A not-for-profit hospital's participation in a physician-hospital organization won't risk the hospital's tax status as long as the PHO's operations and finances aren't dominated by doctors, the Internal Revenue Service says.
But the hospital that sought the ruling from the IRS pulled the plug on its proposed PHO last month, in part because the physicians thought they didn't have enough control.
The situation illustrates the tight spot many hospitals are in as they try to placate physicians and payers while staying ahead of tax codes.
In this case, unlike the IRS, the physicians involved didn't find the PHO conditions acceptable.
Regardless, the ruling is noteworthy because it's believed to be the IRS' first decision on the impact of a PHO on a hospital's tax-exempt status.
The decision is particularly timely because just three weeks ago the IRS sent shivers through the industry by stating in a training manual for agency auditors that it would take a dim view of most PHOs (Sept. 19, p. 16).
In the manual, the IRS said participation in a PHO by a not-for-profit hospital can put the hospital's tax exemption at risk if the financial terms of the arrangement favor the physicians, and especially if the PHO is simply a vehicle through which the hospital shares revenues with loyal physicians.
The IRS made its ruling in a private letter dated Sept. 29. MODERN HEALTHCARE obtained a copy last week, although the IRS has yet to make the ruling public.
The six-page letter addresses the tax implications of a Virginia hospital's participation in a newly formed PHO with key members of its medical staff.
The letter doesn't identify the hospital, but MODERN HEALTHCARE has learned it is 105-bed Williamsburg (Va.) Community Hospital.
Under the proposal, the hospital intended to create a for-profit PHO with as many as 75 physicians on its 110-member medical staff. It would have owned 50% of the PHO.
The hospital and physicians also would have contributed equally to the PHO's start-up capital costs and any future capital requirements.
Any PHO profits, losses or cash distributions would have been allocated based on ownership interests. Therefore, the hospital would have gained or lost half of any money involved.
The PHO's board of directors or an appointed price-negotiating committee, not member physicians, would have managed day-to-day operations. Physician representation on the board would have been limited to 20%.
With the authorization of the board and member physicians, the price-negotiating committee would have been solely responsible for contracts with out- side payers. Neither the board nor physicians would have had the power to negotiate contracts.
At issue was whether physicians would have exerted too much control over the PHO, the hospital's assets and future PHO-derived revenues.
Under federal law, a tax-exempt entity's earnings and the activities it conducts can't benefit individuals.
Citing such protections as limited physician control over the PHO and equal capital contributions and financial distributions among the physicians and hospital, the IRS concluded the Williamsburg Community plan was safe.
"We have concluded that any private interest served by (the) PHO will be incidental," the IRS said.
The safeguards were designed to keep the hospital from being used by the physicians, said attorney Robert Webb of Hazel & Thomas in Falls Church, Va. He represented the PHO.
Ironically, the hospital and physicians terminated the PHO concept about one month before the IRS made its decision, said Davis Bradley, Williamsburg Community's vice president for finance.
One problem was the 20% limit on physicians' board representation. "They didn't like that," Mr. Bradley said.
More importantly, according to Mr. Bradley, the physicians, who primarily were solo practitioners or members of small group practices, believed they had to integrate themselves further before they joined a PHO.