IRS Issues Hospital Industry Report
On February 12, 2009, the IRS released the Final Report of its hospital industry compliance check audits conducted in 2006.
The Final Report reviews and comments upon the executive compensation and community benefit data generated by those audits and by a limited number of follow-up examinations.
Executive Compensation
The Final Report contains several key executive compensation-related findings arising from the questionnaires and follow-up examinations:
- Widespread use of the rebuttable presumption of reasonableness to establish the reasonableness of executive compensation arrangements.
- Average CEO compensation of $490,000 and median CEO compensation of $377,000.
- The highest amounts were reported by facilities located in high population areas and other suburban and urban hospitals, and the lowest amounts were reported by critical access hospitals.
- Despite the fact that many of the compensation amounts reported may appear high to some, nearly all amounts examined by the IRS were upheld as arrived at pursuant to the rebuttable presumption of reasonableness and within the range of reasonable compensation.
- A substantial majority (65 percent) of the hospitals participating in the study reported having one or more business relationships with its officers, directors, trustees, or key employees (other than through their positions as such).
Boards of Directors and senior leadership are well advised to understand the continuing interest of the IRS—and of state charity officials—in compensation matters of executives of nonprofit, tax-exempt organizations. Cautious and prudent business judgment should apply to compensation matters at the senior management level.
Community Benefit
Hospitals were grouped into four types: high population hospitals (those located in the most densely populated areas); other urban and suburban hospitals; critical access hospitals; and rural hospitals that were not critical access hospitals. Also, hospitals were grouped by total revenue, as shown on their Form 990
The percentage of revenues expended for community benefit (including uncompensated care) was greatest in high population hospitals—a median of 9.84 percent. Critical access hospitals had the lowest—a median of 2.84 percent of revenues. The median for rural hospitals is 3.17 while the median for urban and suburban hospitals is 5.75.
The portion of revenues expended for community benefit (including uncompensated care) increased by hospital size, from a median of 3.36 percent for hospitals with revenues under $25 million to 10.54 percent for hospitals with revenues of $500 million and over. The portion of revenues expended for uncompensated care alone generally followed the same pattern, ranging from a median of 3.12 percent for hospitals with revenues under $25 million to 4.68 percent for hospitals with revenues of $500 million and over.
A clear finding of the July 7, 2007 Interim Report was that hospitals report uncompensated care and community benefit in many different ways. This variance was an important driver in development of the Schedule H on the new Form 990. The new Schedule H and its instructions pose questions that will likely produce defined and consistent information of interest to Congress, the IRS, and the public.
Because of the new Form 990, tax-exempt hospitals are aware that they must improve and standardize their reporting of community benefits. It may benefit the Boards to receive a brief on the Final Report’s findings and implications in order to allow the Board to address the commitment to community benefit by their respective health care institutions.
Senator Schumer – Foundation Excise Tax Amendment
Private foundations that are exempt from federal income tax are generally subject to a two percent excise tax on their net investment income. The tax is reduced to one percent in any year in which the foundation’s percentage of distributions for charitable purposes exceeds the average percentage of its distributions over the five preceding taxable years. Under current law, private non-operating foundations are generally required to make annual distributions for charitable purposes equal to at least five percent of the fair market value of the foundation’s non-charitable use assets (with certain adjustments).
The original intent of the excise tax in 1969 was to cover costs of the IRS’ oversight of exempt organizations. The excise tax now raises approximately $400–$600 million a year of which, in 2008, $87.8 million was slated to cover IRS’ exempt organization division.
The current two-tiered tax structure may actually deter foundations from increasing their charitable giving. Many foundations set spending policies at five to six percent to preserve the long-term value of their endowments. But if they substantially increase their grant-making in a particular year—for example, for Katrina relief or for September 11—they also increase the five-year average on which the tax rate is determined. As a result, the foundation pays tax at the two percent rate for the next five years.
Senator Charles Schumer (D-NY) proposed an amendment to the American Recovery and Reinvestment Act of 2009, (i.e., the economic stimulus package) to modify the excise tax rate on investment income of private foundations to a flat rate of 1.33 percent. However, to trim the cost of the economic stimulus package and avoid partisanship, non-germane amendments were limited. As a result the Schumer amendment was not included in the final legislation.
The effort by Senator Schumer was the fourth attempt in the last four Congressional sessions to change this excise tax. The continued attention to this issue may further encourage the Congress to pass a revenue neutral modification to the excise tax in future legislation.
