospital facility during the tax year, less the deductions allowed by chapter 1 of the Code that are directly connected to the operation of that hospital facility. The computation will exclude any gross income and deductions already taken into account in computing any UBI. The facility-level tax will be reported on Form 990-T, Exempt Organization Business Income Tax Return.


The consequences of not complying with Sec. 501(r) can be disastrous for a tax-exempt hospital. The final regulations have provided a good road map to follow, and hospitals should devote the resources needed to comply.


Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.

For additional information about these items, contact Mr. Anderson at 301-634-0222 or

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

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