Governing boards of not-for-profit hospitals would get valuable guidance in avoiding conflicts of interest that could land them in trouble with the Internal Revenue Service, under IRS regulations proposed late last month.
If the regulations remain largely unchanged after a public comment period that ends Nov. 2, this protection would help directors not only to stay out of legal trouble but also to make better business decisions, tax experts say.
The rules establish a set of procedures to follow to avoid so-called "intermediate sanctions," excise taxes that give the IRS a way to punish individuals at tax-exempt organizations without revoking the companies' tax exemption. The sanctions became law with the passage of the 1996 Taxpayers' Bill of Rights.
The new procedures, dubbed the "rebuttable presumption of reasonableness," are akin to hospital compliance programs that guard against fraud and abuse. They are a series of steps that a company's board of directors must follow to ensure that its decisions do not result in individual benefits that grossly exceed fair market value (See box).
As outlined in the proposed regulations, the rebuttable presumption shifts the burden of proof from the tax-exempt organization under fire to the IRS.
"It will have a significant impact on the composition and functioning of many boards of directors of tax-exempt healthcare organizations," said Thomas Hyatt, a tax attorney with Ober Kaler Grimes & Shriver in Washington. "You set certain parameters that show you're being reasonable, and you get it on the record."
Though it could reduce companies' legal exposure, the rebuttable presumption would also create more reliance on outside attorneys and consultants for advice on business deals.
What isn't clear in the proposed regulations is whether or not boards are obligated to have a rebuttable presumption procedure in place.
"The regs answer a number of questions as to how the rebuttable presumption works," said Michael Peregrine, a tax attorney with Gardner, Carton & Douglas in Chicago. "But this puts exempt organizations in a real dilemma as to whether they will put in place the procedures and policies needed to take advantage of this protection."
Deals aren't necessarily deemed improper if the rebuttable presumption is not used, attorneys said.
"One of the good things the regs did was say that it's not a good use of manpower to have the board approve every single deal," Hyatt said.
In the regulations, the IRS also indicates that any excess benefits given directly or indirectly to a for-profit subsidiary of the tax-exempt organization could be subject to intermediate sanctions.
"You can't use for-profit subsidiaries as a sham to do things that you can't do as a tax-exempt organization," Hyatt said. "And that puts out the question: At what point (do) a taxable subsidiary's actions get attributed to the parent organization?"
Despite the IRS' having a middle-of-the-road approach to punish tax offenders, experts are quick to point out that the IRS can still resort to revoking an organization's tax exemption in certain extreme cases.
Though attorneys agree the regulations are thorough overall, the 84-page document is vague on the issue of revenue-sharing compensation arrangements, whereby physicians receive a portion of the income generated by a particular service or activity.
"In regard to revenue-sharing, the IRS was not as specific as it could have and should have been," said T. J. Sullivan, a former IRS official who is a tax attorney with Gardner, Carton & Douglas in Washington.
The regulations indicate that revenue-sharing transactions might be considered excess benefits for insiders and subject to intermediate sanctions taxes, said James McGovern, a principal with KPMG Peat Marwick in Washington and a former IRS official.
Though no one suspects drastic changes will be made to the regulations, Sullivan expects the IRS to receive many comments on the revenue-sharing provisions before the public comment period ends.