When the Internal Revenue Service comes knocking, fears of loss of tax-exempt status or private-gain problems leap to hospital executives' minds.
But the IRS has a new focus on 403(b) tax-deferred annuity plans-named for the applicable section of the Internal Revenue Code-that could catch healthcare providers off guard if they're not prepared.
The 403(b) audits are part of the IRS' ongoing review of tax-exempt organizations' compliance with the Internal Revenue Code.
According to the IRS, 34 hospitals and other tax-exempt healthcare organizations, along with 18 colleges and universities, have been audited or are under review. Initially, the IRS has targeted large hospitals for audits, but eventually smaller providers will come under scrutiny, too.
The IRS hasn't compiled statistics on the number of deficiencies or the amount of taxes and penalties generated as a result of the reviews, said Marcus Owens, director of the IRS' exempt organizations division. But in some instances, the paybacks by employers reach seven figures, he said.
Limitations.Only tax-exempt, 501(c)(3) organizations, such as not-for-profit hospitals, and government-sponsored school systems are allowed to offer 403(b) tax-deferred annuities. These voluntary plans allow employees to shelter savings until after retirement.
Diversified Investment Advisors, a Purchase, N.Y.-based pension investment manager, began giving audit seminars a year ago to prepare employers for 403(b) scrutiny. "The IRS has started to receive money (as a result of its audits), so monitoring (not-for-profit organizations' compliance) has become a lot more important," said Melanie Schussler, Diversified's director of pensions.
Because the plans are voluntary, hospitals historically have taken a laissez faire attitude about administering them, said Mark M. Skinner, president of The Copeland Cos., an East Brunswick, N.J., pension adviser. "There's no one in the hospital that's saying, `Gee, let's make sure the limits are being followed."'
Pitfalls.Of the smattering of audits conducted so far, the IRS has identified a number of tax-code violations.
"What we're seeing may well be a microcosm of what's out there," said Robert Architect, a tax-law specialist in the IRS' employee plans division.
One significant problem area involves IRS limits on the amount of money that an employee may funnel into the 403(b) plan. Generally, the employee may elect to set aside $9,500 of his or her salary a year. But under certain circumstances, the ceiling may be as high as $30,000.
In many cases, hospitals are inappropriately exceeding the lower limit because the required calculations aren't easy, Ms. Schussler said.
The IRS is finding deliberate and inadvertent abuses of the higher limit, said Roz Ferber, an IRS tax-law specialist.
When such a violation is discovered, the excess amount must be included in the employee's gross compensation for the year, significantly inflating the worker's tax burden. In addition, the employer must recalculate and pay Social Security and unemployment compensation amounts as well as pay a fine for violating the federal tax code's withholding requirements.
But Joe Walshe, a partner with Coopers & Lybrand in Washington, said the IRS has agreed to settle with the clients he's worked with so that individual employees haven't had to pay back taxes on money that shouldn't have been sheltered.
Misinterpretations.Audits of teaching hospitals have revealed abuses or misinterpretations of IRS rules on employee eligibility. Private-practice physicians, for example, are not allowed to make 403(b) contributions because they're not technically employees.
Surprisingly, the IRS also has discovered hospitals that are not 501(c)(3) organizations and therefore aren't qualified to offer 403(b) plans in the first place. In such cases, all amounts contributed to the plan must be included in employees' gross income.
Because the rules governing 403(b) plans have existed for 20 or 30 years in many cases, ignorance isn't a legitimate excuse for mistakes, Mr. Architect said.
Early next year, the IRS hopes to initiate a voluntary disclosure system that will enable employers to voluntarily admit 403(b) violations, submit plans for correction and pay fines.
An employer will sign a "closing agreement" with the IRS and pay a percentage of the total tax liability. The amount of the percentage will be less than 100%, although an exact percentage hasn't been determined yet, he said.
In most cases, Coopers & Lybrand's Mr. Walshe has advised clients to voluntarily disclose violations to the IRS. But before seeing the terms of the IRS' pending disclosure program, he was hesitant to recommend that all providers reveal compliance problems.