Guidance for Hospitals that Fail to Comply with IRC §501(r) Requirements

Guidance for Hospitals that Fail to Comply with IRC §501(r) Requirements

Background

IRS Notice 2014-3, which was released by the IRS on December 30, 2013, contained a proposed Revenue Procedure that provided correction and disclosure procedures under which certain failures to meet the requirements of IRC §501(r) will be excused for purposes of IRC §501(r)(1) and §501(r)(2)(B). The proposed IRC §501(r) regulations provided that errors or noncompliance with IRC §501(r) that are determined by the IRS to be non-willful and/or non-egregious will be excused if the error or noncompliance is corrected and disclosed in accordance with the guidance outlined.

Tax-exempt and government hospitals were subject to the statutory requirements of IRC §501(r)(4) through IRC §(r)(6) for tax years beginning after March 23, 2010. IRC §501(r)(3) applies to tax years beginning after March 23, 2012. As noted in the Revenue Procedure, a hospital facility’s omission of required information from a report or policy described in IRC §501(r)(3) or IRC§501(r)(4), or error with respect to the implementation or operational requirements described in IRC§501(r)(3) through IRC§501(r)(6) will not be considered a failure to meet a requirement of the regulations if the following two conditions are met:

1. The omission or error was minor and either inadvertent or due to reasonable cause; and
2. The hospital facility corrects the omission or error as promptly after discovery as is reasonable given the nature of the omission or error.

The Revenue Procedure goes on to state that “For purposes of this provision, correction must include the establishment (or review and, if necessary, revision) of practices or procedures (formal or informal) that are reasonably designed to promote and facilitate overall compliance with the §501(r) requirements”.

Regulation Changes

After taking into consideration comments received in response to IRS Notice 2014-3, the Treasury Department and IRS made nine changes to the proposed Revenue Procedure included in IRS Notice 2014-3. Several of these changes are outlined below.

The Revenue Procedure clarifies that any failure to meet the requirements of IRC §501(r)(3), that does not meet the requirements to be deemed to be minor or inadvertent, will result in an excise tax being imposed on the hospital facility under IRC §4959.

The Revenue Procedure clarifies that certain minor omissions and errors that are described in and corrected in accordance with Treasury Regulation §1.501(r)-2(b) are not considered failures to meet a requirement of IRC §501(r) and are therefore outside the scope of the Revenue Procedure.

In addition, the Revenue Procedure clarifies that “an egregious failure includes only a very serious failure, taking into account the severity of the impact and the number of affected persons, and that a hospital facility’s correction and disclosure of a failure is a factor tending to show that the failure was not willful”. In determining whether a failure is either willful or egregious, the IRS will take into consideration all of the facts and circumstances. A hospital facility’s correction and disclosure (discussed below) of a failure(s) of this type will be taken into account by the IRS in evaluating whether or not the failure was willful in nature.

The Revenue Procedure deleted the requirement included in IRS Notice 2014-3 to provide a description of the discovery of the failure.

For those errors that are deemed to be minor and inadvertent, a hospital facility is not required to use the correction procedures outlined in the Revenue Procedure. For these types of errors that are inadvertent and due to reasonable cause, it will suffice if the hospital facility makes all of the necessary corrections.

Correction Procedures

Under Treasury Regulation §1.501(r)-2(c), a hospital facility’s failure to meet the requirements of Treasury Regulation §1.501(r)-3 through §1.501(r)-6, that is neither willful nor egregious, shall be excused if the hospital facility corrects and makes disclosure in accordance with the rules set forth by revenue procedure, notice or other guidance published in the Internal Revenue Bulletin. The Revenue Procedure sets forth the following four specific criteria that must be met when making corrections to any error that is not deemed to be minor in nature:

1. Restoration of affected individuals. Corrections should be made, to the extent reasonably feasible, with respect to all affected individuals and should restore the affected individuals to the position in which he or she would have been had the failure not occurred. This is regardless of whether the error occurred in the current or prior years. Additionally, for any FAP-eligible individuals that paid more than owed, refunds are not required to be issued by the hospital facility if the excess payment was less than $5.
2. Reasonable and appropriate correction. The hospital facility should determine a correction which is reasonable and appropriate for the particular failure. Depending upon the particulars of the situation, there may be more than one reasonable and appropriate correction.
3. Timing. The hospital facility should make the necessary correction as promptly after discovery as is reasonable given the nature of the failure.
4. Implementation/modification of safeguards. A hospital facility that has not established practices or procedures, whether formal or informal, should do so as part of its correction process. If it already has established procedures, the hospital facility should evaluate whether changes are needed to reduce the likelihood of the same failure recurring and correction of such failure in case it would occur. Additionally, such practices and procedures should be evaluated by the hospital facility to determine whether or not they are designed to promote and facilitate the hospital facility’s compliance with IRC §501(r)(3) through §501(r)(6) requirements.

Disclosure Procedures

The following disclosure procedures apply to hospital facilities that file a Form 990, Return of Organization Exempt from Income Tax. A failure is disclosed, for purposes of the Revenue Procedure, only if the hospital facility reports certain information on its annual Form 990. In the case of multiple errors, the information should be reported in aggregate. The Revenue Procedure specifies that the disclosure of the failure must include:

1. A description of the failure, including the type of failure; the cause of the failure; the hospital facility or facilities where the failure occurred; the date(s) of the failure and its discovery; and the number of occurrences;
2. A description of the correction of the failure, including the method and date of correction; and, if applicable, a description of how affected individuals were restored to a position that they would have been in had the failure not occurred;
3. If applicable, a statement as to why one or more individuals affected by the failure to meet the requirements of IRC §501(r)(3) through §501(r)(6) for which restoration was not reasonably feasible; and
4. A description of the practices and procedures, if any, revised or newly established by the hospital facility to minimize the likelihood of the type of failure recurring and to facilitate the prompt identification and correction of any such future failures that do occur, or, if not revising previously existing practices or procedures to minimize such likelihood, an explanation of why no changes in practice or procedures were necessary.

For those hospital organizations that are not required to file a Form 990, the Revenue Procedure states that, in order to be compliant with the disclosure requirements listed above; the hospital facility may either (1) file a Form 990 for the tax year and make the necessary disclosures or (2) make all information pertaining to the disclosures available on a website. If the organization chooses to make the necessary disclosure information available on a website, it must do so by the due date of its Form 990 for the tax year had the hospital organization been required to file one.

Additional Scope Matters

The Revenue Procedure provides that a hospital facility that has been contacted by the IRS concerning an examination may use the provisions of the Revenue Procedure to correct and disclose a failure only, if at the time the organization is first contacted by the IRS:

1. The hospital facility has corrected, or is in the process of correcting, the failure in accordance with the procedures; and
2. The due date for the annual return for the year in which the failure was discovered has passed and the hospital facility has already disclosed the failure in accordance with the procedures.

Conclusion

The modifications and clarifications contained within the Revenue Procedure were effective immediately upon its release on March 10, 2015. Hospital facilities should become familiar with the elements contained in the Revenue Procedure in determining the potential correction and disclosure procedures that could potentially be required to avoid any applicable excise taxes.

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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.