Tax-exempt hospital boards should closely review the Final Report and evaluate the need for greater focus on the process by which executive compensation is determined.

On February 12, 2009, the Internal Revenue Service (IRS) released its long awaited “Final Report” on the results of its hospital industry compliance check audits conducted in 2006.   The Final Report focuses principally on two main topics:   executive compensation and community benefits reporting.   As such, the Report is worthy of mention to the board and, in particular, to the compensation committee.

With respect to executive compensation, the Final Report reveals high amounts of compensation, as well as broad reliance on the three-part “Rebuttable Presumption of Reasonableness” safe harbor.   Senior IRS officials have expressed some concern that application of the Rebuttable Presumption may be precluding the IRS from investigating instances of allegedly excess compensation, beyond the concept of “burden shifting” originally contemplated by the regulations.   Thus, the “Rebuttable Presumption” may be a particular target of criticism, despite the fact that it embodies prudent governance practices.   The Rebuttable Presumption’s acceptance of for-profit, as well as not-for-profit, compensation as comparable may receive particular criticism.

With respect to community benefit, the Final Report addresses three main issues:

  • What are the leading types of community benefit provided by hospitals
  • Which types of hospitals reported spending the most on community benefit
  • What are the revenues and profits of the hospitals responding to the compliance check audit

The Final Report does not take a position on what constitutes community benefit, or on whether (or how) the existing community benefit standard should be modified.   It suggests a wide diversity in terms of community benefit provided by hospitals, as do recent U.S. Government Accountability Office and Congressional Budget Office reports.   The Final Report is thus unlikely to resolve the debate concerning the viability of the community benefit standard of tax exemption.

The Final Report is being released in the midst of a highly charged political environment, with heightened taxpayer expectations of regulatory scrutiny when tax revenues or tax subsidies support a particular organization or industry sector.   Recent compensation caps imposed on executives of federally assisted banks are but one example.   Accordingly, tax-exempt hospital boards are well advised to closely review the Final Report and evaluate the need for greater "common sense" focus on the process by which executive compensation is determined, and on the manner in which community benefit is provided and reported.

A more detailed McDermott On the Subject analyzing the Report will be released shortly.  Click here to view the Report