IRS Releases Long-Awaited Report on Hospital Pay and Services

By Grant Williams

The Internal Revenue Service today released findings from a much-anticipated study of nearly 500 nonprofit hospitals that is sure to raise controversy over how much compensation hospitals pay to top officials and how hospitals set that compensation.

The 178-page report also looks at another controversial topic: How much hospitals do to provide charitable services to people in the neighborhoods where they are located in order to qualify for a federal tax exemption.

The IRS said the average total compensation that hospitals that responded to a questionnaire paid to their top management official was $490,000; median compensation was $377,000.

At 20 hospitals that the IRS selected for closer inspection through audits, the average total compensation paid to a top management official was $1.4-million; median compensation was $1.3-million. (The hospitals were audited because the institutions reported paying greater compensation amounts relative to their size and type.)

“Amounts reported appear high but also appear supported under current law,” the IRS said. “For some, there may be a disconnect between what, as members of the public, they might consider reasonable and what is permitted under the tax law.”

The IRS said nearly all hospitals in the study followed "important elements" of a set of federal rules in setting compensation. Those rules provide a series of steps, including the use of data to compare salaries earned by executives at similar charities and for-profit institutions, by which charities can establish that they have done everything possible to set a reasonable salary. Federal rules call that threshold a “rebuttable presumption” of reasonableness. Organizations that are found to pay excessive compensation are forced to pay fines called "excise taxes."
Of the audited hospitals, 85 percent met the requirements of the rebuttable presumption process, the IRS said, putting the burden of proof on the tax agency to show that compensation was not reasonable. The IRS concluded that among this group of audited hospitals, none paid excessive compensation under the law and thus did not owe excise taxes.

IRS officials said in an interview that, among the 15 percent of hospitals that did not use the rebuttable-presumption process, at least one hospital was found by the tax agency to have paid excessive compensation.

40-Year-Old Ruling

The IRS study also looked at how nonprofit hospitals are following the current “community benefit standard,” which the tax agency uses to determine a hospital’s eligibility for tax-exempt status. Under a 40-year-old IRS ruling, hospitals must show that they provide benefits to the people and neighborhoods in the region they serve.

“Uncompensated care was the largest reported community benefit expenditure for each of the study’s demographics, other than for a group of 15 hospitals reporting large medical-research expenditures,” the IRS said. The IRS questionnaire was sent to hospitals in the 26 largest urban areas, other urban and suburban hospitals, and two types of rural hospitals.

“Overall, the average and median percentages of uncompensated care as a percentage of total revenues were 7 percent and 4 percent respectively,” the tax agency said. “Uncompensated care accounted for 56 percent of aggregate community benefit expenditures reported by the hospitals in the study.”

The IRS said the next largest categories of community benefit expenditures were for medical education and training, research, and community programs.
“No correlation was found between community benefit expenditure levels and per capita income levels of the hospital’s surrounding area,” the IRS said. “However, community benefit expenditure levels generally increased as uninsured rates of the hospital’s surrounding area increased.”

The IRS said the data on community benefits has limitations. “For example, although the IRS designated the general categories of activities that could be reported as community benefit for purposes of the study, determining what was treated as community benefit (for example, bad debt or Medicare shortfalls) and how to measure it (cost versus charges) was largely within the [hospitals’] discretion,” the tax agency said.

The IRS concluded that the standards for reasonable compensation and community benefit “have proved difficult” for the revenue service to administer. “Both involve application of imprecise legal standards to complex, varied, and evolving fact patterns,” the IRS said. “Some have suggested that these standards need to be revised. As these discussions occur, and despite the limitations described [in the report], the study provides important information.”

In a statement, Sen. Charles E. Grassley, Republican of Iowa, said he was “disappointed that the IRS didn’t provide guidance to the hospitals on how to define community benefit and uncompensated care, so the numbers are likely to be overstated in some cases.”

Mr. Grassley, the senior Republican on the Senate Finance Committee, said he was also disappointed that the study does not include data on for-profit hospitals’ level of uncompensated care and other community benefits and compensation. “That information is necessary to understand how nonprofits are different from for-profits,” he said. “I intend to ask the IRS to conduct a study like that so we’ll have a full picture.”

Mr. Grassley said that “neither the IRS nor Congress has done a very good job when it comes to establishing the criteria” for nonprofit hospitals since the IRS adopted the community benefit standard in 1969. That standard modified an earlier IRS ruling that based the tax-exempt status of hospitals primarily on the provision of charity care.

“The Treasury Department could do a lot of good, and probably more quickly than Congress, by re-establishing those charity-care requirements,” said Senator Grassley. “And if it looks like that can’t get done, then Congress will have to step in.”