Radiology groups should understand the tax implications of arrangements with hospitals before they begin negotiations, according to W. Kenneth Davis, Jr, JD. He presented Tax-exempt Laws and Radiology Groups: Myth Versus Reality on October 17, 2008, at Managing Legal Exposure in Radiology, a meeting held in Philadelphia by the RBMA. Davis, a partner in Katten Muchin Rosenman, Chicago, explains that using the wrong approach to joint ventures and contracts with tax-exempt hospitals can have highly undesirable consequences for a radiology group. Because there is so much misunderstanding of the 501(c)(3) tax exemption for hospitals, the radiology group should protect itself from unpleasant surprises by knowing the legal requirements imposed on hospitals and their effects on the physician groups that work with them.
W. Kenneth Davis, Jr, JD
As federal and state scrutiny of hospitals’ tax exemption becomes more intense, the need for caution in designing joint ventures and contracts will only increase, Davis says. The tax treatment afforded hospitals has never been questioned as often, or as closely, as it is today. The attorneys general of some states are investigating whether tax-exempt hospitals actually provide the community benefits on which their state tax exemptions are based. Davis adds that, at the federal level, influential legislators are trying to determine whether more uncompensated care should be required in exchange for hospitals’ federal tax exemptions.
Understandably, these trends have made hospitals highly aware of the need to protect their tax-exempt status. If it is threatened, they may lose not only the ability to avoid taxation of their income, but the chance to obtain charitable contributions; the donations on which many hospitals depend are unlikely to be made if the donors will not be granted any tax deductions for their gifts. In addition, hospitals often depend on tax-exempt bonds for access to capital.
If a hospital’s agreements with a radiology group have been structured with the proper attention to remaining above suspicion, exemption challenges can be avoided. If mistakes have been made in contracting, however, the hospital may be placed in a position where it can avoid penalties only at the expense of the radiology group—and that expense may be large, if the group cannot document the fair market value of its transactions with the hospital.
Davis points out the importance, in negotiations, of distinguishing between real legal issues and those that are actually business concerns that the tax-exempt hospital may present as legal problems related to tax exemption. The 501(c)(3) exemption requires the hospital to be operated for charitable purposes, to avoid political campaigning or substantial lobbying, to serve public (not private) interests, and to serve patients who are unable to pay, as well as all of those who are able to pay, including Medicaid/Medicare enrollees. Charitable purposes can include medical education, training, and research, in addition to health care. The hospital’s board must represent the community; its medical-staff enrollment must be open; and its profits must be used for patient care, facility improvements, and equipment, not private benefit.
Of course, a hospital would be unable to serve its charitable purpose unless it conferred some private benefit on others (it must, after all, usually work with employees and contracted service providers). The hospital’s earnings cannot, however, be distributed to individuals or groups or to those considered insiders (who are in positions to influence or control the hospital). Major contributors, board members, shareholders, officers, and founders are defined as insiders, but physicians may or may not be.
Radiology and Tax Exemption
For radiology groups, Davis says, the hospital’s tax-exempt status may be an issue in negotiating exclusive provider agreements, leases, gain sharing, service relationships, and joint ventures. Because radiology is associated with large investments in capital equipment, the use of tax-exempt bonds can cause problems. Private business use of more than 5% of the proceeds of a bond, or the property purchased with it, is forbidden, whether that use is direct or indirect. The effective limit may be as low as 3%, since up to 2% of the private-use 5% can be used to pay for the bond-related borrowing process.
A management contract for bond-financed facilities may constitute private use, Davis says,