Section 4959 Excise Tax for Failure to Meet the Requirements of Section 501(r)(3) and Noncompliant Facility Income Tax for Failure to Meet the Requirements of Section 501(r)

This snapshot addresses the applicability of both the excise tax under Section 4959 for failure to meet the requirement of Section 501(r)(3) as well as the Noncompliant Facilities Income (NCFI) Tax for failure to meet the requirements of Section 501(r).

Resources

IRC Section 501(c)(3) - Tax Exempt Organizations.

IRC Section 501(r) - Additional requirements for tax-exempt hospital organizations.

IRC 501(r)(2)(A)(i) - Provides that Section 501(r) applies to an organization that operates a facility that is required by a State to be licensed, registered, or similarly recognized as a hospital.

IRC 501(r)(2)(B)(i) - Requires an organization that operates more than one hospital facility to meet the requirements of Section 501(r) separately with respect to each hospital facility.

IRC 501(r)(2)(B)(ii) -  States that an organization will not be treated as described in Section 501(c)(3) with respect to any hospital facility for which the requirements of Section 501(r) are not separately met.

IRC Section 4959 - Imposes a $50,000 excise tax for any taxable year a hospital organization fails to satisfy the Community Health Needs Assessment (CHNA) requirements under Section 501(r)(3).

IRC Section 6033(b) - Requires organizations described in section 501(c)(3) and subject to section 6033(a) to file annual information returns at such time and in such manner as the Secretary may by forms or regulations prescribe.

Treas. Reg. 1.501(r)-1- Definitions for terms used in Treas. Reg. 1.501(r)-2 through 1.501(r)-7.

Treas. Reg. 1.501(r)-2 - Failure to satisfy Section 501(r).

Treas. Reg. 1.501(r)-2(b) - Minor omissions or errors.

Treas. Reg.  1.501(r)-2(c) - Excusing certain failures if hospital facility corrects and discloses.

Treas. Reg.  1.501(r)-2(d) - Taxation of noncompliant hospital facilities.

Treas. Reg. 1.501(r)-3 - Community health needs assessment (CHNA).

Treas. Reg. 1.501(r)-4 - Financial assistance policy (FAP) and emergency medical care Policy.

Treas. Reg. 1.501(r)-5 - Limitations on charges.

Treas. Reg. 1.501(r)-6 - Billing and collections.

Treas. Reg. 1.501(r)-7 - Effective/applicability dates of Treas. Reg. 1.501(r)-1 through 1.501(r)-6.

Treas. Reg. 53.4959-1 - Taxes on failures by hospital organizations to meet Section 501(r)(3).

Treas. Reg. 1.6012-2(i) - Reporting by hospital organizations with noncompliant hospital facilities.

Treas. Reg. 1.6012-3(a)(10) - Hospital organizations organized as trusts with noncompliant hospital facilities.

Rev. Proc. 2015-21 - Provides guidance regarding correction and disclosure procedures for hospital organizations to follow so that certain failures to meet the requirements of Section 501(r) will be excused for purposes of Sections 501(r)(1) and 501(r)(2)(B).

Analysis

History

Section 9007 of the Patient Protection and Affordable Care Act (ACA), enacted March 23, 2010, added Sections 501(r) and 4959 to the Code and amended Section 6033(b). A hospital organization must meet the requirements of Section 501(r) separately with respect to each hospital facility it operates in order to be described in Section 501(c)(3). The statutory requirements of Section 501(r) (except for the requirements of Section 501(r)(3)) apply to taxable years beginning after March 23, 2010. Section 501(r)(3) applies to taxable years beginning after March 23, 2012. On December 31, 2014, final regulations were published under Section 501(r) and are effective for tax years beginning after December 29, 2015. See Treas. Reg. 1.501(r)-7. For taxable years beginning on or before December 29, 2015, a reasonable interpretation of the statute applies.

Additional Requirements for Section 501(c)(3) Hospital Organizations

Section 501(r) imposes additional requirements on Section501(c)(3) organizations that operate one or more hospital facilities. Each Section 501(c)(3) hospital organization is required to meet four requirements of Section501(r) separately with respect to each hospital facility it operates. (Section 501(r)(2)((B)(i)). Each hospital facility operated by a hospital organization must:

  1. Conduct a community health needs assessment (CHNA) at least once every three years and adopt an implementation strategy to meet the community health needs identified in the CHNA by the 15th day of the fifth month after the end of the taxable year in which the CHNA was conducted. (Section 501(r)(3); see Treas. Reg. 1.501(r)-3).
  2. Establish a written financial assistance policy (FAP) and a written emergency medical care policy. (Section 501(r)(4); see Treas. Reg. 1.501(r)-4).
  3. Limit amounts charged for emergency or other medically necessary care to individuals eligible for assistance under the hospital's financial assistance policy to not more than amounts generally billed to individuals who have insurance covering such care (AGB) and limit amounts charged for other medical care covered under the FAP to less than the gross charges for such care. (Section501(r)(5); see Treas. Reg. 1.501(r)-5).
  4. Not engage in extraordinary collection action against an individual to obtain payment for care until after reasonable efforts have been made to determine whether the individual is eligible for assistance under the hospital’s FAP. (Section501(r)(6); see Treas. Reg. 1.501(r)-6).

Section 4959 Excise Tax for CHNA Failures

The ACA added Section 4959 to the Code. Section 4959 imposes an excise tax of $50,000 on a hospital organization that fails to meet one or more of the requirements of Section 501(r)(3) for any taxable year.

If the hospital organization operates multiple hospital facilities and fails to meet the requirements of Section501(r)(3) with respect to more than one of those facilities, the $50,000 tax is imposed on the hospital organization separately for each hospital facility’s failure; so, there could be multiple assessments if there are multiple facilities that failed to meet the requirements of Section 501(r)(3) and/or if one or more hospital facilities failed to meet the requirements of Section 501(r)(3) in multiple tax years. Treas. Reg. 53.4959-1.

While the Section 4959 excise tax applies separately with respect to each hospital facility operated by the hospital organization that fails to satisfy the requirements of Section 501(r)(3), there can be only one $50,000 tax per facility per tax year, regardless of the number of failures. The excise tax is in addition to the noncompliant facility income tax (discussed below) and applies even if the hospital organization loses its tax exempt-status.

The Section 4959 excise tax is required to be reported on Form 4720, which must be filed on or before the 15th day of the fifth month after the end of the hospital organization’s tax year for which the failure to satisfy Section501(r)(3) occurred. Organizations also report excise taxes under Section 4959, and indicate whether Form 4720 has been filed, on Schedule H (Form 990), line 12.

Noncompliant Facility Income Tax

A hospital organization failing to meet one or more requirements of Section 501(r) separately with respect to one or more hospital facilities it operates may have its tax-exempt status revoked as of the first day of the taxable year in which the failure occurs. In making this determination, the IRS will consider all the facts and circumstances. Where a hospital organization operates only one hospital facility and fails to meet one or more of the requirements of Section 501(r) with respect to that facility, revocation is the only recourse. However, a hospital organization operating more than one hospital facility that fails to meet one or more requirements of Section 501(r) with respect to one or more of those hospital facilities may still maintain its tax-exempt status.

Treas. Reg. .501(r)-2(d) provides that the income derived from the noncompliant hospital facility (“noncompliant facility income”) during the taxable year will be subject to tax in lieu of revoking the tax-exempt status of the hospital organization. The tax is generally computed under Section 11, unless the hospital is a trust described in Section 511(b)(2), in which case the tax is computed under Section 1(e). This tax is imposed on the net income of each noncompliant hospital facility that fails to satisfy one or more requirements of Section 501(r). The noncompliant facility income derived from a hospital facility during a taxable year is the gross income derived from that hospital facility during the taxable year, less the deductions allowed that are directly connected to the operation of that hospital facility during the taxable year, excluding any gross income taken into account in computing any unrelated business taxable income described in Section 512 that is derived from the facility during the tax year.

To be directly connected with the operation of a hospital facility that has failed to meet the requirements of Section 501(r), an item of deduction must have a proximate and primary relationship to the operation of the hospital facility. Allowed deductions include expenses, depreciation, and similar items attributable solely to the operation of a hospital facility. Where expenses, depreciation, or similar items are attributable to a noncompliant hospital facility and other hospital facilities operated by the hospital organization (and/or to other activities of the hospital organization unrelated to the operation to the operation of the hospital facility), such items must be allocated on a reasonable basis. The gross income (and any directly connected deductions) from one noncompliant hospital facility cannot be aggregated with the gross income (and directly connected deductions) from the hospital organization’s other noncompliant hospital facilities subject to the noncompliant facility income tax or with its unrelated trade or business activities described in Section 513. The application of the noncompliant facility income tax on income derived from one or more noncompliant hospital facilities operated by a hospital organization does not, by itself, affect the tax-exempt status of bonds issued to finance the noncompliant hospital facility. The tax on noncompliant facility income is reported on Form 990-T, even if the hospital is organized as a trust. See Treas. Reg. 1.6012-2(i), Treas. Reg. 1.6012-3(a)(10).

Potential Correction of Failures

Treas. Reg. 1.501(r)-2(b) states that a hospital facility's omission of required information from a report or policy described in Treas. Reg. 1.501(r)-3 or Treas. Reg. 1.501(r)-4, or error with respect to the implementation or operational requirements described in Treas. Reg. 1.501(r)-3 through Treas. Reg. 1.501(r)-6, will not be considered a failure to meet a requirement of Section501(r) if:

  1. Such omission or error was minor and either inadvertent or due to reasonable cause; and
  2. The hospital facility corrects such omission or error as promptly after discovery as is reasonable given the nature of the omission or error.

For purposes of this provision, correction must include the establishment (or review and, if necessary, revision) of practices or procedures (formal or informal) that are reasonably designed to promote and facilitate overall compliance with the requirements of Section501(r).

Under Treas. Reg. 1.501(r)-2(c), a hospital facility’s failure to meet the one or more of the requirements of Treas. Reg. 1.501(r)-3 through Treas. Reg. 1.501(r)-6 that is neither willful nor egregious shall be excused for purposes of Section501(r)(1) and Section501(r)(2)(B) if the hospital facility corrects the error and makes disclosure in accordance Rev. Proc. 2015-21.

Summary

Section 501(r) imposes additional requirements on Section501(c)(3) hospital organizations that operate one or more hospital facilities. Each such hospital organization is required to meet four requirements of Section 501(r) separately with respect to each hospital facility the hospital organization operates. There are three types of sanctions that may apply for failures to satisfy the requirements of Section 501(r):

  1. The $50,000 excise tax under Section 4959 for failure to satisfy the requirement of Section 501(r)(3) for any taxable year.
  2. For hospital organizations that operate multiple hospital facilities, the noncompliant facility income tax imposed on the hospital organization with respect to each hospital facility that fails to meet one or more of the requirements of Section 501(r).
  3. Under certain circumstances, potential loss of tax exempt status loss of tax-exempt status.

Before deciding which sanctions described above may (or must) be imposed, the facts and circumstances must be considered. It must be determined whether the failure is a minor error or omission that is either inadvertent or due to reasonable cause and therefore not considered a failure under relevant guidance, or whether the failure is excusable. However, note that the Section 4959 excise tax applies even if a failure to meet the requirements of Section 501(r)(3) is excusable. See Treas. Reg. Section 53.4959-1(b)(1); Rev. Proc. 2015-21. If the hospital facility’s failure was neither willful nor egregious, ascertain whether the hospital facility corrected and disclosed the failure in accordance with Rev. Proc. 2015-21.

Audit Tips

  • Determine whether each hospital facility conducted a timely and adequate CHNA as described under Section501(r)(3)(A)(i) and Treas. Reg. 1.501(r)-3(b) and whether the completed CHNA was made widely available to the public. If this requirement was not met, imposition of the excise tax under Section 4959 is appropriate unless the hospital organization’s failure to meet these requirements involved an omission or error that that is described and corrected in accordance with Treas. Reg. 1.501(r)-2(b) (and thus is not considered a failure).
  • Determine if each hospital facility has adopted timely an adequate implementation strategy (IS) under Section 501(r)(3)(A)(ii) and Treas. Reg. 1.501(r)-3(c) that addresses the health needs of the community served by the hospital facility identified through the CHNA process. If this requirement was not met, imposition of the excise tax under Section 4959 is appropriate unless the hospital organization’s failure to meet these requirements involved an omission or error that that is described and corrected in accordance with Treas. Reg. 1.501(r)-2(b) (and thus is not considered a failure).
  • Ascertain each hospital facility’s reason(s) for its failure(s).
  • Review Form 990-T (See Line 39 on the 2016 Form 990-T).
  • Determine whether there was a minor error or omission that is not considered a failure to meet the requirements of Section501(r) under Treas. Reg.  1.501(r)-2(b).
  • If not a minor error or omission, determine whether the failure may be excused under Treas. Reg. 1.501(r)-2(c) if the failure is corrected and disclosed.
  • If the hospital facility’s failure was neither willful nor egregious, ascertain whether the hospital facility corrected and disclosed the failure in accordance with Rev. Proc. 2015-21
  • If appropriate, determine the applicable sanction(s):
    • The Section 4959 excise tax (note that failures under Section 501(r)(3) are still subject to the Section 4959 excise tax, even if later corrected and disclosed)
    • Revocation of tax-exempt status, or
    • Taxation of noncompliant facility income
  • Review activities that generate noncompliant facility income and