Not-for-profit hospitals are in danger of being smacked by a "perfect storm" unless they take action and get a handle on internal financial controls and governance, according to industry insiders and outsiders.
And the storm appears to be getting closer: A report given last week to the Senate Finance Committee is a huge step toward introducing a bill that, if it becomes law, would require greater transparency of charitable organizations and would force them to comply with more stringent Internal Revenue Service filing requirements.
The report, which will be followed by a second and final report this spring, came at the request of committee Chairman Chuck Grassley (R-Iowa) and the panel's ranking Democrat, Max Baucus of Montana. The lawmakers last September sent a letter to Independent Sector, a coalition of foundations and not-for-profit organizations, asking it to assemble an independent group to recommend actions needed to strengthen governance and accountability within public charities.
Starting in October 2004, the Panel on the Nonprofit Sector-made up of more than 24 experts and leaders-used comments from hundreds of not-for-profit organizations to compile its initial offering.
Grassley's office said that he plans to introduce legislation this spring based on the report.
Among the panel's recommendations is that top executives of not-for-profits be required by the IRS to sign the Form 990 and attest to the accuracy and completeness of its contents. The report suggests harsher penalties for not-for-profit executives who engage in business self-dealing.
Other panel suggestions call for the IRS to make electronic filing of 990 forms mandatory and require audits of charitable organizations with more than $2 million in annual revenue. For those with less than $2 million in revenue but more than $500,000, financial statements would have to be reviewed by an independent public accountant.
Smaller not-for-profits don't escape the panel's sweep either. The report says that 501(c)(3) organizations that are currently excused from filing an annual information return because their annual gross receipts fall below $25,000 should be required to file an annual notice with the IRS listing, among other things, the organization's revenue and expenditures, top executive and his or her address, Web site address and mission statement.
Penalties for failing to comply with IRS filing requirements should include suspension of the offending charitable organization's tax-exempt status, according to the report.
As for self-governance, the report calls for not-for-profits to pay close attention to the auditing process and install board members with some financial literacy. They should also have their financial statements independently audited.
Observers are saying that the initial report should put not-for-profit hospitals on alert.
"All the past events have led to this perfect storm, and it's time to take action-now," said Paul Gilbert, an attorney with the firm Waller Lansden Dortch & Davis, who represents both for-profit and not-for-profit hospitals across the country.
So, what should otherwise compliant not-for-profit hospitals be doing to protect themselves and remain in good standing as lawmakers prepare to change the rules?
In simple terms: If you're a not-for-profit hospital that does not have an audit committee with independent flavor, it's time to create one, Gilbert said.
"The trend is going that way, and it's time for nonprofit hospitals to consider voluntarily putting together independent committees," said Gilbert, who's followed the issue for the past few years.
The primary charge of an audit committee should be controlling practices, Gilbert said. That includes hiring outside auditors that should meet independently of hospital management, he added. Another control component a hospital should consider is creating a compensation committee.
It's widely accepted that not-for-profit hospitals are among the most sophisticated of exempt organizations, and make up the majority of the nation's 5,000 hospitals.
"Things have gotten interesting over the past 18 months and a number of things have happened over the past year to create this perfect storm," Gilbert said. "The key drivers included the IRS announcing compensation reviews and its concern that nonprofits were overcompensating their CEOs, not to mention the fact that the (House) Ways and Means Committee, along with the Senate Finance Committee, saw a way to generate revenue."
At the same time, people started to take a hard look at some not-for-profit hospitals and question their uninsured billing practices and broader missions, Gilbert said.
"Suddenly, people began saying, `If they are going to act like a for-profit hospital, why should they get a tax exemption?' and the government quickly realized that there was tax revenue involved that was not being realized," he said.