IRS Study Shows How Much Hospitals Spend to Aid Their Communities

Officials of the Internal Revenue Service say the agency’s new report on nonprofit hospitals could help policy makers who are considering changes in the federal requirements that determine whether those institutions do enough for society to justify their tax subsidies.

The IRS study looked at how nearly 500 nonprofit hospitals are following the current — and controversial — “community benefit” standard, which the revenue service uses to determine a hospital’s eligibility for taxexempt status.

Under a 40-year-old IRS ruling, nonprofit hospitals must show that they provide benefits to the people and neighborhoods in the region they serve. The ruling listed five ways that hospitals can show they qualify. Among them: They can make a full-time emergency room open to all people regardless of their ability to pay. Or they can use surplus revenue to improve patient care and for medical training.

The ruling said that a hospital need not use all five methods and that its tax-exempt status would be determined by an analysis of all “facts and circumstances” involved.

Lois G. Lerner, director of the IRS’s exempt organizations division, said she cautioned policy makers who would change the current standard to consider the report’s finding that 21 percent of hospitals were spending more than they took in. “Many hospitals appear to be losing money or operating on really tight margins and could find it difficult meeting a quantitative test that keys off charity care or community-benefit expenditure levels,” said Ms. Lerner.

“We think the report does a pretty good job of showing the possible changes to the standard [that] might create some winners and losers,” Ms. Lerner said. “Change needs to be thought out very carefully. It doesn’t mean we shouldn’t do it, but we ought to know what we’re doing before we go into it.”

Key Findings

For its study, the IRS sent questionnaires to hospitals in the 26 largest urban areas; other urban and suburban hospitals; and two types of rural hospitals. None of the hospitals were identified by the IRS in the report, which also looked at the compensation of top hospital executives. Among the report’s key findings:

• Hospitals altogether reported spending an average of 9 percent of total revenue to provide community benefits. The IRS said the spending was not evenly distributed: Nine percent of all hospitals made 60 percent of all community-benefit expenditures, and 19 percent of hospitals made 78 percent of such expenditures.

• The largest urban hospitals spent the most on community benefits as a share of total revenue: an average of 12.7 percent. The lowest levels — 6.3 percent and 8.4 percent — were reported by the two categories of rural hospitals.

• Hospitals devoted the biggest share of their community-benefit spending to providing uncompensated care, accounting for 56 percent of all spending on community benefits. (Hospitals were allowed to count shortfalls in Medicare or bad debt in their calculation.) Hospitals spent an average of 7.2 percent of total revenue on uncompensated care. The next largest categories of community-benefit expenditures were medical education and training, and research.

• “No correlation was found between community-benefit expenditure levels and per-capita income levels of the hospital’s surrounding area,” the IRS said. “However, community-benefit expenditure levels generally increased as uninsured rates of the hospital’s surrounding area increased.”

The IRS report declined to take a position on whether a change in the community-benefit standard is needed. But it concluded that the standards for community benefit have proved difficult for the revenue service to administer. They “involve application of imprecise legal standards to complex, varied, and evolving fact patterns,” the IRS said.

Before its 1969 ruling, the IRS required that nonprofit hospitals provide charity care: free or discounted care to people who cannot afford to pay. Today, IRS officials say that while hospitals do not have to provide charity care, doing so is considered a form of community benefit.

Sen. Charles E. Grassley of Iowa, the senior Republican on the Senate Finance Committee, has said the community-benefit standard is “weak” and that the IRS needs a “bright-line test” to be able to determine whether hospitals are doing enough. Members of Mr. Grassley’s staff have suggested in a background paper that a nonprofit hospital should generally be required to dedicate “a minimum of 5 percent of its annual patient operating expenses or revenues to charity care, whichever is greater.”

“The tremendous advantage of tax-exempt status, and the ability to raise capital through tax-deductible contributions and tax-exempt bonds, puts nonprofit hospitals in a position to provide health care to people who otherwise can’t afford it,” Mr. Grassley said after the release of the IRS report. “In fact, it’s that public good that justifies the tax-exempt status.”

He added, “Neither the IRS nor Congress has done a very good job when it comes to establishing the criteria for enjoying this tax status since the IRS scrapped charity care for its community-benefit standard in 1969. The Treasury Department could do a lot of good, and probably more quickly than Congress, by re-establishing those charity-care requirements. And if it looks like that can’t get done, then Congress will have to step in.”

Sen. Grassley said he was disappointed that the IRS study does not include data on for-profit hospitals’ level of uncompensated care and other community benefits and compensation. “That information is necessary to understand how nonprofits are different from for-profits,” he said. “I intend to ask the IRS to conduct a study like that so we’ll have a full picture.”

Data Limits

The tax agency said the data on community benefits has limitations. “For example, although the IRS designated the general categories of activities that could be reported as community benefit for purposes of the study, determining what was treated as community benefit (for example, bad debt or Medicare shortfalls) and how to measure it (cost versus charges) was largely within the [hospitals’] discretion,” the tax agency said.

Some observers said the report’s limitations were serious.

“I must say that I find the report on the whole a disappointment, particularly in its analysis of community benefit,” said John D. Colombo, a professor at the University of Illinois College of Law, in a posting on the Nonprofit Law Prof Blog.

A key section of the report on community benefit is “completely worthless,” he said.

In that section, he said, “while the distributions and breakdowns all look very impressive, the simple fact is that all the charts and numbers are meaningless because the numbers that are reported by each hospital vary in their content and methodology.”

Others looked forward to data that eventually will be gathered through a new Schedule H for hospitals that the IRS has created as part of its revamped Form 990 federal informational tax return.

The schedule asks for information about charity care and community benefits using standardized definitions.