The IRS has released the results of a two-year study on average executive compensation amounts at tax-exempt hospitals, reporting an average of $1.4 million. The study was based upon a survey sent to 500 tax-exempt hospitals in May 2006 which requested information on the provision and report of community benefits by such hospitals. Although the compensation amount seems high, the IRS found that the examined amounts would be upheld as established according to the rebuttable presumption process and as within the range of reasonable compensation. The IRS was pleased with the fact that nearly every hospital reported having used comparability data when setting compensation of top officials.

Forthcoming guidance on Initial Contract Exception

Under the “initial contract exception,” a hospital may be more relaxed in its salary negotiations in its first contract with a prospective hire. Lois Lerner, IRS Director of Exempt Organizations, has stated that guidance might be issued in this area and that discussions are planned regarding the issues that have developed since the community benefit standard was issued. The IRS uses the rebuttable presumption of reasonableness as a safe harbor for setting executive compensation for tax-exempt officials. With the redesigned Form 990, the IRS and public will have a much better view of the operation of hospitals. According to the IRS, if the initial contract rules are revised, such revisions will apply not only to hospitals, but to all exempt organizations.

Study on For-Profit Hospitals May be Forthcoming

Sen. Grassley (R-Iowa), Senate Finance Committee ranking member, wants to follow up the February 12 study with a study on for-profit hospitals and their level of uncompensated care and other community benefits and compensation for purposes of comparison to nonprofits. Grassley also would like the Treasury Department to re-establish the charity care requirements, which the IRS eliminated in developing the community benefit standard in 1969. Grassley further noted that the IRS did not sufficiently describe to the hospitals in the study how to define community benefit and uncompensated care and that this skewed the numbers.

Effect of the Current Economy

Commentaries believe that the currently struggling economy likely will increase the pressures on tax-exempt hospitals. Moreover, the rebuttable presumption of reasonable compensation might be criticized because of its potential to impede the investigation of instances of excessive compensation. However, the IRS has noted the present community benefit standard does not contain a quantitative requirement, and struggling hospitals would find it difficult “to meet a quantitative test that keys off charity care or community benefit expenditure levels.” On the other hand, the federal government’s bailout of financial institutions and corresponding limits on executive compensation could also help bring about similar limits for taxexempt organizations. Under the Treasury guidelines for accepting money under the Troubled Asset Relief Program, executive compensation is limited to $500,000 and disclosures and limitations on executive compensation are required.