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erupted over hospital tax exemption. Prominent
planiffs lawyers who previously sued the tobacco and HMO industries
brought dozens of class action lawsuits against nonprofit hospitals,
that they failed to live up to charitable promises and obligations, in
a variety of ways, including: turning away deserving patients who
cannot pay, charging uninsured patients much more for services than
patients, and aggressively pursuing collection of bills against
patients. Causes of action include third-party breach of contract
with taxing authorities, breach of charitable trust, and violation of
law consumer protection and fair debt collection practices. So
far, almost every suit has been dismissed. According to one court:
Accompanying this litigation has been increased focus and
over hospitals' billing and collection practices for patients
pay out of pocket. Conventionally, hospitals maintain a set of
prices" called a "chargemaster" that are much higher than what they
actually receive from
Medicaid, or private managed care plans. However, these high list
prices are what they routinely charge patients who pay out of pocket,
indigent or uninsured patients. Hospitals maintain that good
practices, and various federal regulations, require them to do
Federal regulators claim that hospitals are overinterpreting their
(such as the "anti-kickback" statute discussed in section E). For
additional discussion and analysis, see U.S.
Senate Finance Committee, Hearings on Charity Oversight and Reform (June
22, 2004); DHHS, Questions
On Charges For The Uninsured (Feb. 2004); DHHS, Hospital
Discounts Offered To Patients Who Cannot Afford To Pay Their Hospital
(Feb. 2004). See generally, Community
Catalyst, Not There When You Need It: The Search for Free Hospital Care
2003); Saul Weiner, et al., Rationing Access to Care to the Medically
The Role of Bureaucratic Front-Line Discretion at Large healthcare
42 Med. Care 306 (2004); American Hospital Association, Billing
and Collection Practices; George
A. Nation, Obscene
contracts: the doctrine of unconscionability and hospital billing of
This controversy has resulted in
state-court litigation over the ability of hospitals to enforce these
inflated charges, or the ability of patients to obtain refunds.
far, courts are split. Compare Cox
v. Athens Regional Medical Center, Inc., 631 S.E.2d 792, 798-99
(finding that hospital has no obligation to charge only “reasonable”
same Morrell v. Wellstar Health System, Inc., --- S.E.2d ----, 2006 WL
(same); DiCarlo v. St. Mary's Hosp., Slip Copy, 2006 WL 2038498
with River Park Hospital v.
Bluecross Blueshield of Tennessee, 173
S.W.3d 43 (Tenn. 2003) (hospital rates must be objectively reasonable);
Univ. Hospital v. Healthcare Management Alternatives, 832 A.2d 501
Penn., 2003) (same).
In line with the Utah County
case, cases in Illinois have also held that writing off even large
amounts of bad debt is not the equivalent of charity care, and does not
justify charitable property tax exemption. See Riverside Medical
Center v. Dept. of Revenue, 795 N.E.2d 361 (2003).
Prof. Jill Horwitz argues that hospital need not provide more
care than for-profits in order to justify tax exempt status.
it suffices that they provide a broader range of services, including
that are not profitable. Jill R. Horwitz, Why we need the
sector: the behavior, law, and ethics of not-for-profit hospitals, 50
L. Rev. 1345-1411 (2003). John Colombo argues for a looser test
for exemption based on enhancing access to care in the community, more
than for-profit counterparts, where this can be documented. John
Colombo, The Role of Access in Charitable Tax Exemption, 82 Wash. U. L.
Q. 343 (2004). See generally, Jack E. Karns, Justifying
the nonprofit hospital tax exemption in a competitive market
13 Widener L.J. 383-561 (2004); Symposium, 25(4)
Health Aff. w287 (Aug. 2006); Comment, 20 Rev. Litig. 709 (2001);
Symposium, 15 Health Matrix 5 (2005)
As the update to Chapter 10.A discusses, there has been a sharp increase in the number of specialty hospitals, which do not usually have emergency rooms. This is in response to several business factors: physicians are creating for-profit specialized facilities that target more profitable areas of care; these hospitals tend to attract fewer Medicaid patients; and without emergency rooms, they tend to receive fewer uninsured patients. For an overview of recent trends, see U.S. Government Accounting Office, Specialty Hospitals: Geographic Location, Services Provided, and Financial Performance (GAO-04-167, Oct. 2003). The report summarizes:
Advocates of these newer specialty hospitals contend that the focused mission and dedicated resources of specialty hospitals allow physicians to treat more patients needing the same specialty services than they could in general hospitals and that, through such specialization and economies of scale, the potential exists to improve quality and reduce costs. In contrast, critics are concerned that specialty hospitals may concentrate on the most profitable procedures and serve patients that have fewer complicating conditions—leaving general hospitals with a sicker, higher-cost patient population. They contend that this practice of drawing away a more favorable selection of patients makes it more financially difficult for general hospitals to fulfill their broad mission to serve all of a community’s needs, including charity care, emergency services, and stand-by capacity to respond to communitywide disasters. Critics have also raised concerns that physician ownership of specialty hospitals creates financial incentives that could inappropriately affect physicians’ clinical and referral behavior.See also David Shactman, Specialty Hospitals, Ambulatory Surgery Centers, and General Hospiotals: Charting a Wise Public Policy Course, 24(3) Health Aff. 868 (June 2005).
Regarding whole hospital joint ventures, in St. David’s Health Care System v. United States, 349 F. 3rd 232 (5th Cir. 2003), the court found that a fact issue existed over whether a nonprofit hospital had ceded operational management to Columbia/HCA. The court found rejected the trial court's summary judgment ruling that the particular structure adequately protected the board’s control over the hospital’s charitable purpose, noting that the hospital had only a 50% share of the voting control over the joint venture and that the manager was paid a percentage of net revenues, which creates an incentive to maximize profits. For commentary, see Gary J. Young, Federal Tax-Exemption Requirements for Joint Ventures Between Nonprofit Hospital Providers and For-Profit Entities, 13 Ann. Health L. 327 (2004)
1. Shared Services. Hospitals sometimes find it efficient to operate certain internal functions such as laundry services on a shared, cooperative basis with other hospitals. Undue attention has been devoted to whether such supporting enterprises are themselves tax exempt. Ordinarily, the answer would be no because, while laundry services within a hospital clearly are related to the hospital's function, standing alone they do not constitute a charitable enterprise. However, section 501(e) provides a special exemption for "cooperative hospital service organizations" that perform the following services for tax-exempt hospitals: "data processing, purchasing, warehousing, billing and collection, food, clinical, industrial engineering, laboratory, printing, communications, record center, and personnel." Owing to effective lobbying from commercial laundries, laundry services are notably absent from this list, though. HCSC-Laundry v. U.S., 450 U.S. 1 (1981). Construing this precedent, the IRS has ruled that a cooperative service organization loses its entire exemption if any of its activities are not on the list enumerated in the statute. Tech. Advice Mem. 9542002 (July 18, 1995) (shared security, parking, and housekeeping services are impermissible).
One way around this restrictive statute is to characterize a supporting institution as an "integral part" of an exempt organization. Scattered precedents allow subsidiaries to qualify as an integral part of a charitable whole even if, standing alone, they do not perform charitable activities, so long as the activity would be "related" if it were performed internally by the charitable parent. This doctrine was given a restrictive interpretation, however, in a court decision concerning an HMO run by a hospital. Based on some obscure reasoning, the court essentially ruled that an HMO is too different from a hospital to qualify for exemption under the integral part test. Geisinger Health Plan v. Commissioner, 30 F.3d 494 (3rd Cir. 1994).
2. Hospital Reorganization and Integration. There are two tax exemption issues in vertically integrated networks: (1) which subsidiaries will lose exemption if their functions are examined separately from the hospital's; and (2) will the holding parent company qualify for exemption even though it is a "shell" corporation that offers no charitable service directly, and even though a number of its subsidiaries are run as for-profit ventures? The answer to the former is explored above in terms of each of a number of different health care ventures (HMO, nursing home, physician group practice, etc.). The answer to the latter is generally yes, following the "integral part" thinking described above. The leading ruling is Northwestern Medical Corp., described in Tax Notes, Sept. 9, 1993, where the IRS approved the exemption of a "superparent" for a regional hospital network composed of several hospital systems, each with its own exempt parent. In Wilson Area School District v. Easton Hosp., 747 A.2d 877 (Pa. 2000), the court upheld the charitable status of a non-profit hospital that owned a number of for-profit subsidiaries because the subsidiaries helped to further the hospital's general health care purposes. See generally Melvin Horowitz, Corporate Reorganization: The Last Gasp or Last Clear Chance for the Tax-Exempt, Nonprofit Hospital?, 13 Am. J. L. & Med. 527 (1988); Mary Squires, Corporate Restructuring of Tax-Exempt Hospitals: The Bastardization of the Tax-Exempt Concept, 14 Law, Med. & Health Care 66 (1986); General Counsel Memorandum 39508 (May 28, 1986); General Counsel Memorandum 39598 (Dec. 8, 1986).
A further complication is whether independent hospitals can qualify for the "integral part" treatment if they affiliate with each other but do not form an outright parent-subsidiary relationship. Ordinarily, these affiliations would fall under the "shared services" rule above, which strictly limits the scope of exemption when one hospital provides services to other hospitals. In recent rulings, however, the IRS has stated that nonprofit hospitals can affiliate and still maintain exemption if they form "joint operating agreements" in which they cede operational authority to a single entity. These arrangements are considered to be functionally equivalent to a parent-subsidiary relationship sufficient to avoid the shared services limitation and to qualify for the integral part treatment. See 5 BNA Health L. Rep. 1713 (1996).
3. Payroll Taxes for Contracting Physicians. General Counsel
Memorandum 39862 clarifies that compensation and payment incentives are
much less controversial when they are in exchange for tangible services
performed by the physician. Then, the only test is one of commercial
Arrangements where the hospital bills directly for the services of
physicians and then compensates them with a portion of the receipts are
not as uncommon as the GCM suggests; the reimbursement changes it
relate only to Medicare, not to private insurance. Indeed, under
payment, bundling of hospital and physician services is becoming even
This raises a different tax issue of some importance, however, namely whether as indicated in n.3 of the GCM, these physicians are to be considered employees rather than independent contractors. Hospitals greatly prefer the independent contractor label, not only because they avoid payroll taxes, but also because of vicarious liability and corporate practice of medicine considerations. The IRS, however, has cracked down on this characterization with numerous hospital audits resulting in some very large demands for back taxes. See Tech. Advice Memoranda 9535001-9535002 (1995). These rulings are causing great consternation and are likely to be challenged in court. One went so far as to opine that a radiologist with an independent practice who reads electrocardiograms part time at several different hospitals and is paid piece work could still be classified as a part-time employee at each hospital. The best route to avoiding this result is for a physician to employ herself through a professional corporation which then contracts with the hospitals. It is much harder to characterize a corporation as an employee.
4. Taxation of Health Insurance. One more point is necessary to have a complete picture of health insurance taxation. Health insurers that are taxable face the accounting question of whether anticipated loss payouts and contributions to their capital reserves count as business expense deductions that lower their earned income. To answer this question, the tax laws have devised special, favorable accounting rules that apply only to insurers. For a while, the IRS resisted extending these accounting rules to HMOs, under the logic expressed in Jordan (page 1323) that they are not insurers, but it has since relented. See B. Brooke, T. Dirig & M. Yuhas, Taxation of HMOs after Section 461(h) and General Dynamics, 68 J. Tax'n 329 (1988).