New arrangements, new scrutiny. The IRS reconsiders hospital-physician relationships at tax-exempt facilities

The pressure to maintain adequate operating margins has forced many not-for-profit hospitals to adopt more overtly competitive behavior than they have in the past. However, in struggling to remain economically viable, these facilities should carefully avoid actions that would threaten their tax-exempt status. Not-for-profit facilities should be particularly careful that their arrangements with physicians, which often appear designed to increase referrals, do not violate the criteria according to which the Internal Revenue Code extends tax exemption to charitable organizations. Section 501(c)(3) of the code exempts organizations "no part of the net earnings of which inures to the benefit of any private shareholder or individual." According to this provision, "insiders" (i.e., those with a personal interest in or opportunity to influence organization activities from the inside) are entitled to no more than reasonable payment for their goods or services. The Internal Revenue Service (IRS) takes the position that, as employees or individuals having a close professional working relationship with a hospital, physicians are insiders. Thus a hospital that pays physicians what the IRS judges to be more than fair market value for services (or charges physicians less than fair market value for office rental) may find its exemption in jeopardy. If not-for-profit hospitals want to maintain their tax-exempt status, they must be certain the arrangements they enter into with physicians truly further their exempt purpose: to promote the health of the community.