The Internal Revenue Service has made an example out of Hermann Hospital by using a tax settlement with the Houston facility to set forth guidelines on physician recruitment and retention practices.
Under the deal with the IRS, the hospital was required to release copies of its closing agreement with the IRS. The agreement, which typically is confidential, resolves charges that the 618-bed not-for-profit facility violated the terms of its tax exemption by using questionable financial tactics to recruit and retain physicians.
Such tactics included income guarantees, free office space and loans that didn't have to be repaid.
Under the settlement, the hospital will maintain its designation as a 501(c)(3) organization under the federal tax code. But Hermann is required to pay a $1 million fine, which represents the federal income tax it would have paid in fiscal 1990 if it had been a for-profit company.
Perhaps more importantly, the hospital agreed to make its physician recruitment and retention activities conform to guidelines that the IRS presumably would like to see all not-for-profits follow (See chart).
"The IRS is using this mechanism to get out guidelines of general applicability to all exempt organizations," said Elizabeth Mills, a tax attorney with McDermott, Will & Emery in Chicago.
The guidelines likely are designed to replace a long-rumored legal opinion on physician recruitment that the IRS was expected to release sometime over the past several years, said Michael Peregrine, a healthcare attorney with Gardner, Carton & Douglas in Chicago.
As for Hermann, the settlement represents another chapter in the hospital's long history of trouble over the handling of finances.
The troubles date back to 1985, when the state of Texas filed criminal charges against nine hospital trustees and executives over the mishandling of the $400 million Hermann Hospital Estate.
In 1988, the state ordered the hospital to ensure that at least 10% of its annual admissions were charity cases.
And in 1991, the hospital fired then-President Harry Neer for buying meat and poultry for the hospital from a company with ties to two hospital board members (Dec. 23/30, 1991, p. 4).
In fiscal 1990, which ended Sept. 30, 1990, the hospital posted its first profit after five consecutive years of losses. It's been profitable ever since.
Last year, for example, the hospital earned a whopping $48.7 million on total revenues of about $409.8 million, according to HCIA, a Baltimore-based healthcare information company.
To turn things around, Hermann took the advice of the Arthur Andersen accounting and consulting firm, which recommended the hospital spend at least $1 million in fiscal 1990 on physician recruitment and retention, said Kuyk Logan, a hospital spokesman.
Starting in fiscal 1989 and continuing through fiscal 1992, the hospital engaged in physician recruitment and retention strategies that put its tax exemption at risk.
Under federal tax law, the earnings of a tax-exempt organization can't inure to the benefit of private individuals, and the activities of a tax-exempt organization can't be conducted for the benefit of private individuals.
Hermann's suspect conduct included physician income guarantees, subsidized office personnel, free office space, unpaid loans, subsidized parking and "purchases and other transactions" that may have benefited former board members and individuals.
Mr. Logan confirmed that the last item alluded to the meat scandal.
The probable violations of the tax code were uncovered during a 1992 internal audit that followed the meat scandal, Mr. Logan said. The hospital then voluntarily brought them to the attention of the IRS last year, he said.
In addition to the fine, the hospital agreed to follow a new, 27-point set of IRS guidelines on physician recruitment and retention. The guidelines place a number of restrictions on physician recruitment and retention practices.
Many of the guidelines address the issue of doctor-stealing by hospitals.
Under the guidelines, a hospital can't give anything to a staff physician if the purpose is to keep the physician from leaving, Ms. Mills said.