Hosting Internal Revenue Service agents on your campus for two or three years is something few hospital executives would volunteer to do.
But that's just what a central Illinois hospital did late last year when its leaders met with IRS agents to plan its comprehensive audit, one of only a few publicly identified in a 15-year-old IRS examination of tax-exempt organizations.
The IRS is auditing 421-bed Carle Foundation Hospital in Urbana, Ill., a not-for-profit hospital owned by the not-for-profit Carle Foundation. The audits are part of a national program initiated in 1990 that operates out of regional IRS offices under the agency's Coordinated Examination Procedure, or CEP, project, recently expanded and renamed the Team Examination Program, or TEP.
"Our name came up on the list," said Robert Tonkinson, the hospital's chief financial officer. "We were not expecting it at all. We were all aware that these audits were occurring but had no indication that we would receive an IRS notification. There was no opportunity to dissuade them. It was a done deal."
Tonkinson said the IRS, which has been conducting audits of large medical centers in the Chicago area since the mid- to late 1990s, told the hospital the TEP audits are spreading to downstate Illinois.
An IRS spokesman said the agency did not know how many audits agents have completed since the program began, the total amount of CEP tax-settlement recoveries, or what percentage of the audits were performed on hospitals and healthcare organizations. But in 2003 the IRS conducted 464 CEP audits, which recovered $115.8 million in settlements, according to the Internal Revenue Service Data Book 2003, the most recent agency data available. The IRS does not identify audit subjects.
Healthcare tax attorney Wayne Henry of the law firm Stinson Morrison Hecker met with several IRS agents in Chicago and learned that as of July 21, 2000, the agency had identified 875 candidates for such exams and had selected 787 of those. Of the first 63 cases closed by the IRS, the settlements averaged $2.5 million with an average audit length of three years, according to former IRS official Marcus Owens, a lawyer now in private practice with the law firm of Caplin & Drysdale. By 2000, Henry said, the IRS agents told him that the Chicago office had closed 160 CEP cases and had another 79 under audit, 32 of which were healthcare organizations.
"The IRS is still going after big fish in these audits," said Henry, who noted that the IRS even has inquired about hospital cell phone use in one audit. "But the Carle audit may signal a new wave of exams at smaller healthcare organizations, too."
Thomas Hyatt, a healthcare tax lawyer with Ober Kaler, said the audits grew more common in the 1990s as the IRS realized how successful they were in uncovering taxes and began to include healthcare organizations and hospitals in the last decade.
"They don't do many, because they're very resource-intensive," Hyatt said, pointing out that the audits require experts in data management and processing, computer systems and tax specialties.
IRS agents typically question everything on the organization's Form 990 and look for the trail behind it, Hyatt explained. Because the audits are costly and labor-intensive, typically involving as many as seven agents, the agency "tends to select targets they think would be a fruitful source of inquiry," Hyatt said.
Owens said that before the audits began, IRS regional offices surveyed tax-exempt facilities in their areas, identified organizations that met the CEP criteria, prioritized auditing lists and set up a schedule for a three-year period. The first thing IRS agents do in planning an audit, he said, is to examine the not-for-profit organization's Form 990 on the Internet, closely review its Web site and compare the two for consistency.
"Agents will do Web searches, read news articles, hear from disgruntled employees and build a paper trail before contacting the organization," Owens said.
Hospitals have to fend for themselves in coping with the audits. Officials with regional, state and national hospital associations said the CEP/TEP audits have been off their radar screens for years.
Illinois Hospital Association spokesman Danny Chun said members have not requested IHA advice.
"It's not a new issue," Chun said. "And we don't have a handle about how many of these are happening out there."
American Hospital Association spokesman Richard Wade said the AHA's legal staff hasn't issued member guidance on the audits in more than a decade. "Our legal staff will talk with members about them periodically, but generally most hospitals have their own audit and accounting firms and go directly to them," Wade said. "We don't hear about them and don't track their frequency."
Tonkinson said the IRS informed Carle of its audit plans in October 2004. The IRS auditors recommended that Carle create its own team and designate a liaison responsible for securing the requested documents and interacting with agents, he said. Carle's director of accounting, Lynne Riley, was named to the post.
At that first meeting in late November 2004, Carle officials asked why they were selected and what information the IRS was seeking. Tonkinson said the agents told him the IRS was expanding the audits to include smaller organizations and that there was no specific reason Carle was chosen, except that it fit the profile of organizations with more than $100 million in revenue or assets.
The agents told Carle officials they would require on-campus office space, desks, phone and Internet connections, and would likely remain for 18 to 24 months.
"We're early in the process and most days there isn't anybody (from the IRS) here," he said.
The IRS told Carle it could expect up to seven agents working on-site at least one week per month.
To date the agents have requested W-2 and 1099 tax forms for the requested audit years, as well as general ledger and accounts payable transactions. They told the Carle team they'll examine pension plans, tax-exempt bond issues, and benefit and compensation plans. They will also review contracts with physicians, foreign employees and outside vendors, as well as anything relating to tax-exempt status, they said.
Tonkinson said he doesn't know anything Carle could have done differently to prepare for the audit. "We are committed to ethical business practices, have an active compliance program and comply with all laws and regulations."
His advice to other hospitals? "Work your hardest to comply with the law and when your turn comes to be reviewed, you won't have to worry about what they'll find."
Carle said he expects that the IRS will find areas of disagreement.
"The IRS wouldn't continue this program if it hadn't been profitable to them," he said. "But the regulations are complex enough, with plenty of room to disagree. It's much too early in the process for us to be able to estimate what it will cost us."
In addition to the drain on the hospital's staff, time, resources and copying and document production, there will be fees for outside counsel and accounting services in addition to any final settlement on taxes due.
"It takes away valuable resources that could be used to improve the health of our community and do good things within our organization," he said. "It detracts money and time from those efforts."
The hospital reported total patient revenue of $461.5 million in the fiscal year ending June 30, 2004, up from $363.7 million the previous year, according to the American Hospital Directory, an online database. Carle earned $3.6 million in operating income in fiscal 2004, up from a $4.6 million loss on operations in 2003. It earned net income of $33.1 million in 2004, up from $20.3 million in 2003.
Catherine Jacobson, senior vice president of finance and chief financial officer for Chicago-based Rush University Medical Center, is an alumnus of the CEP audits. Jacobson oversaw Rush's 1997 audit. She said agents with at least six different specialties spent nearly a year at Rush auditing two fiscal years of Medicare cost reports, compensation and benefits policies, and payroll documents.
"We were one of the first to get a CEP and our outside accountant, Arthur Andersen, had only done one or two at that time," recalled Jacobson, who then served as the hospital's chief compliance officer.
"They told us there was no reason why they chose us, except we were on their list because of our size. That's why we appeared on their radar screen. We knew it was likely to happen, but we didn't know how to prepare because nobody had much experience yet. But we did assign a liaison, a finance director who oversaw the preparation of the 990s and other tax forms. He served as the main contact with the agents. And we relied heavily on Andersen."
She said Rush never quantified the costs of complying with the audit. But in addition to the settlement, which she declined to disclose but said she recalled was about the average amount, the hospital paid Andersen hundreds of thousands of dollars in accounting fees.
In addition to Rush, a number of Chicago's other large, academic medical centers and teaching hospitals received CEP audits.
Mary Rauschenberg, certified public accountant and director at Deloitte Tax, said tax-exempt hospitals seldom know why they were selected for CEP audits.
"Sometimes you want to ascribe it to just plain dumb luck," Rauschenberg said, noting that the IRS set up a system of criteria for identifying which organizations are audited. "I'm aware of one occasion when a corporate integrity agreement caught the IRS' attention and prompted an audit. Other times it could be a disgruntled employee or someone else making a credible allegation. It could be a combination of factors."
Rauschenberg, who has worked on nearly 20 CEP audits directly and has consulted on many more, almost half of them of at hospitals, said in the early CEP audits the IRS found some significant noncompliance in certain areas and after word of the audits spread, compliance improved.
"But in recent years we've seen diminishing returns," she said. "On top of that, the (IRS') exempt organizations division has lost employees. I think there are fewer audits and smaller settlements now."
She said that while most audits end within two to three years, she has been involved in one that has remained open for seven years. She has seen the IRS settle for as little as $100,000 and for more than $5 million.
"But I have never heard of any organization going through a CEP audit without paying any additional taxes," she said.
Carle's Tonkinson said the TEP audit may also include executive compensation issues, but they are separate from the more narrowly focused project the IRS announced last year (May 31, 2004, p. 6). In May 2004 the agency said it would send a series of "soft contact letters," also known as "desk audits," to around 2,000 not-for-profit organizations, including tax-exempt hospitals. Agency officials predicted that about one-quarter of those would result in audits. That investigation, which will operate from the agency's new compliance unit in Ogden, Utah, focuses on executive compensation, private inurement of hospital board members and executives, and excess benefit transactions.
According to Owens, as of March 1 only about half of those audit letters had gone out. Owens said an IRS official told him another large batch is expected to be sent by mid-May. While Owens said he knows tax-exempt organizations have received the letters, to date he's unaware of any hospitals receiving them.
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IRS coordinated examination and team examination audits at a glance
â– Began in 1990
â– Average two to three years
â– May include up to seven IRS agents on site
â– Average tax settlement is about $2 million
â– Originally aimed at large, tax-exempt organizations fitting a 20-point formula but have since expanded to include smaller organizations
Source: Modern Healthcare reporting