The Internal Revenue Service has given not-for-profit hospitals reason to believe that good intentions and effort count for something, even when the results run afoul of the requirements for tax-exempt organizations.
IRS good with good intentions?
Example suggests effort counts for not-for-profits
Final regulations published in the Federal Register March 28 clarify the relationship between the requirements for tax-exempt status and the sanctions the government imposes when exempt organizations engage in what are called excess-benefit transactions. More to the point, they clarify under what circumstances a hospitals exemption might be at risk, and how executives and boards can soften that risk by adopting and abiding safeguards, said lawyers who specialize in tax issues for exempt organizations.
Tax issues are boring to hospitals and executives, said lawyer Michael Peregrine, a partner in McDermott Will & Emery. This is one where youve got to take notice.
Under Section 4958 added to the Internal Revenue Code in 1996, the IRS can levy penalty taxes on insiders such as board members or executives who approve transactions that convey more value than the organization gets in return. The taxes are a way for the government to police the activity short of revoking tax-exempt status and without harming the organization. Potential excess-benefit transactions for hospitals include executive compensation, joint ventures,
leases, property sales and acquisitions of physician practices.
There are circumstances under which, if you do this so much, or it is so bad, you could lose your tax exemption, Peregrine said. The IRS solicited comments on proposed rules in September 2005 that sought to clarify those circumstances, and to further illustrate them, the final rule offers new examples. A spokesman for the American Hospital Association said the organization hadnt noted anything thats not routine in the regulations.
Tom Hyatt, a principal in Ober, Kaler, Grimes & Shriver, observed that Most of the commenters were looking for more specificitymore detailed and clear examples of how the rules would applyand the IRS pretty consistently said, No.
Nonetheless Hyatt and others took particular interest in one of the generic examples, which shows how internal controls and good faith will factor in a hospitals favor when the IRS is judging the import of a transgression (See table). Everybody should get excited about Example No. 6, said James King, a partner in Jones Day, describing the message this way: You dropped the ball, but you tried your best and tried afterward to make it better.
The language wont shield executives or board members from paying the excise taxes on excess-benefit transactions, King said, but it could protect the hospitals tax exemption and, more routinely, comfort balky bond issuers.
The bond lawyers get very excited about whether private inurement (payments or arrangements that benefit private interests) adversely impact your tax-exempt status, King said. Having this in here, if people pay attention and follow ittry to do your best and if you stub your toe fix ityou can say, Look at Example No. 6.
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