The IRS has issued new guidance to assist Section 501(c)(3) nonprofit hospital organizations in complying with the requirements of Section 501(r), enacted by the Affordable Care Act. (For prior coverage, see our previous advisory.) In Notice 2014-3, the IRS has set out a proposed procedure for hospitals to disclose and correct any violations of Section 501(r) that are not “willful” or “egregious.” A second notice, Notice 2014-2, provides that hospital organizations may rely on proposed IRS regulations under Section 501(r).

Section 501(r) requirements

Section 501(r) requires a Section 501(c)(3) hospital organization to conduct and implement a community health needs assessment (“CHNA”) and establish financial assistance and emergency care policies. It also places limits on a hospital organization’s patient charges and billing and collection practices for patients who are eligible for financial assistance. The requirements apply to organizations that operate one or more facilities that are licensed or registered as a hospital under state law.

The IRS has issued two sets of proposed regulations under Section 501(r), one in June 2012 and one in April 2013. The 2012 proposed regulations, which addressed the financial assistance and emergency care policy requirements, patient charges, and billing and collection practices, were widely criticized as being overly detailed and complex. The 2013 proposed regulations addressed the CHNA requirement and outlined the consequences of failing to satisfy Section 501(r).

Hospitals may rely on the proposed regulations

Both the 2012 and the 2013 regulations remain in proposed form. Hospital organizations are not required to comply with the detailed requirements of the proposed regulations in order to demonstrate that they have satisfied Section 501(r) until the IRS issues the regulations in final form. Notice 2014-2 provides that hospital organizations may rely on the proposed regulations, however, until final regulations are issued, in order to avoid ambiguity as to whether they have satisfied the statutory provision. For example, a hospital organization that complies with the 2013 proposed regulations with respect to CHNAs can be assured that it has satisfied the CHNA requirement in Section 501(r), pending issuance of final regulations.

Correcting and disclosing Section 501(r) violations that are not “willful” or “egregious”

The stakes for a hospital organization that is required to comply with Section 501(r) are high: A violation could potentially result in revocation of the organization’s federal tax-exempt status, which could in turn cause a default of any outstanding tax-exempt bonds. In the case of a hospital organization that operates multiple hospital facilities, a failure by one facility to satisfy the requirements could cause the net income from that facility to become taxable.

The 2013 proposed regulations set out a continuum of three types of failures to satisfy Section 501(r). The first category is minor, inadvertent errors that are due to reasonable cause. Such errors will not be treated as violations of Section 501(r) so long as they are corrected promptly. The second category is more serious failures that are not either “willful” or “egregious.” The proposed regulations provided that failures in this second category may be excused, so long as the hospital organization corrects and discloses the violation under a procedure to be issued by the IRS. IRS Notice 2014-3 provides a draft of the disclosure and correction procedure. The third category is failures that are “willful” or “egregious.” Violations in this category may not be excused.

Under the draft procedure, a hospital organization must, as an initial matter, have begun to correct the failure before any IRS examination has commenced. The fact that a hospital corrects and discloses the failure under the procedure does not necessarily mean that the failure is not “willful” or “egregious,” and that it may therefore be excused, but it may be a positive factor in that determination.

A “correction” must satisfy the following principles, under the draft procedure: 

  1. To the extent possible, each person affected by the hospital facility’s violation should be restored to the position he/she would have been in had the violation not occurred;
  2. The correction should be reasonable and appropriate for the failure;
  3. The correction should be made as promptly after discovery as is reasonable; and
  4. The hospital facility should implement such changes to practices and procedures as may be needed to reduce the likelihood of similar violations in the future.

A hospital organization must disclose a Section 501(r) violation by reporting it on Schedule H of IRS Form 990 for the tax year in which the violation is discovered. The reporting under the proposed procedure must include descriptions of:

  1. The violation;
  2. The discovery of the violation;
  3. The correction made, and whether all persons were restored to the position they would have been in had the violation not occurred; and
  4. Any practices and procedures implemented or changed as a result, or an explanation of why no changes were made.

The descriptions must specify dates, the number of occurrences and persons affected, and the dollar amounts involved.

The IRS is seeking comments on the draft procedure. Comments should be submitted by March 14, 2014. Please contact the authors if you are interested in submitting comments.