Alabama's largest not-for-profit hospital system last week avoided losing its tax-exempt status by paying an undisclosed fine to the Internal Revenue Service, which had accused the system of misusing charitable money by overpaying for physician practices.
The investigation of Birmingham-based Baptist Health System-and the subsequent settlement-is the latest example of the extreme dangers hospitals face when practice acquisition strategies blow up in their faces.
For example, city-owned 131-bed Bossier Medical Center in Bossier City, La., was sold to Dallas-based Christus Health after overgenerous contracts with a handful of its physicians led to net losses of $5.2 million last year (May 10, p. 20).
After a four-year audit, which 11-hospital Baptist had vowed to fight to the bitter end, the system decided it couldn't risk losing its federal tax-exempt status.
A preliminary audit report in December 1997 proposed revoking the system's tax-exempt status because IRS auditors concluded Baptist was using its charitable assets for the private benefit of physicians by paying more than fair market value for their practices (Dec. 22-29, 1997, p. 3).
Although the amount of the settlement was not disclosed, Baptist will be liable for $491,258 in taxes the IRS determined it owed, Robert Greene, the system's senior vice president and chief financial officer, confirmed.
"(IRS auditors') contention on some of the issues was that we were paying above market prices for some doctors," Greene said.
He said the system had obtained outside appraisals on all its physician deals.
"We felt all along we had a basis for what we paid for physician practices," Greene said.
But although Baptist has not admitted any wrongdoing by its trustees, officers or director, the system settled with the IRS to end the threat of revocation of its tax-exempt status.
"It's like a death knell," Greene said of revocation. "That's why we took this very seriously."
The audit was part of a nationwide program for tax-exempt organizations called the Coordinated Examination Program. Other not-for-profit hospitals are undergoing similar audits, but none have lost their tax-exempt status, Greene said.
At stake in Baptist's case were five issues of tax-exempt bonds worth $270 million, issued between 1991 and 1996. The system's total debt structure, including taxable and tax-exempt issues, is $350 million, Greene said.
In addition to having to settle, Baptist lost a potential merger partner thanks to its tax problems.
When the IRS issued its preliminary audit report about Baptist in December 1997, the system was in merger talks with Pensacola, Fla.-based Baptist Health Care Corp. The deal was supposed to close in mid-1998.
That deal was put on hold while the Alabama system dealt with the IRS issue.
"Our boards were talking about how the process would work mechanically and legally and were in the process of preparing a statement of justification for a potential merger, but it was decided that it would be best to have Baptist Health System have an opportunity to focus on this IRS problem," said Jerry Maygarden, senior vice president for corporate relations at Baptist Health Care.
At this point, a year and a half later, the five-hospital Florida system is not considering rekindling its ties to Baptist Health System, he said.