Physician Loans: Getting the Right (Financial) Balance

Healthcare

Physician Loans: Getting the Right (Financial) Balance

Hospitals often provide loans to their employee physicians as part of a recruitment and retention process. Additionally these loans are used to further the exempt purpose of the Hospital by establishing community based medical services in the Hospital’s Primary Service Area. These loans are typically structured with below market interest rates and/or provisions for forgiveness if certain performance targets are met. There are a number of operational and accounting issues that hospital CFO’s and finance executives should be aware of when working with their physicians.

When dealing with loans with the characteristics described above (hereinafter “Physician Loans”) a CFO should first consider its classification on the Hospital’s balance sheet. If the provisions of the loan require the physician to provide a specified level of service in exchange for the forgiveness of payments, then clearly, the loan should be classified as a prepaid cost with the cost amortized as the physician fulfills their obligation.

But what if the provisions of the loan are simply to further the exempt purpose of the Hospital, that is to assist physicians to set up healthcare offices in the local community?

In this case it is important to review the relevant provisions of the agreement. Typically a Physician loan expected to be repaid, will have a provision for interest income earned by the hospital for the time value of money advanced. This is a good indicator of classification on the Hospital’s balance sheet as a note receivable. In some instances, the physician can earn forgiveness of the loan if certain contractually defined covenants are met. This too, is a good indicator of classification on the Hospital’s balance sheet as a note receivable.

Once you have reviewed the contracts and have determined that a Physician loan qualifies as a receivable, it must be evaluated for collectability. Accounting Standards Codification 310-10-35 (“ASC 310”) provides guidance for accountants in evaluating notes for impairment. A note receivable is considered impaired if it is probable that the lender will be unable to collect at least some of the scheduled principal and interest payments due under the contractual terms of the loan agreement. When a note receivable is considered impaired, you should use one of the following methods to determine the amount of the loan loss.

Now that we have considered the basic accounting and financial reporting aspects of a Physician Loan, the CFO should consider the tax and cost reporting for these types of transactions.

  • Discounted Expected Future Cash Flows.
  • The Fair Value of the Collateral.
  • The Market Value of the Note Receivable.
  • Aggregate Collection Experience.

The discounted expected future cash flows method is the easiest to apply in practice in determining impairment of loans to physicians as the payment streams are usually measurable at the time you determine collectability is in question. The remaining methods are not easily measurable since the parties involved can arbitrarily determine fair value, market value and aggregate collection experience.

If the discounted expected future cash flow of the note receivable is less than the contractual value of the note receivable, the Hospital should record a valuation allowance and a corresponding charge to bad debt expense. The valuation allowance should be adjusted periodically based on the hospital’s reporting schedule, but no less frequently than annually.

Then there is the issue of recognition of interest income on an impaired loan. While there is no specific guidance in ASC 310 on the recognition of interest, it does require disclosure of the Hospital’s policy for recognizing interest income on impaired notes including how cash receipts are recorded. Physician loans with valuation allowance for un-collectability fall under the guidance of this accounting provision.

Now that we have considered the basic accounting and financial reporting aspects of a Physician Loan, the CFO should consider the tax and cost reporting for these types of transactions. First, the physician should be made aware that any payment concessions made by the Hospital in such arrangements will result in taxable income to the physician. Any principal and interest forgiven by the Hospital must be reported on form 1099. The Hospital should also consider how the interest income should be reported on the Medicare cost report. In a provider reimbursement review board decision, physicians may be considered related parties, in which case, interest income recorded by the Hospital should be offset with interest expense. As a general rule, interest expense on a loan from a related party is non-allowable under Medicare regulations.

Of paramount importance to consider then is how the physician loan as a recruitment vehicle complies with the provisions of the federal physician self referral law (hereinafter “Stark Laws”). Payments received from Medicare for patients referred under an agreement that is in violation of Stark Laws, could be denied. Monetary penalties could also be imposed in the event of non-compliance. Many New Jersey Healthcare institutions are heavily reliant on reimbursements from Medicare and likely could not afford to lose funding as a result of non-compliance. In order for an institution to be in compliance, management should ensure that physician loans qualify for the recruitment exception under the Stark Laws. There are four criteria the arrangement needs to meet to qualify for exception.

  1. The recruitment agreement must be in writing and signed by all parties.
  2. The recruitment agreement must not be conditioned on receiving referrals.
  3. Remuneration cannot be directly or indirectly related to the volume of actual or anticipated referrals.
  4. The physician cannot be limited to where they can refer Medicare patients.

The legal matters associated with the Stark Laws are fairly complex. We recommend that any healthcare organization with loans to physicians consult legal counsel for an opinion on compliance with the provisions of the Stark Laws prior to finalizing the agreements.

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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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