How much profit can non-profit hospitals make and be tax exempt?

September 16, 2013

I’ve been involved in a local community effort to downsize a large proposed hospital expansion in my tiny historic village, Rhinebeck, New York (population 2,657). It’s been very interesting because it exposes many of the issues that I’ve long studied and thought about. There is the broad issue of what level of profitability hospitals can have while still being tax exempt from property and corporate income taxes. There are issues around the levels of executive compensation. And most interestingly is the question of non-profit hospital being used as shells for profit-making entities. And what does all this do to their status as tax-exempt institutions?

The Illinois General Assembly studied the issue of setting some standards to determine if hospitals were operating as non-profits, but their hospital lobbying group derailed the legislation. The practice of sheltering for-profit activity is beginning to be studied because it reduces state and federal corporate income and property tax collections. Local governments generally rely on property taxes for 50 percent or more of general fund revenues and exempting hospitals from property taxes can place an enormous burden on taxpayers.

The Internal Revenue Service has been grappling with the issue of profitability and tax exempt status for non-profit hospitals. In its most recent study, in March 2013, it surveyed 500 nonprofit hospitals nationally to analyze the ratio of revenues to expenses to get some sense of profitability. The numbers varied but the IRS determined that profit or median excess revenue (operating revenues minus operating expenses) for hospitals with total revenue below $250 million was 3.8 percent (page 27):

Generally non-profit hospitals are not racking up huge margins nationally. In contrast, Rhinebeck’s hospital reported excess revenue of 13 percent for the second half of 2013 according to the corporate entity’s June Financial Executive Summary filed on EMMA:

Does this make Northern Dutchess Hospital a for-profit? No, not necessarily, but it highlights the issue of whether it should be considered tax exempt for property tax purposes. In Rhinebeck’s case, 33 percent of the proposed expansion is slated for for-profit doctors’ offices and it took me awhile to understand why the hospital would want to do this, as lease revenues would probably barely cover bond repayment costs. I discovered a growing trend among hospitals detailed by the Center for Public Integrity (emphasis mine):

Clinic facility fees have become a hot button issue as more Medicare patients seek care in hospital clinics, and as hospitals purchase medical offices and rebrand them as an arm of the hospital. That can result in patients seeing the same doctor in the same building, but suddenly being charged more because hospital facility fees are being added on, a practice that has been criticized by the Medicare Payment Advisory Commission and consumer groups.

CMS now allows from $56.77 to $128.48 for clinic visit facility fees and wants to replace that with a flat charge of $88.31.

So Northern Dutchess would incorporate “for-profit” doctors offices into the non-profit shell and gain the ability to charge patients and Medicare a “facility fee.” Bingo; instant cash flow. But critics are already attacking this practice. From the Center for Public Integrity again:

Dr. Kevin Kavanagh, a retired physician who heads Health Watch USA, a patient advocacy group based in Kentucky, said that CMS should be paying the same rate for a service “regardless of where it is performed.” He said many patients wind up paying twice as much for routine medical care because of a facility fee. “I don’t see any extra value in a hospital campus for the exact same service,” he said.

The deconstruction of the non-profit status of hospitals is increasing. It’s quite an experience to see it first hand.

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