Douglas Mancino, Partner, Seyfarth Shaw LLP, and Ruth Madrigal, Principal, KPMG, discuss recent tax-related developments in the health care space. They cover 501(r) compliance, the 4960 excise tax on compensation in excess of $1 million, criticisms that have been levied against tax-exempt health care organizations, and Inflation Reduction Act tax credits related to clean energy investments. Douglas co-authored the third edition of AHLA’s Taxation of Hospitals and Health Care Organizations.
Watch the conversation here.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
Douglas Mancino, Partner, Seyfarth Shaw LLP, and Ruth Madrigal, Principal, KPMG, discuss recent tax-related developments in the health care space. They cover 501(r) compliance, the 4960 excise tax on compensation in excess of $1 million, criticisms that have been levied against tax-exempt health care organizations, and Inflation Reduction Act tax credits related to clean energy investments. Douglas co-authored the third edition of AHLA’s Taxation of Hospitals and Health Care Organizations.
Watch the conversation here.
To learn more about AHLA and the educational resources available to the health law community, visit americanhealthlaw.org.
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Speaker 2:This episode of A HLA speaking of health law is brought to you by A HLA members and donors like you. For more information, visit American health law.org.
Speaker 3:Hello, my name is Doug Manino. I'm a partner with Cypress Shaw in Los Angeles, California. Uh, I'm also past president of the American Health Law Association and the co-author of the New Treatise Taxation of Hospitals and healthcare organizations that the A HLA is , uh, supporting. And I'm here with , um, my colleague Ruth, and she's gonna introduce herself and talk about her background, both currently with KPMG, as well as with the government. Ruth .
Speaker 4:Great. Thanks, Doug. Hi, I am Ruth Madrigal . I am a principal in charge of the Washington National Tax Exempt Organizations Group at KPMG. I previously have practiced in law firms, and I think Doug was referring specifically to , um, the time that I spent in the Treasury's Office of Tax policy, working on all things tax exempt organizations and , uh, charitable contributions. Uh, so I'm really happy to be here today to talk about what's going on with Exempt Healthcare.
Speaker 3:Great. Well, this podcast is really going to be , uh, conversational in nature. Uh , both Ruth and I have collaborated on many things together over the years, and this is just one wonderful opportunity to talk about things, healthcare , uh, especially , uh, with what's going on in Congress and in the criticisms about healthcare organizations providing inadequate amounts of , uh, community benefit and compensating their executives too highly , uh, which arguably they say deprives the community of further benefits. Uh, we're gonna talk a little bit about 5 0 1 R compliance. That's a front burner issue today. And then lastly, we're gonna talk about the 49 60 excise tax on compensation in excess of a million dollars. So, Ruth, why don't you lay the groundwork for , um, what's, what's peaking the interest at the IRS , uh, on determining 5 0 1 R compliance levels , uh, on a , as a front burner issue?
Speaker 4:Well, yeah, Doug, I think we have not seen , uh, a lot of activity by the IRS in , uh, examinations in the last few years. I mean, obviously the cuts in their funding over the last decade really inhibited their ability to do much exam work. Um , but the additional funding that they've been provided , uh, has helped them to not only upgrade systems and, and, and, and work through , uh, a reorganization, but also to lo relaunch some of their exam programs. And in particular in the EO space, they have , uh, been communicating about , uh, increased examinations. And in March, on their website, they indicated that they were especially interested in starting exams of hospitals , uh, over 5 0 1 R compliance. And in that same announcement, they mentioned that they were also going to be looking at tax exempt status and compliance with the community benefit standard. I think that's really interesting. I think 5 0 1 R wise , we haven't really seen much exam activity. At least I don't, I don't think we have. There was a round of exam activity around hospitals and UBIT allocations that we saw for several years. Um , but apart from the , um, sort of mandatory review of , uh, every three years of tax exempt hospitals, that was largely done behind the scenes and a few compliance check letters. If they couldn't find a financial assistance policy, for example, we, we had clients that would get a financial assistance policy, compliance check letter that said, Hey, we can't find it. Can you tell us where it is? And, and then that was about the end of it. What we have heard are, are happening more recently, are some full blown 5 0 1 R audits, and I've heard a handful have started, and I think we're gonna see some more of them as people find these letters and contacts in their , in their in the mail. Uh, but looking at all of the aspects of 5 0 1 r , the , the financial assistance policy, making it widely , uh, available, publicizing it widely, and , um, as well as the billing and collections , uh, policies and procedures that are also part of 5 0 1, R five and six . Um, so I think that that's, that's a real difference in the change. Um, I don't know . I don't have any infor , I don't have any inside information about where this interest came from, but I, I don't think it's coincidental that the IRS has been getting some congressional letters. Uh, for example, last August, there was a bipartisan letter that came to the IRS , um, from some senators asking specifically about the community benefit standard and how that is reported on the, the Form nine 90 Schedule H and sort of criticizing the IRS for LAX enforcement. And then at the same time, those same senators last August sent a letter to tigta , uh, uh, asking TIGTA to look into IRS enforcement. So I, I don't know that tho , I don't know that those are connected, but I wouldn't be surprised if they were.
Speaker 3:Well , I, I have have a client that's been selected for one of these examinations, and what is relatively clear is that the first information document request, IDR as we call it, is comprehensive. And I have every, every belief that this is a uniform , uh, widely coordinated initiative to maximize the , uh, input of information concerning levels of 5 0 1 R compliance , uh, throughout the United States. So I'd be shocked if , um, many of the people listening to this podcast , um, aren't already aware or , and in receipt of the , um, IDR process, but it is clearly comprehensive. Uh, several years ago there was , Ruth indicated , uh, targeted 5 0 1 R compliance checks. Uh, I had one concerning a psych hospital that didn't have an emergency department, as most psych hospitals do not , uh, but it was a targeted compliance check solely for that aspect. Prior to that, we had some compliance checks that actually predated the effective date of the final 5 0 1 R regulations, which made no sense to me. But now that the , uh, 5 0 1 R regulations have been final for some time, I think there's every expectation that , uh, a number of footfalls will be exposed , uh, through this process. And as Ruth and I have discussed , uh, this is really now at the level of the c-suite because failure to , uh, comply with key elements like the community health needs assessment and implementation plan requirement, not only can bring about , uh, a $50,000 excise tax , uh, but can result in revocation of exemption, or if you have multiple facilities within a single corporation , uh, ubit taxation of revenues derived from noncompliant facility. You might wanna comment on that, Ruth.
Speaker 4:Yeah, that was , um, it was interesting when we were doing the regs for this, I happened to be at the , the Treasury's Office of tax policy when we were doing the , um, the 5 0 1 R regs. And Congress really only provided a , a tax, an excise tax on the CHNA portion of the 5 0 1 R. And so that, I think we've seen some more looking at that and maybe A-A-C-H-N-A tax here and there, but the real, the real stick sort of involved in the other, the other pieces of 5 0 1 r , the FAP and the billing and collections and , uh, type , uh, provisions is revocation . So that's a pretty rough sanction . Um , if there are multiple, like you said, multiple hospital facilities in one entity entity , and there's only compliance issues at one of those facilities, the, the statute and the regulations provide that you would treat that facility as though it were taxable. And so there's a, that provides a bit of an intermediate sanction in a, in a system that has multiple facilities in that entity. But that, that , those are pretty significant sanctions. So I think one thing , uh, that probably everyone in the audience is aware of, but it's, it's worth underscoring, is that the, the final regs, because these sanctions can be so big , incorporate two provisions that really , um, provide an incentive to get at these violations first before the IRS comes in and looks at you. One is for minor and inadvertent , uh, infractions, right? You have to have the, the financial assistance policy on the wall in the, in the emergency room. And if it falls off the wall, you just have to pick it up and fix it and keep going. Minor and inadvertent foot faults. You can, you could , if you fix it before the IRS gets there, it's sort of a no harm, no foul rule that's built in . And then there's another rule built in for more significant violations. Again, if you fix it before the IRS gets there, and if it's more than minor and inadvertent, you need to confess and correct is how I think about that rule . You have to fix it and , uh, disclose it. But if you do that, then, then you're really not looking at a one of those, the taxability or the revocation , um, sanctions. So I think those are important to underline.
Speaker 3:I'd like to emphasize the, the fact that this is not dissimilar from the early stages of the anti kickback statute and the Stark self-referral law. A lot of organizations were not terribly good at complying with them, and some got , uh, pretty well sanctioned as a result. Uh , by analogy, I think this is now a provision that should rise to the compliance level at the c-suite. Uh, the general counsel should be involved , uh, the CEO should be monitoring compliance because ultimately the buck stops there in terms of non-compliance. And there , there should be a culture of compliance throughout the entire organization , um, going down to individual departments like billing and collection and so forth. Um, and we did, we do hear reports , uh, most recently at the a BA tax section meeting of , uh, nonprofit hospitals , uh, putting in car , putting in place , uh, private label credit card arrangements to pay off hospital debt, and thinking that that might be a way, a workaround to compliance with , uh, some of the , uh, collection , uh, requirements , uh, and, and collection limitations of 5 0 1 R . Um, so I, I , I would, I would emphasize the compliance element here should be a front burner issue throughout the entire facility and multiple facilities.
Speaker 4:Yeah. And one thing we saw when, when, you know, a decade ago when these rules first went into place, was that a number, at a number of hospitals, this was a, a, a cross-functional implementation , uh, activity at the time. Right? They, a number of folks were doing a lot of the things that were required by 5 0 1 R , but we're not doing them all in one place, and maybe we're not doing them consistently. Maybe some of the , uh, the community public , uh, pub publicizing of the financial assistance policy was done in one place, and you have the billing and collections activities being done in another department. So coordination among the different , um, activities, I think as, as you said, tended to be a c-suite issue a decade ago. And I wonder about whether turnover has sort of , uh, lost some of that muscle memory in some of the organizations.
Speaker 3:Well, I, I , I'll give you a recent example. I reviewed a nine 90 , uh, provided by a client that has a , a psych hospital. And lo and behold, looking at Schedule H, they clearly did the community health needs assessment in 2021 , uh, which will be taking place again in 2024. But they reported on the Schedule H that they did their implementation plan in 2018 , which should have been done in 2021. So again, that's just, that's just a minor example of , um, inconsistent levels of compliance even within a single organization. So multiply that, if you have multiple hospitals in multiple states and you're relying on, you know, multiple executives geographically remote from the main headquarters of the organization , uh, that just multiplies the levels of opportunities for non-compliance.
Speaker 4:Yeah, agreed. And all of the merger and acquisition activity that has taken place over the most, you know, the last few years, I think increases the level of difficulty right in , in trying to get folks all on the same compliance and making sure that you've got the right people , uh, involved.
Speaker 3:Let me , let , let me shift non-compliance gears, if I may, Ruth to mm-Hmm, <AFFIRMATIVE> 49 60 , the excise tax on remuneration in excess of a million dollars. And I mentioned non-compliance because the IRS publishes data about forms 47 20, which are the excise tax returns filed by , uh, tax exempt organizations , uh, specifically with regard to identifying compliance with the 49 60 excise tax. And based on data for from 2019 , uh, that I got from a private source, a couple of academics wrote an article where they did what academics do. They surveyed nine nineties for compliance with that tax . And basically when you compare that data to the IRS data, it ICA indicated that there's almost 75% non-compliance with that ex excess tax . Wow . And when you <crosstalk> that to an industry that is , Ruth just mentioned, undergoes constant mergers, acquisitions, dispositions , uh, I recently wrote in an article that this becomes a matter of financial due diligence in terms of compliance because the onus is on the employer, not the employee to pay the 20 now 21% excise tax , uh, if there's compensation and excess of million dollars. And the other thing I would point out is because healthcare organizations are probably the most significant segment of the exempt organization world that do mergers and acquisitions, dispositions on a routine basis , um, this really should be a , uh, another compliance check matter as well as a due diligence , uh, check matter.
Speaker 4:Absolutely. And I would chime in here, Doug. I know that you've seen it, and I think, I think you're even writing about it if it , if I'm not mistaken, but this issue can hit employees even when you're not paying them more than a million dollars on the regular. We've , um, because of adjustments that need to be made taking into account , um, retirement plans, deferred compensation plans, and also the big hiccup, I think sometimes is the , um, the, the separations, the involuntary separations that can occur that that can then trigger , um, payment of this tax even if you're well below , uh, a million dollars in annual compensation.
Speaker 3:Yeah. I, what , what I would say is this, if you're a non , uh, freestanding nonprofit hospital , uh, you should, as a matter best practice, have a change in control plan. So you are creating a , uh, passive aggressive management that's unwilling to undergo a change in control. But that then triggers what Ruth was talking about, that is potential double trigger involuntary terminations after a change in control takes place. And so the threshold for that is considerably lower. It applies to highly compensated people, which for 2024 is $155,000. So you may have , uh, nonprofit hospitals that are maybe mid or smaller size that are going to be impacted by , uh, the , uh, uh, uh, uh, excess parachute payment excise tax component of 49 60.
Speaker 4:Yeah. We frequently see clients that , um, that, that they think, well, we don't really pay that many people in the system more than a million dollars. We have a lot of people that are in a clump, sort of less than a million, and it's a , it's a big bother to try to figure out who our top five are. And so as long as we're getting the tax right, and we're, we're paying the tax on the one or two people that are over a million, we'll be fine. Right. To which I say the answer really is wrong because the , to have those covered employees, your top five in a given year, right, post 2017, those add up each year, you add your top five and your top five, and people don't drop off of that. And so even though many of them make well below a million and will always make well below a million when you have these changing control provisions, and when you have these at these parachute payments that trigger the excise tax at , at places much, much lower down, and at salary levels , much more, much lower down, knowing who your covered employees are is really important. And being able to , um, I I , I mean, if I was the IRS, I would walk into a hospital and ask, who are your covered employees? And, and see if they can produce a list of their covered employees. I think a number of clients have not been investing in doing that work on an annual basis. And when you get several years down the road, it may be a much larger task to try to recreate that forensically.
Speaker 3:Yeah . Yeah . Take, take for example, you're , you're always gonna have attrition at the senior executive level. Some somebody's gonna be dissatisfied or gets a new opportunity for a better position with another hospital or health system. And so the number of people today in 2024 is considerably larger than it was in 2018, the year that vision became effective. And so , and that's just a short six year span, extrapolate that to 10 or 15 years, and you could have 30 or 40 people who are covered people. And with , with the fact that the $1 million , uh, threshold is not indexed for inflation , uh, and salaries of executives are as well as highly compensated physicians , um, you , you could be bumping against that ceiling quicker than you think , uh, not to mention the excess parachute payment exposure if there is a change in control.
Speaker 4:Right. Right. So should we , um, mention a few more of the, the criticisms and concerns and where these things are coming from and some of the legislative activity out there? Sure. I , I can , um, I think many people have seen that there are private , um, uh, study, I guess institutes that are starting to , um, critique hospitals and coverage of , uh, of charity care in particular. And what I found interesting, I think one of the first that I saw was the Loan Institute a few years back issued a report. And it seems to me what , what struck me about that when it first came out was that it was using a different yardstick than I'd ever seen used in the healthcare space before. Right? We've had the community benefit standard , uh, for a long time, and we've had five , uh, the, the, the Schedule H where you have some reporting on community benefit is , and, but what the Loan Institute started looking at was, it, it, they defined community benefit in a different way. For example, excluding medical research and training of new doctors in, in , uh, in the , the academic medical centers, which I, I thought was an interesting development. Um,
Speaker 3:Al also, also the legislators pick and choose data. Uh, Bernie Sanders issued a report , uh, a couple of months ago , uh, using pre Affordable Care Act anecdotes to argue, to support his argument that nonprofit hospitals are not doing enough , uh, uh, community benefit and are using billing practices that probably became antiquated and unlawful under 5 0 1 R in 2010, but drawing from data from 2006 , uh, to make the case.
Speaker 4:That's really interesting. So I think maybe one of the upshots of the new IRS compliance activity, might I , I mean, I don't know if they still will publicize data the way that they did in the , say the, the college and university study that they did, you know, 15 years ago where they actually did a broad-based study and came to some conclusions and publicize that. But it would be useful if Congress wants to legislate in this area and a number of the , uh, these letters, these congressional letters are indicating that maybe Congress should be acting. It would be great if that was based on some new data about what is actually happening in the sector now. Yeah ,
Speaker 3:My guess , my guess is the current leadership at the exempt organization function of the IRS will be , uh, uh, very focused on , uh, responding to congressional oversight with regard to the alleged , um, insufficient levels of community benefit, as well as alleged non-compliance with 5 0 1 R . But I think with that note, we should wrap up with talking about some of the developments that you're working on in the energy sector because , uh, that's, I think from my standpoint, a real sleeper in the nonprofit healthcare space. Uh, but it creates a wonderful opportunity now.
Speaker 4:No, that's right. I've been spending a lot of time on the , uh, tax credits that were , uh, insti , that were substantially modified in the Inflation Reduction Act for years and years. There have, there's been an investment tax credit that gave for-profit businesses an incentive to invest in clean energy , uh, investments, solar panels, geothermal , uh, all kinds of different clean energy assets. And the, the Inflation Reduction Act really beefed up the credits that are available for that anywhere from 30 to 70% is what's available now, if you meet some of the requirements, the new requirements for paying a prevailing wage to your contractors, or if you use domestic materials in your construction . So 30 to 70% of the basis of that property could be returned to , um, to you in a tax credit. And the big news for tax exempt organizations and governmental entities, so tax exempt and governmental hospitals, were looking at you , you are now eligible for these investment tax credits , um, of 30 to 70%. And that's a lot of money.
Speaker 3:They're refundable.
Speaker 4:Yes. You, you don't have to offset them against UBIT or anything like that. It , there's a new mechanism, a new section 64 17 was enacted in 2022, which makes the credit refundable for tax exempt and governmental entities. Um, and I think this really could change the game in terms of the financing of , uh, of new energy properties We've seen in the past that, say, for-profit , um, engineering firms or other for-profits might come in and offer to finance a hospital's , uh, new energy property in exchange for having tax ownership so that, that for-profit can depreciate the property or take the investment tax credit on that property. But now the hospital could take that investment tax credit themselves. And I think that it's , um, important to weigh that up when you're looking at, at financing alternatives. Um, and , and I, I advise you strongly to get good tax advice on this, and not necessarily from your engineering , uh, consultant, but to talk to your own advisor because these credits are often the , the people who know about these credits, the people who've been doing the investment tax credit work for years have been doing it all in the for-profit space. So a lot of my colleagues who, who have been working on these credits for years have never worked with a tax exempt client. And that's gonna be true across the industry. The folks that really know the credits and really know how to, to , to do the studies that are necessary for providing the right amount of documentation, they, but they , they know their stuff, but they don't know the tax exempt space. And so it's really important to keep your tax exempt lawyer in the mix and working on this project along with the accountants or lawyers that are doing the tax credit because your tax exempt lawyer will be able to flag issues for folks that don't know ubit , for example, when you're doing these credits, if you're, you're, you're taking a credit and capitalizing , uh, an amount for these assets that could have an impact on the UIC calculations, or there could be a variety of possible capitalization positions that are more or less tax aggressive. And having someone advising you that, that knows your space and knows your, your risk tolerance. I think a lot of times in the for-profit space, the only consideration is how do we maximize our tax credit amount? Um, and, and sometimes in the tax exempt space, there are a range of considerations and the the rules might apply differently. Yeah . And so it's, it's good to keep your tax tax exempt lawyer in the mix.
Speaker 3:The o the only o other point I would make, Ruth, is that , uh, unlike credits like the new markets tax credit, which you have to go through considerable hoops to make it available , uh, in terms of deriving the economic benefit at the exempt organization level , uh, the energy credits are, I won't say they're more simple, but they're more straightforward in terms of , uh, what you have to do to , uh, uh, claim them and get a refund.
Speaker 4:Absolutely. Absolutely. Uh , I mean the, the credits are available to tax exempts , just like for profits in that if you buy the property, if you have it installed, you have to buy it and you have to do a cost segregation study to , uh, document your eligible basis. But then you, you just claim it on a nine 90 t that's the form that's gonna be used to claim the credit. Um , you have to pre-register. So there's an online pre-registration process. So you need to allow time , uh, between the filing of the nine 90 T and the , uh, before you file that nine 90 t to pre-register. So there's a three to four month time period , uh, that it might take to put your information in and get some, some registration numbers back from the IRS. But it is a very straightforward process for getting the, the benefit directly as opposed to getting the benefit through a for-profit partner.
Speaker 3:So with that , uh, we wanna thank all of you for , uh, listening to this podcast. Thank you, Ruth, for do joining me on it. And , um, we look forward to , uh, talking again soon.
Speaker 4:Thanks, Doug. It was great to talk to you.
Speaker 2:Thank you for listening. If you enjoyed this episode, be sure to subscribe to a HLA speaking of health law wherever you get your podcasts. To learn more about a HLA and the educational resources available to the health law community , visit American health law.org .