WASHINGTON - The Treasury Department and the Internal Revenue Service have released final regulations that make clear that most failures to meet certain requirements created by the Affordable Care Act won't hurt the tax-exempt status of nonprofit hospitals' bonds.
The final regulations for charitable hospitals were published in the Federal Register Wednesday and are similar to regulations that had been proposed. Bond and tax lawyers said they think the regulations are helpful.
The final regulations became effective Dec. 29, though hospitals can continue to rely on regulations proposed in 2012 and 2013 until their first taxable year starting after Dec. 29, 2015.
The Patient Protection and Affordable Care Act added section 501(r) of the Internal Revenue Code. This section includes more requirements that charitable hospital organizations - or entities that have or seek to have 501(c)(3) status - are supposed to follow in order to keep those tax-exempt statuses. Bonds issued for 501(c)(3) organizations can become taxable if the organizations for which they are issued lose their tax-exempt statuses.
One of the requirements under section 501(r) is that a hospital organization needs to conduct a community health needs assessment at least once every three years and adopt a strategy to meet the health needs identified by the assessment. Another requirement is for a hospital organization to have written policies relating to financial assistance and emergency medical care.
Hospital organizations operate one or more "hospital facilities," which are facilities that have state licenses or similar recognition. Each facility needs to be in compliance with the requirements of section 501(r) at the facility level.
The regulations provide circumstances when Treasury and the IRS will excuse omissions of required information or errors in implementing the requirements. They generally allow "reasonable noncompliance" without jeopardizing the tax-exempt status of bonds, said Christopher Jones, a tax lawyer at Ballard Spahr in Philadelphia.
Treasury and the IRS will not view an error or omission as a failure to meet the requirements of section 501(r) if the error or omission was minor and either inadvertent or due to reasonable cause, and the facility promptly corrected the mistake. The regulators will also excuse a facility's error if it is "neither willful nor egregious," and the facility corrects and discloses the mistake, according to the regulations.
If a facility makes an error or omission and the regulators will not excuse it for those two reasons, the IRS will look at the facts and circumstances when determining whether the hospital organization's 501(c)(3) status should be revoked.
In instances where a hospital organization only operates one hospital, that facility's compliance with the section 501(r) requirements determines whether the organization keeps its tax-exempt status. If errors are excused, then the organization's 501(c)(3) status will remain intact, and its 501(c)(3) bonds will not be affected, said Lauren Mack, a Chicago-based lawyer with her own firm.
In cases where a hospital organization operates multiple facilities, the organization will not lose its 501(c)(3) status if one of its facilities is noncompliant with the requirements. However, if the organization continues to keep its 501(c)(3) status, but would not do so if the noncompliant facility was the only hospital facility the organization operated, the organization would be taxed on income derived from the noncompliant facility.
Under the regulations, this tax would not affect the tax-exempt status of bonds whose proceeds were used to finance the noncompliant facility. Specifically, the tax would not cause the noncompliant hospital facility to be an "unrelated trade or business" of the organization. Under federal tax law, facilities that are unrelated trade or business are deemed to be private business use, and 501(c)(3) bonds are not tax exempt if more than 5% of their proceeds is used for private business use and more than 5% of their debt service is paid for or secured by private parties.
Regulations proposed in 2013 mentioned that the tax would not affect the tax-exempt status of bonds, and the final regulations add the part relating to "unrelated trade or business" in response to numerous comments to the proposed rules.
Lawyers said they liked the fact that the tax would not affect bonds.
"I believe it is both the correct policy result and the result that is consistent with the tax code," said Dave Caprera, an attorney at Kutak Rock in Denver.
Not treating the tax as an unrelated trade or business activity for bond purposes was likely the intent of the proposed regulations, but "the final regs make it very clear," Jones said.
Elizabeth Walker, a lawyer at Hall, Render, Killian, Heath & Lyman in Indianapolis, said that preventing bonds from being hurt by the tax makes sense in circumstances where the help would apply.
"Hopefully it's a very uncommon fact set," she said.
Clifford Gerber, a tax partner at Sidley Austin in San Francisco, said it's particularly important that the final regulations, like the proposed regulations, provide that hospital organizations that operate multiple facilities will not lose their 501(c)(3) status due to a noncompliant facility. Language in the tax code suggests that 501(c)(3) status could have been lost. As a result, without the regulations, bond-financed property at the site of a noncompliant hospital facility could be treated as owned by an organization without 501(c)(3) status, Gerber said. The bonds could then become taxable, since under federal tax law, all 501(c)(3) bond-financed property has to be owned by a 501(c)(3) organization or a governmental unit.
Mack said that there was a concern about how the section 501(r) requirements "would have a ripple effect on the bonds." The IRS tried to make it clear that as long as an organization doesn't lose its 501(c)(3) status, there will be no impact on bonds.
