When a physician board member for Bronson Healthcare Group sought a contract with the two-hospital system in Kalamazoo, Mich., on a joint venture several years ago, James Falahee Jr. sighed in relief. The board member had recused himself from board discussions of the prospective contract with his corporation. In addition, he left the room and did not vote while board members discussed the outside independent appraisal establishing fair market value and whether the deal would benefit the hospital.
"Just declaring a conflict of interest doesn't end of the issue," said Falahee, the senior vice president of legal affairs, general counsel and chief compliance officer for two-hospital Bronson. "It's how you handle that conflict to avoid potential excess-benefit transactions and other tax liability issues with the IRS."
That's why Falahee -- unlike some of his colleagues at hospitals across the country -- was not surprised or dismayed earlier this month when the Internal Revenue Service released proposed regulations that would threaten the tax-exempt status of not-for-profit hospitals and other 501(c)(3) organizations for committing excess-benefit transactions.
"We put our policies in place in 1997 and since then have had several occasions to deal with these kinds of issues," Falahee said. "A general counsel or compliance officer should anticipate and implement policies and procedures so you can learn about potential questionable transactions early on in the process and either amend the agreement or make sure it's not pursued. Your antenna should go up because you never want to jeopardize the tax-exempt status of your organization."
The 20-page set of proposed regulations, which appeared in the Sept. 9 Federal Register, increases the stakes for not-for-profit hospitals and other tax-exempt organizations by threatening revocation of exemptions for certain transaction violations. Parties have until Dec. 8 to submit comments and final regulations will be published in the Federal Register next year.
Healthcare attorneys said the proposed rulemaking swings the enforcement pendulum again, offering not-for-profit organizations a carrot-and-stick approach that rewards both compliance and self-reporting, but also defines when it would impose the ultimate sanction: revocation.
The proposed rules offer five examples illustrating the distinctions, pointing out that the "prohibited private benefits may involve noneconomic benefits as well as economic benefits" and may arise "regardless of whether payments made to private interests are reasonable or excessive." The proposed rules also lay out scenarios under which tax-exempt organizations could lose their 501(c)(3) status after committing excess-benefit transactions that inured private interests, as well as illustrations of scenarios that do not constitute violations.
Falahee said the proposed regulations provide more detail on what the IRS considers an excess-benefit transaction, how to identify those and how to handle them if they are uncovered.
With the proposed regulations, Chicago healthcare attorney Michael Peregrine, of the law firm McDermott Will & Emery, said the proposed rules for the first time expressly link maintaining exemption to avoiding excess-benefit transactions.
In the past, the IRS has gone after only transaction participants -- disqualified persons, such as board members or other insiders, who privately benefited from excess benefits. "The proposed regulations put a real premium on internal tax compliance, another task for the compliance officer, because the IRS says things will go better if the organization finds the excess-benefit transaction itself and makes a good faith attempt to fix it before the IRS finds out," Peregrine said. "This puts a little more oomph behind the IRS intermediate sanctions."
While the IRS is extending the olive branch of compliance benefits along with the sword of tax revocation, it's unclear whether healthcare compliance officers have embraced tax compliance as comprehensively as they have compliance with fraud and abuse laws. Lisa Murtha, a Philadelphia attorney and managing director with Huron Consulting, said awareness of tax issues still lags behind fraud and abuse risks among healthcare compliance officers. Murtha, a former hospital compliance officer, said while that's true, it's also changing quickly. "I wouldn't say that tax awareness is as high, but it's catching up and is higher than ever before," said Murtha, a board member of the Health Care Compliance Association.
Gerald Griffith, a healthcare tax attorney with the Detroit office of Honigman, Miller, Schwartz & Cohn, said that gap is understandable. "Fraud, billing and coding problems tend to be more prevalent and potentially widespread and involve more people within an organization than tax issues," Griffith said.
He said while fewer people are involved on the tax side, which is almost exclusively internal, there can be almost as many potential problems. Those same contracts can include excess-benefit transactions. "And if the IRS perceives that the organization is operating for the benefit of a small group of insiders ... the IRS can impose intermediate sanctions, including revocation."
Wayne Henry, a former IRS attorney now with the Omaha office of Stinson Morrison Hecker, said because nothing happens in Washington in a vacuum, the proposed regulations "could mean we're in the eye of the storm. Right now it's pretty quiet out there, but there could be rough weather ahead."
Henry said because of the huge, growing federal deficits and the congressional spotlight on alleged abuses in the tax-exempt sector, the IRS faces political and economic pressure to correct loopholes. "They have the intermediate sanctions to impose on disqualified persons for excess-benefit transactions, but wanted tax-exempt organizations to recognize that in egregious situations they could lose that status."
Henry said hospitals could take comfort in knowing that the IRS has very rarely revoked a hospital's tax-exempt status. "But ... the potential penalties are so huge and costly that no one should take that risk."
Washington healthcare tax lawyer Thomas Hyatt of the firm Ober/Kaler said the proposed regulations signal that the IRS is building a foundation for increasing its enforcement in the tax-exempt arena. "It is identifying the basis for revocation to help strengthen its hand in litigation down the road should it face legal challenges," Hyatt said.
Bronson's Falahee said hospitals need to pay attention to tax liability issues, too. "You can't ignore the IRS," he said. "I think these proposed regulations may wake a few people up."