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Increased focus on IRC 501(r) compliance: Is your hospital prepared?

July 2, 2024 / 10 min read

The IRS has shown increased focus on hospital audits, targeting IRC 501(r) compliance. 501(c)(3) hospitals have regulations to follow, including compliance with Community Health Needs Assessments, financial assistance, billing and collections, and more. Ensure you’re prepared for an IRS audit.

The Internal Revenue Service is increasing its focus on hospital audits targeted at IRC 501(r) compliance. These regulations include compliance with the Community Health Needs Assessments (CHNA) and Implementation Strategy (IS), financial assistance, billing and collections, and limitation of charges. The rules under these regulations are required for 501(c)(3) hospitals. The Form 990, Schedule H is required for 501(c)(3) hospitals to be filed each year. The Schedule H asks pointed questions regarding compliance with IRC 501(r). However, the Schedule H only scratches the surface of the requirements. The IRS audits are looking beyond the answers on the Form 990 Schedule H and focusing on proving the answers that are marked on the Schedule H.

All 501(c)(3) hospitals are encouraged to review their processes and procedures for IRC 501(r). In this article, we highlight best practices to help ensure an IRS audit proceeds smoothly. This isn’t an all-inclusive list of requirements and best practices. The regulations under IRC 501(r) are extensive and should be reviewed in detail by 501(c)(3) hospital facilities.

All 501(c)(3) hospitals are encouraged to review their processes and procedures for IRC 501(r).

More details on Community Health Needs Assessment and Implementation Strategy compliance requirements

A Community Health Needs Assessment and Implementation Strategy are required to be conducted once every three years.

Community Health Needs Assessment 

The CHNA must complete the following steps to satisfy the “conducting” requirement:

  1. Define the community it serves.
  2. Assess the health needs of that community.
  3. Take into account input from persons who represent the broad interests of the community.
  4. Document the CHNA in a written report that is adopted for the hospital facility by an authorized body of the hospital facility.
  5. Make the CHNA report widely available.

The regulations go into further detail, providing guidance on the first three points for preparing the CHNA. The fourth and fifth steps are where errors tend to occur, which are areas drawing IRS focus. Ensuring the CHNA is both widely available and adopted by an authorized body are mandatory to satisfy the “conducted every three years” requirement. If this isn’t properly completed, the hospital facility may be subject to a $50,000 penalty.

Under the regulations, an authorized body — the entity authorized to pass approval — is classified as either: 

Agents may request board minutes that document the approval of the CHNA, so it’s recommended that the meeting minutes clearly state that the CHNA was approved by the authorized body.

It’s also recommended that the CHNA includes the date on which the board approved the report. This isn’t required, but this allows for the public (and IRS agents) to quickly see the date the CHNA was approved to ensure it was within the three-year requirement.

In addition, the CHNA should be easily found on the hospital’s website. The CHNA and the prior two rounds of reports are required to be posted on the hospital’s website. It’s a recommended best practice that it takes a site visitor no more than two clicks from the homepage to find the CHNA.

Implementation Strategy (IS)

The IS is a written plan that addresses each significant health need identified in the CHNA. The IS describes how the hospital facility plans to address the health need or identifies the health needs that the hospital facility doesn’t intend to address and explains why the hospital facility doesn’t intend to address the health need.

The IS is subject to board approval and is required to be approved by an authorized body of the hospital facility. The IS isn’t required to be posted on the website, but it’s required to be made publicly available if requested and must be attached to the Form 990 upon filing if it’s not posted on the website.

Some hospitals choose to combine the reporting of the CHNA and IS into one report. Although this may feel efficient, the best practice is to have separate reports clearly labeled and disclosing the board approval date.

Community benefit report versus a CHNA

Note that an annual community benefit report isn’t a CHNA. A CHNA is an extensive report of the community the hospital serves and identifies the needs of the community. The IS then evaluates how the identified needs of the community will be addressed. An annual community benefit report often reviews the hospital’s impact on the community over its past reporting year.

An annual community benefit report isn’t required under the 501(r) regulations.

Financial Assistance Policy and Emergency Medical Care Policy

All 501(c)(3) hospitals are required to have a financial assistance policy (FAP) for providing charity care. The FAP must apply to all emergency and other medically necessary care provided by the hospital facility. The FAP needs to be approved by an authorized body.

All 501(c)(3) hospitals are required to have a financial assistance policy (FAP) for providing charity care.

Financial Assistance Policy

A FAP must include the following:

  1. Eligibility criteria for financial assistance and whether such assistance includes free or discounted care.
  2. The basis for calculating amounts charged to patients.
  3. The method for applying for financial assistance.
  4. The actions that may be taken in the event of nonpayment (if there isn’t a separate billing and collections policy).
  5. 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.
  6. 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.

Patient sampling

If under an IRS audit, hospital facilities should expect to have an IRS agent request samples of patients to trace the application process, eligibility calculation, and ultimate billing to those patients. The purpose is to ensure that the actual process in action for determining charity care follows the publicly posted FAP. 

The hospital facility may also be requested to provide samples of denials for charity care to be traced as part of an IRS audit. Again, this is testing the application of the financial assistance process. The IRS agents may also dig into presumptive eligibility and the criteria that would trigger a patient to fall under presumptive eligibility.

Provider listing

A provider listing needs to be updated frequently as a living document. Prior IRS Notices have alluded to a quarterly review of the provider listing, implying that this is best practice. The purpose of this listing is to allow patients to clearly understand which providers are covered under the hospital facility’s FAP. This listing needs to be made public as part of the FAP. 

Billing and Collections policy

The financial assistance policy should reference where a patient can find or request a Billing and Collections policy if a separate policy exists. If a separate policy doesn’t exist, then the FAP must include the actions the hospital facility may take in the event of nonpayment (extraordinary collection actions). The Billing and Collections policy isn’t required to be disclosed online but the FAP should note where a patient can access a copy. If there is a separate billing and collections policy outside of the FAP, then that policy also must be approved by an authorized body.

Widely publicizing the Financial Assistance Policy

The FAP, financial assistance application, plain language summary, and translated copies (if required) must be made widely available to the public. These documents must be on the hospital’s website (again, user friendly to find). Paper copies and conspicuous displays in patient registration and discharge areas should also be present. IRS agents may do a facility tour and request paper copies from patient registration areas or hospital information desks. They will look for postings of the FAP in waiting areas. If your facility has changed to only electronic or online versions of the FAP, application, and plain language summary, know that paper copies are required. Consider reviewing training manuals and the knowledge of personnel registering patients. If an IRS agent requests a paper copy, is your team prepared to hand a copy over?

Emergency medical care policy

A hospital must have an emergency medical care policy (EMPC) — a written policy for a hospital facility to provide, without discrimination, care for emergency medical conditions to individuals regardless of whether they are FAP-eligible. The policy should prohibit hospital facilities from discouraging or engaging in actions to discourage individuals from seeking emergency medical care. This doesn’t mean that the policy is limited to the services in an emergency department. Emergency and other medically necessary care is more extensive. Specialty hospitals with no emergency departments still need to follow the regulations for establishing an EMCP. This policy needs to be adopted by an authorized body.

Limitation on charges and collections

The limitation on charges provisions is focused on the calculation and utilization of Amounts Generally Billed (AGB). In the case of emergency or other medically necessary care, a hospital facility must limit the amount charged for care it provides to any FAP-eligible individuals to not more than the amounts generally billed to individuals who have insurance covering such care and, for all other medical care, less than gross charges for such care.

The allowable methods for calculating the AGB are:

  1. Look-back method
  2. Prospective Medicare method

Under an IRS audit, hospital facilities should be prepared to provide the calculated AGB percentage and supporting workpapers. A sampling of patient bills may be requested to ensure that the limitation on charges was properly applied. This also feeds into the sampling used to trace FAP eligibility and application. Reasonable methods to determine whether an individual is FAP-eligible may be reviewed by the IRS in this sampling process.

Reasonable methods to determine FAP eligibility

Hospital facilities are required to use reasonable methods to determine FAP eligibility of patients. This includes holding on any extraordinary collection actions until reasonable efforts are made to determine whether the individual is eligible for FAP. 

Extraordinary collection actions (ECAs) include the following:

  1. Selling an individual’s debt to another party.
  2. Reporting adverse information about the individual to consumer credit reporting agencies or credit bureaus.
  3. Deferring or denying, requiring payments before providing medically necessary care due to nonpayment.
  4. Actions that require a legal or judicial process (liens, civil action, arrest, garnishing wages, etc).

If the hospital contracts with a collection agency, the hospital is responsible for ensuring that ECAs aren’t inappropriately applied. IRS agents may ask for contracts with collection agencies to understand the agreement regarding ECAs. In addition, if debt is sold, the hospital is still responsible for ensuring proper steps are taken for FAP eligibility before ECAs move forward.

Reasonable efforts include actions such as notifying patients per the timelines set in the regulations, assistance to complete FAP applications, etc. A signed waiver from a patient stating that the patient doesn’t wish to apply for assistance under the FAP or receive FAP information won’t satisfy reasonable efforts when moving forward with ECAs.

Failure to meet requirements of 501(r)

Failure to follow the 501(r) regulations may result in revocation of tax-exempt status. Facts and circumstances are considered for each error to determine the severity of next steps. 

Failure to follow the 501(r) regulations may result in revocation of tax-exempt status.

Minor omissions and errors will not be considered a failure to meet 501(r) if the following are addressed:

  1. The omission or error was minor and either inadvertent or due to reasonable cause.
  2. The hospital facility corrects the omission or error promptly after discovery as is reasonable given the nature of the omission or error.

Certain failures to comply may also be “excused” if the hospital facility corrects and discloses such failures. Willfulness of actions related to the noncompliance and the severity of the impact and number of affected persons will be considered and based on facts and circumstances.

If a hospital fails to meet one or more of the requirements of 501(r), the income from the noncompliant hospital facility (as defined in the regulations) during that taxable year may be subject to tax. This tax doesn’t mean that tax exemption is revoked under 501(c)(3)and it doesn’t mean that the noncompliant hospital facility is considered unrelated business income.

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