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Internal Revenue Service 501(r) — Did You Know?

Lyman Sornberger
President and CEO, LGS Health Care and
Chief Healthcare Strategy Officer, Capio Partners, Cleveland, OH

 On December 31, 2014, the Internal Revenue Service (IRS) published the long-awaited final regulations implementing the Affordable Care Act (ACA) requirements for tax-exempt hospitals.

The ACA added new Internal Revenue Code (IRC) section 501(r), which describes criteria hospital organizations must meet to be recognized as exempt from federal income tax under Code section 501(c)(3). The regulations apply to organizations that operate one or more facilities that are required to be licensed or registered as hospitals under applicable state law. Organizations that operate multiple hospitals must meet the requirements with respect to each licensed hospital, even if multiple hospitals operate in the same building. The final regulations also clarify that separate buildings operated under the same license are treated as a single hospital.

Regardless of the complexity or specific standards needed to be met, understanding new legislation and how to implement the regulations is a daunting challenge. This Did You Know? article generalizes key components that hospitals need to be aware of when employing 501(r).

Did You Know: You’re not required to include the plain language summary in each billing statement? Under 501(r) (6), you’re required to provide the plain language summary at least 30 days before initiating extraordinary collection actions (ECA) against a consumer. Written notices are required to include a statement that indicates financial assistance is available for eligible individuals. Also, notices must identify the ECA(s) the hospital intends to initiate and states a deadline after which such ECA(s) may be initiated. No ECA can be initiated any earlier than 30 days after the date the written notice is provided. Why not share the notice on your website as a proactive action and promote having patients make an early payment. This strategy will enhance the patient experience.

Did You Know: You still have flexibility to set the parameters of eligibility for your financial assistance policy (FAP) at your hospital? As 501(r) changes occur you may see your charity care decrease as consumers move to high-deductible plans-in the short term. If your FAP doesn’t cover this and you experience significant uncollected amounts, it could cause an increase in bad debt and decrease in your charity care. In states with expanded Medicaid, hospitals could also see a decrease in charity care and an increase in Medicaid shortfall.

Together, these two factors could significantly reduce charity care in some hospitals. You should understand how 501(r) can affect your not-for-profit status if you cover the under-insured [those with insurance] population today. Regardless of a change in your operating process or complying with new regulations, the patient experience must always be a consideration.

Did You Know: A hospital facility may (but is not required to) use a definition of “medically necessary care” applicable under the laws of the state in which it is licensed, including the Medicaid definition, or a definition that refers to the generally accepted standards of medicine in the community or to an examining physician’s determination?

How is Medical Necessity defined? The American College of Medical Quality defines medical necessity as accepted healthcare services and supplies provided by healthcare entities, appropriate to the evaluation and treatment of a disease, condition, illness or injury and consistent with the applicable standard of care. Appropriate services and supplies are those that are neither more nor less than what the patient requires at a specific point in time.

Determinations of medical necessity must adhere to the standard of care and treatment of the patient. It is the standard terminology that all healthcare professionals use in a review process when determining if medical care is appropriate and essential and must be unrelated to payers’ monetary benefit.

Did You Know: All 501(r) policies must be approved by an authorized body of the hospital facility? “Authorized body” is defined as the governing body of the hospital organization that operates the hospital facility or a committee of, or other party authorized by that governing body to the extent such committee or other party is permitted under state law to act on behalf of the governing body. What personnel are included in your authorized body? Typically committees handling the responsibilities for this requirement include the CEO, CFO, Nursing Officer, Compliance Leader, Revenue Cycle top executive and other stakeholders as necessary.

Did You Know: The preamble to the final regulations states the following: “The 2012 proposed regulations and the final regulations refer only to refunds of payments ‘for the care’ at issue and are intended to require refunds only of payments for the episode(s) of care to which an individual’s Financial Assistance Policy (FAP) application (and therefore his or her FAP-eligibility determination) relates? Thus, if an individual receives and pays for a hospital facility’s care in both year one and year two but only applies for financial assistance in year three for care received in year three and is determined to be FAP-eligible for the care provided in year three, the hospital facility would only have to refund any excess amounts the individual paid for during year three care, not any amount the individual paid for the year one care.”

Did You Know: While there’s no risk you would actually charge a patient more than amounts generally billed (AGB) when providing a 100 percent discount, the IRS doesn’t provide an exception to computing AGB and providing the results of the computation in your FAP? A hospital still has flexibility to offer a variety of discounts as long as the discounts all result in charges less than AGB. For instance, if you calculated AGB at 55 percent (which means you typically collect 55 cents on every dollar of gross charges), you could offer discounts of 100 percent, 80 percent, 60 percent and 50 percent at varying levels of FPG and still be in compliance. You are permitted to take the AGB adjustment to “charity.” Any additional adjustment above the collection rate is considered to be a hospital courtesy. Did You Know: If an individual doesn’t meet the criteria of your FAP, that individual isn’t eligible for financial assistance and the 501(r) regulations don’t apply? Keep in mind that patients with balances due (self-pay) aren’t necessarily eligible for financial assistance in most instances. Section 501(r) doesn’t apply to a self-pay patient who doesn’t apply or meet “presumptive eligibility” criteria for financial assistance.

Did You Know: The IRS final regulations (Section 1.501(r)-6(c)(5))(i) stipulate, in general, that with respect to any care provided by a hospital facility to an individual, if an individual submits an incomplete FAP application during the application period, the hospital facility will have notified the individual about how to complete the FAP application and given the individual, a reasonable opportunity to do so for purposes of paragraph (c)(3)(ii) of this section only if the hospital facility? In addition the hospital must:

    • Suspend any ECAs to obtain payment for the care as described in paragraph (c)(8) of this section;
    • Provide the individual with a written notice that describes the additional information and/or documentation required under the FAP or FAP application form that must be submitted to complete the FAP application and that includes the contact information; and
    • Make a reasonable effort to orally notify the individual about the hospital facility’s FAP and
    • about how the individual may obtain assistance with the FAP application process.

Did You Know: The IRS doesn’t provide an exception to computing AGB and providing the results of the computation in your FAP? Typically, the two method options are a retrospective and prospective calculation.

Did You Know: A hospital may send an individual’s debt to a debt collection agency or other party to collect amounts owed by the individual to the hospital while still maintaining ownership of the debt, and if adverse information isn’t reported to consumer credit reporting agencies or credit bureaus?

Did You Know: That you can set a patient up on a temporary payment arrangement pending FAP approval as long as any excess payments are refunded upon FAP eligibility determination?

Did You Know: The pertinent section of the regulations sited below is Section 1.501(r)-6(c)(4)? Paragraph (A) discusses the written notice and paragraph (B) discusses the required plain language summary.

(i) In general. With respect to any care provided by a hospital facility to an individual and except as provided in paragraph (c)(4)(iii) of this section, a hospital facility will have notified an individual about its FAP for purposes of paragraph (c)(3)(i) of this section only if the hospital facility does the following at least 30 days before first initiating one or more ECA(s) to obtain payment for the care:

(A) Provide the individual with a written notice that indicates financial assistance is available for eligible individuals, identifies the ECA(s) that the hospital facility (or other authorized party) intends to initiate to obtain payment for the care, and states a deadline after which such ECA(s) may be initiated that is no earlier than 30 days after the date that the written notice is provided.

(B) Provide the individual with a plain language summary of the FAP (as defined in §1.501(r)-1(b)(24)) with the written notice described in paragraph (c)(4)(i)(A) of this section (or, if applicable, paragraph (c)(4)(iii) of this section).

(C) Make a reasonable effort to orally notify the individual about the hospital facility’s FAP and about how the individual may obtain assistance with the FAP application process.

Those stakeholders who are charged with implementing 501(r) have a big responsibility to follow the law. And, if the regulations are introduced incorrectly there will be grave consequences for the hospital or health system.

IRS can revoke the tax-exempt status of organizations that fail to meet the requirements of section 501(r) and the final regulations with respect to their hospital facilities. In determining whether to revoke exemption, the IRS considers all relevant facts and circumstances, including: 

  • Prior failures to satisfy section 501(r); 
  • Nature, size and significance of the failures;
  • Significance of the facilities that failed to meet the requirements; 
  • Reason for the failures; § Establishment and implementation of policies to facilitate compliance; and
  • Efforts to correct and prevent failures.

The IRS will not revoke tax exemption because of minor errors or omissions in policies that are inadvertent or due to reasonable cause as long as they are corrected promptly after the organization discovers them. That said the compliance of the regulations should be carefully and thoughtfully implemented and maintained. There is a lot at stake for hospital executives or the authorized body of the organization for not following 501(r). Losing not-for-profit status is akin to a hospital death sentence. 

Lyman Sornberger, President and CEO for LGS Health Care and Chief Healthcare Strategy Officer for Capio Partners. Prior to his roles at LGS Health Care and Capio Partners, Sornberger was the Executive Director of Revenue Cycle Management for Cleveland Clinic Health Systems (CCHS) from 2006–2012. This role comprised of the Revenue Cycle Management for all 11 Cleveland Clinic Health Systems Ohio and Florida Hospitals and 1,800 Foundation Physicians. His responsibilities included all CCHS Patient Access Services, Health Information Management and Billing. Prior to his affiliation with CCHS Mr. Sornberger was with the University of Pittsburgh Medical Center for 22 years as a leader in revenue cycle management. Sornberger is a graduate from the University of Pittsburgh with a BS and a Masters Degree in Business. He can be reached at 216-337-4472 or This email address is being protected from spambots. You need JavaScript enabled to view it..

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