Hospitals represent one of the largest industries in the U.S., with revenues greater than $1.4 trillion. The American Hospital Association reports that there are 5,200 nonfederal, short-term general, and other special hospitals in the country, of which 3,000 are non-for-profits (NFPs), 1,300 for-profits (FPs), and about 1,000 state and local government organizations. About 60% of community hospitals are NFP entities and managed by a community board.
People use 501(c)(3) and NFP terms interchangeably, which they are not. The former are recognized by the Internal Revenue Service (IRS), a federal agency, as being tax-exempt because of their charitable programs under the tax code. Section 501(c)(3) of the code authorizes tax exemption for NFP organizations pursuing charitable, religious, educational or scientific missions. An NFP is usually organized as a corporation and designated as such by the state. NFP status does not automatically confer tax exemption.
Though not that many NFPs do not do so, but FPs must run lean, efficient organizations since they are also focused on providing a return on investment. Because they are tax-exempt, NFPs pay no tax on net income, state and local corporate income taxes, local property taxes, and sales tax on their purchases. These are taxable events for FPs. NFPs do not have shareholders and do not pay dividends, whereas FPs may do so. NFPs contend that they do generate taxable revenue through the likes of payroll taxes and taxes from non-patient care.
IRS
There are regulations common to all hospitals, but some apply only to 501(c)(3) and NFP hospitals. The IRS requires hospitals to report and describe “community benefits” as a percentage of hospital expenses. The tax benefits for NFPs in relation to providing community benefits hinge on an “open medical staff and ER [emergency room], regardless of ability to pay; community board of directors; caring for all patients covered by Medicare and Medicaid or ability to pay; and using surplus funds to maintain facilities, equipment and patient care, [and] advance medical training, research and education.”1
The IRS also requires all hospitals to file Schedule H of Form 990 and, though not required, to self-report compliance with “community benefits” activities every three years. However, there are no specific rules or definition of community benefit activities.
Should NFPs be required to provide community benefits in proportion to their tax-exemption benefits? This view recently gained favor after a study concluded that NFP hospitals do not provide more free care than other types of hospitals, and sometimes even less care than FP or government hospitals.2
How much benefit to hospitals is there?
A recent report suggested that 2,927 U.S. NFP hospitals received $37.4 billion in total tax benefits in 2021. These included “federal income tax ($11.5 billion; 31%), sales tax ($9.1 billion; 24%), property tax ($7.8 billion; 21%), state income tax ($3.7 billion; 10%), charitable contributions ($3.2 billion; 8%), bond financing ($2.1 billion; 6%), and federal unemployment tax ($200 million; <1%).”3 In 2020, a Senate committee reported that benefits averaged $9.4 million per hospital. Although some of the numbers may be flawed, the committee concluded that many of the largest NFP hospitals spend less than 2% of their total revenue on charity care. The Lown Institute Hospitals Index reported that 80% of NFP hospitals spent less on “financial assistance and community investment than the estimated value of their tax breaks.”4
The American Hospital Association declared that hospitals spent 15.5% of their total annual expenses in 2020 as benefits to the community, of which 6.9% was due to financial assistance and unreimbursed Medicaid and other programs.
Clearly, NFP and tax-exempt hospitals provide valuable and necessary services to the public, including funding critical research and revenue-losing inpatient programs such as behavioral health, nephrology, burns, pulmonology, and infectious diseases—often in inner city or rural communities where FP hospitals may not exist. Operating margins for NFPs have hovered between 1 and 3%.
Although hospital margins have been hit over the past few years, management consultants Kaufman Hall reported that, for the previous 12 months, hospital operating margins increased significantly. In April 2024, they went from <1% to 4.3% the previous month. This was primarily due to increasing volumes but also higher prices.
Compensation
Besides proportional community benefits, excessive compensation provided to senior NFP hospital executives is a major source of criticism. This is because the public accepts large sums for FP companies beholden to investors and shareholders, while the expectation for NFPs is the opposite.
On average, NFP hospital CEOs earn about $700,000, exceeding by $300,000 the salaries of university presidents. The Senate report stated that “in 2021, the most recent year for which data is available for all of the 16 hospital chains, those companies’ CEOs averaged more than $8 million in compensation and collectively made over $140 million.”
Excessive compensation for NFP hospital board members is also a concern. As an ex-officio board member at a large health system for four years in the early 1990s, little or no compensation was offered, even though we dedicated many hours before, during and after each board or sub-committee meeting. Most board members are productive citizens and own important businesses or have often high-paying jobs. Compensation for NFP board members has now become commonplace. The percentage of hospital boards offering cash compensation has doubled from 13% in 2018 to 27% in 2022, compared to only a 3% increase from 2014 to 2018. However, trustee compensation has sometimes been negatively associated with NFP hospital charity care provision. Even though board members, trustees and other insiders have a fiduciary responsibility towards the NFP entity, and are not permitted to benefit themselves or other insiders, my own experience is that, in many ways, they benefit from their presence and contacts.5
For-profit activities
Health systems are always looking for new revenue to subsidize losing service lines, new construction, ambulatory centers, administrative hiring, modern technology, litigation and the cost of new regulations. However, analysis of IRS data by Kaiser Health Network showed that NFP health systems “held more than $283 billion in stocks, hedge funds, private equity, venture funds and other investment assets in 2019.” Only 7% of their total investments were principally related to their nonprofit missions. The biggest concern is the substantial mergers and acquisitions of hospitals and physician groups by health systems and private equity investors.
Suggestions
There are several common-sense suggestions advanced by healthcare and legal experts. Congress needs to define exactly what constitutes community benefits to justify a hospital claiming NFP status. The Affordable Care Act required NFP hospitals to conduct community health needs assessments in their geographic area, which included seeking input from low-income, underserved areas. However, Congress did not take the next step and require hospitals to address these concerns. In addition, there are no precise and reasonable standards for what constitutes financial assistance to qualify under community benefits.
The IRS Form 990 listing filed by NFP hospitals lists, among other details, the community benefits they provide. This form is confusing and unclear, leading to partial and inexact data. For instance, hospitals often classify unreimbursed care for some patients as a bad debt expense, because many poor patients do not complete hospitals’ financial assistance processes. This form needs to be revised based on clarification of community benefits and standards for financial assistance. Form 990 could also report forgone federal, state and local taxes, as well as savings associated with using tax-exempt bonds, in the interests of complete transparency.
NFP hospitals are vital to healthcare delivery in the U.S. Tightening some regulations, clarification by Congress, and the recruitment of board members with a diversity of views and backgrounds6 will result in increased transparency and provide assurance to taxpayers that their hard-earned taxes are being used for the benefit of their communities.
References
- https://www.gao.gov/products/gao-23-106777
- Bai G, Zare H, Eisenberg MD, Polsky D, Anderson GF. Analysis suggests government and nonprofit hospitals’ charity care is not aligned with their favorable tax treatment. Health Aff (Millwood). 2021;40(4):629–636
- Plummer E, Socal MP, Bai G. Estimation of tax benefit of US nonprofit hospitals. JAMA. Published online September 26, 2024. doi:10.1001/jama.2024.13413
- https://lownhospitalsindex.org/hospital-fair-share-spending-2024/#system-deficit
- https://www.sanders.senate.gov/wp-content/uploads/Executive-Charity-HELP-Committee-Majority-Staff-Report-Final.pdf
- Satiani B, Prakash S. https://hospital-medical-management.imedpub.com/articles/%20it-is-time-for-more-physician-and-nursing-representation-on-hospital-boards-in-the-us.php?aid=9753
Bhagwan Satiani, MD, is an associate editor for Vascular Specialist. He is not an attorney.
