Exempt Organizations Advisory - IRS Releases Final Report on Nonprofit Hospitals

Suzanne Ross McDowell (smcdowell@steptoe.com)
Catherine W. Wilkinson (cwilkinson@steptoe.com)
   
On February 12, 2009, the IRS released the final report on its study of nonprofit hospitals which began in 2006. The report aims to help the IRS and public better understand nonprofit hospitals and their community benefit and executive compensation practices and reporting.  The results of the report are based on responses to questionnaires sent to more than 500 nonprofit hospitals beginning in 2006 and on the results of examinations of 20 hospitals regarding their executive compensation practices.

The final report summarizes the reported community benefit and executive compensation data across various demographics, including the type of community in which the hospital is located and the hospital’s revenue size.

Community Benefit Findings

The report’s key community benefit findings are as follows:

• There was considerable diversity in the demographics, community benefit activities, and financial resources among the respondent hospitals. In particular, significant differences were observed between the critical access hospitals and the high population hospitals, and between the smallest and largest hospitals based on revenue size.
• The average and median percentages of total revenues reported as spent on community benefit expenditures were 9% and 6%, respectively.  Among the community types, these percentages were lowest for rural hospitals (both critical access and non critical access hospitals) and highest for high population hospitals. The percentage spent on reported community benefit expenditures generally increased with revenue size.
• Uncompensated care was the largest reported community benefit expenditure for each of the study’s demographics, other than for a group of 15 hospitals reporting large medical research expenditures (93% of all research expenditures reported by the study’s respondents).
• After uncompensated care, the next largest categories of community benefit expenditures, ranked as a percentage of total community benefit expenditures, were medical education and training (23%), research (15%), and community programs (6%). The expenditure mix, however, varied both by community type and revenue size. Further, the group of 15 hospitals reporting large medical research expenditures materially impacted the overall numbers in this area.
• The overall group of hospitals reported excess revenues (total revenues less total expenses) of 5% of total revenues. Reported excess revenues varied across the community type and revenue size demographics, with large revenue size hospitals generally the most profitable and critical access hospitals the least profitable.
• Uncompensated care and community benefit expenditures were concentrated in certain hospitals and unevenly distributed. For example, 9% of the hospitals reported 60% of the aggregate community benefit expenditures of the overall group; 14% of the hospitals reported 63% of the aggregate uncompensated care expenditures.
• No correlation was found between community benefit expenditure levels and per capita income levels of the hospital’s surrounding area.  However, community benefit expenditure levels generally increased as uninsured rates of the hospital’s surrounding area increased.

Executive Compensation Findings

The final report summarizes the executive compensation information arising from the questionnaires and compensation examinations conducted as part of the study. The reported data was analyzed based on community type and revenue size. The key findings are as follows:

• Nearly all hospitals in the study reported complying with important elements of the rebuttable presumption procedure available to establish compensation of certain persons.
• The average and median total compensation amounts reported as paid to the top management official by respondents to the questionnaire were $490,000 and $377,000, respectively. By community type, the largest amounts were reported by high population and other urban and suburban hospitals while critical access hospitals reported the smallest amounts paid. Average and median total compensation paid increased with revenue size.
• Hospitals were selected for examination based on high compensation amounts paid taking into account the size and circumstances of the hospital. The average and median total compensation amounts reported by the group of 20 examined hospitals were $1.4 million and $1.3 million, respectively.
• Although many of the compensation amounts reported may appear high to some, nearly all examined amounts were upheld as established pursuant to the rebuttable presumption process and within the range of reasonable compensation.

Observations

The IRS observed that both the community benefit and the reasonable compensation standards are difficult for the IRS to administer because they require the application of imprecise legal standards to complex, varied and evolving fact patterns.  The IRS also stated that the study should provide important information for continuing discussions about possible revisions to these standards.  The IRS stated it will continue its enforcement work in this area through examinations and other compliance initiatives.