The Legal Basis for Tax Exemption of Hospitals

As charitable tax-exempt organizations, Catholic and other not-for-profit hospitals are required to provide community benefit. Section 501(c)(3) of the Internal Revenue Service Code exempts organizations that are organized and operated exclusively for among other things, religious, charitable, scientific, or educational purposes. This section also stipulates no part of the organization’s net earnings can inure to the benefit of any private shareholder or individual.

Beginning in 1956, the IRS interpreted Section 501(c)(3) to permit hospitals to qualify as "charitable" if they provided charity care to the extent of their financial ability to do so. This was based on the historical premise that to be charitable, you had to "aid the poor". This narrow interpretation of a charitable organization was later broadened by Revenue Ruling 69-545 (see below). However, many people still incorrectly believe that the provision of charity care is a requirement for not-for-profit hospitals to qualify for federal tax exemption.

The Community Benefit Standard

In 1969, partly in response to the adoption of Medicare and Medicaid (which assumed that all health care would be covered by either a third party or the government), the IRS changed its "charity care" approach and issued Revenue Ruling 69-545 which stated that hospitals can qualify as charitable if they engaged in the "promotion of health". The ruling states that "The promotion of health, like the relief of poverty and the advancement of education and religion, is one of the purposes in the general law of charity and is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community."

It was in the context of this Revenue Ruling that the "community benefit standard" was born. Based on the facts presented, the IRS concluded that a hospital satisfies the "community benefit standard" if it:

• Operates an emergency room in which no one requiring care is denied treatment;
• Provides care to all who can afford to pay, including Medicare and Medicaid beneficiaries;
• Uses surplus funds to improve the quality of patient care, expand facilities, and advance education and training programs;
• Maintains a board of trustees composed of independent civic leaders; and
• Maintains an open medical staff.

The ruling also noted that "The absence of particular factors [such as charity care through the emergency room]…will not necessarily be determinative." The ruling went on to say "…the Service will weigh all relevant facts and circumstances in each case."

IRS Interpretations of Section 501(c)(3) as Applied to Hospitals

In 1992, the IRS issued Hospital Audit Guidelines which gave IRS auditors instructions on how to determine whether a hospital was meeting the factors enumerated in Rev. Rul. 69-545. These included, among others:

• Interviewing ambulance drivers to determine whether they are instructed to take indigent patients to another hospital.
• Interviewing social workers to determine whether the community is familiar with the availability of emergency services at the hospital.
• Ascertaining when and how determination is made of financial responsibility and whether a deposit is required before care is rendered.
• Determining whether the hospital is involved in projects and programs which improve the health of the community, including reviewing newsletters, press releases, and calendars of events.

In a 1991 General Counsel Memorandum, the IRS stated that activities that enhance a hospital's financial health or efficiency, even if they increase the hospital's ability to further its charitable purposes, do not in and of itself constitute community benefit.

In 2001, the IRS issued Field Service Advice (FSA) 200110030. In this document, the IRS clarified that if a charity care policy is included as a justification for an organization’s exempt status, then the entity must demonstrate that the policy is communicated to the public, that charity care is actually provided at reasonable levels, and that charity care patients are not routinely discriminated against.

Court Rulings on the Community Benefit Standard

There have been two recent appellate court cases that have applied the community benefit standard (in contexts not specifically applicable to most tax-exempt hospitals). Although these cases were not directly on point, in one of them, the court did offer the following relevant observations:

• That in defining the community benefit standard, every activity that promotes health does not necessarily support tax exemption. The court pointed out that many taxable enterprises offer products and services that promote health.
• While providing health care products and services to a broad section of the community is necessary to satisfy the community benefit standard, it is insufficient in and of itself. The organization must provide "some additional plus." One "plus" the court identified specifically was whether it devoted surpluses to research, education and training.
• That the "additional plus" must be of a "sufficient magnitude" to support that the health care provider operates primarily for the benefit of the community.
• That whether a hospital meets the standard will depend on the totality of the circumstances

It is within this context that CHA and others have worked to establish guidelines for identifying and inventorying community benefit activities in the spirit of the IRS interpretations.