IRC § 501 (r) Developments and the Importance of Compliance Programs

This article previously appeared on Manatt, Phelps & Phillips' Health Update and is republished here with permission. It was co-authored by Harvey Rochman, Partner, Litigation and Steve Chiu, Associate, Manatt Health.

The Internal Revenue Service (IRS) has moved aggressively to ensure that tax-exempt hospitals are complying with financial assistance, billing and collection requirements under the Affordable Care Act (ACA). The IRS reported earlier this year that it had trained auditors, commenced compliance reviews of thousands of tax-exempt hospitals and initiated field examinations where it found evidence of noncompliance. Accordingly, tax-exempt hospitals should take stock of their efforts to comply with Section 501(r) with an emphasis on the sufficiency of their practices and procedures to ensure compliance. These practices and procedures are the key to avoiding, and reducing the significance of, violations which will inevitably occur in complex revenue cycle operations.

What Is Section 501(r) of the Internal Revenue Code (IRC)?

Enacted as part of the ACA, Section 501(r) of the Internal Revenue Code (IRC) establishes a national scheme governing the financial assistance, billing and collection practices of hospitals exempt from taxation under IRC § 501(c)(3), including government hospitals with dual tax-exempt status. Although Section 501(r) contains only a few broad and apparently simple provisions, the associated regulations first proposed by the IRS in 2012 and finalized on December 31, 2014, establish a detailed and far-reaching legal framework requiring new policies and procedures, many changes to common revenue cycle practices and substantial new compliance obligations.

The significance of the obligations imposed by Section 501(r) has been underestimated. For example, the final regulations not only require new policies and procedures, but also require hospital organizations to identify, correct and in many cases publicly disclose errors implementing the law and hospital policies. This includes the errors of revenue cycle vendors and subvendors for which the hospital is responsible. Failure to comply may result in audits, investigation, required corrections, public disclosure of violations and potentially loss of a hospital's tax-exempt status. Moreover, in order to receive credit for correcting and disclosing a violation, which can reduce the seriousness of the violation, the violation must be identified and the correction and disclosure process started before the IRS itself discovers the violation.

These federal laws do not displace other federal laws, such as the Fair Debt Collection Practices Act, or preempt existing state laws, such as California's Hospital Fair Pricing Policies and New York's Patient's Financial Aid Law. Rather, tax-exempt hospitals must develop policies and procedures that mesh federal and state laws, and they must comply with the strictest applicable legal requirements.

The IRS Continues to Prioritize ACA Oversight and Compliance with Section 501(r).

While some have hoped that the IRS would retract or reduce the impact of the litany of specific requirements laid out by the regulations or further delay compliance deadlines, that has not happened.¹ To the contrary, in 2016:

• The IRS has failed to extend compliance deadlines associated with its Section 501(r) regulations—which have now passed for virtually all tax-exempt hospitals.
• In February, even before many of the compliance deadlines mentioned above, the IRS announced that it had assembled a list of hospitals that appear to be out of compliance, based on reviews of hospital policies (which must be posted on hospital websites) and hospital tax filings on Schedule H to IRS Form 990. It also announced that it was beginning to train roughly 30 agents to conduct in-depth hospital field examinations and would soon begin these examinations.
• In June, the IRS reported to Senator Grassley that it had completed 2,482 compliance reviews for 2014-2016 and had referred 163 hospital organizations for field examinations, some of which were under way at that time.
• In September, the IRS Tax Exempt and Government Entities Division issued its fiscal year 2017 Work Plan which continued to emphasize that ACA oversight and compliance with Section 501(r) would be a significant priority.

Notably, a hospital review also may be instigated by a consumer complaint through the IRS's established process for submission of complaints about tax-exempt organizations. In February, the IRS noted that it would take into consideration any complaints it receives in connection with its decision to refer hospitals for field examinations.

Hospitals Must Ensure They Have Robust Compliance Programs.

Given the extensive regulatory framework, the significant ramp-up in enforcement activity, and the significant work required to establish a legally sufficient compliance program, tax-exempt hospitals should now confirm that they are in compliance with the key provisions of 501(r),² but even more importantly, they must ensure that they have a robust compliance program including procedures that (i) are reasonably designed to promote and facilitate compliance with Section 501(r) and (ii) will allow hospitals to identify, correct and disclose violations of Section 501(r) and the hospital policies adopted to comply with Section 501(r).

The 501(r) regulations make clear that, in addition to helping prevent violations, strong compliance practices and procedures are essential to reducing the legal impact of violations that will inevitably occur in complex revenue cycle operations. Under the 501(r) framework, there are three types of violations: (1) minor omissions or errors requiring correction, but not disclosure; (2) excusable failures that must be corrected and disclosed to the IRS; and (3) inexcusable failures that must be corrected and disclosed but also threaten a hospital organization's tax-exempt status. The regulations make it clear that procedures designed to ensure compliance and a compliance program that allows for the identification, correction and disclosure of errors before the IRS discovers any issues are critical to establishing that any errors are minor or excusable and thus central to avoiding the serious consequences of inexcusable failures.

The Distinction Between Minor and Serious Violations Depends Largely on Compliance Practices.

The relatively few examples provided by the IRS in the final regulations and related revenue procedures establish that the category of "minor" violations is fairly limited (e.g., a required posting falling off a hospital wall and being rehung) and that many violations will fall into the more serious categories which require both correction and disclosure. More importantly, in the absence of intentionally wrongful conduct, the crucial distinction between these violation types depends largely on the organization's compliance practices and procedures.

For example, the IRS regulations state that the existence of meaningful procedures reasonably designed to promote and facilitate compliance with Section 501(r) is a key factor in determining that a violation constitutes a "minor omission or error" that must be corrected but need not be disclosed. Additionally, the IRS decision to classify a failure as "excusable" versus "inexcusable" is also based significantly on whether a facility has established 501(r) compliance practices and procedures and whether those practices and procedures were routinely followed. In fact, of the nine factors that the IRS has stated that it will consider when deciding whether a failure to meet 501(r) requirements justifies revocation of a hospital organization's tax exemption, eight either expressly require a hospital organization to maintain an established compliance program or involve examination of the functions of such program (e.g., early detection and correction of violations, measures to prevent recurrence of compliance errors).

The legal consequences of noncompliance can be severe. For inexcusable failures, the IRS may revoke a hospital or hospital organization's tax-exempt status. Even for excusable failures (i.e., those failures that are not willful or egregious), a hospital organization will be required to correct and publicly disclose such failure to the IRS, which may review, conduct intensive field examinations (during which the IRS may investigate any compliance errors, even if unrelated to the 501(r) failure at issue), and require further corrective actions. Additionally, the scrutiny on a hospital that arises from disclosure may lead to media inquiries, government investigations and, potentially, litigation from consumer attorneys.

Conclusion

Given the IRS's current actions and the complex obligations established by Section 501(r), hospitals should ensure that they have a robust compliance program in place which will allow the hospital to limit violations, identify them when they occur, and provide the hospital with the resources to appropriately correct and disclose the violations. Hospitals must also ensure that their contracts with billing and collection vendors include essential terms prescribed by the 501(r) regulations and provide the hospitals with the rights and resources necessary to comply with Section 501(r).

_{¹Unlike other provisions of the ACA that drew strident objections from Republican lawmakers, the ACA provisions enacting Section 501(r) were coauthored by Republican Senator Charles Grassley and did not appear in the most recent Republican attempt to repeal portions of the ACA (H.R. 3762—114th Congress (2015-2016)).}

_{²These include provisions related to Community Health Needs Assessments and associated implementation strategies, the establishment of financial assistance and emergency medical care policies, numerous publication and notice requirements related to such policies, calculation methodologies limiting maximum charges to those eligible for financial assistance, billing and collection timelines, reasonable efforts to determine whether a patient is eligible for financial assistance, and restrictions on extraordinary collection actions taken by hospitals to collect patient debt.}