By: Kim Hunwardsen

Tax-exempt health care organizations are not exempt from tax reform; instead, the sector may be heavily impacted by the proposed tax reform changes released by House Ways and Means Committee Chairman Dave Camp on February 26, 2014. The draft legislation is not expected to be voted on in 2014, but health care organizations should be aware of the issues being discussed in D.C. and identify the potential impact on their organizations. The proposed changes would be effective for taxable years beginning after December 31, 2014, unless noted otherwise.

To read the Joint Committee on Taxation's technical summary, click here.

Unrelated Business Income
The proposed legislation identifies several changes to the unrelated business income tax (UBTI) rules. One of the more significant changes would require organizations to calculate unrelated business income (UBI) separately for each activity versus aggregately. This means organizations could no longer offset income from a certain type of activity with losses from another activity. Instead losses generated on an activity could only be carried forward to future years to offset future income on that activity. It is likely this provision may have been triggered in response to the Final Report on Colleges and Universities released in April of 2013. Many of the colleges and universities included in the IRS exams were found to be claiming losses from activities that weren't considered to be UBI and using those losses to offset income from valid UBI activities.

The other significant UBTI changes proposed relate primarily to fees organizations receive related to licensing their name or logo and sponsorship payments around fundraising events. While these changes would not have an impact on most health care organizations, they do represent a narrowing of the scope in what amounts received by exempt organizations should be excluded from tax. A favorable change in the legislation proposes raising the specific deduction against UBTI to $10,000. Currently, tax-exempt organizations filing Form 990-T for UBI activities receive a $1,000 specific deduction to offset taxable income.

Penalty Provisions

Effective for Form 990 filed on or after January 1, 2015, the legislation proposes to double penalty amounts. The daily penalty for failure to file would go from $20 to $40 for organizations with less than $1 million in gross receipts and from $100 to $200 for organizations over $1 million. The daily penalty for failure to comply with public inspection requirements would go from $20 to $40. The daily penalty for failure to file a reportable transaction disclosure would go from $100 to $200. In addition, legislation also proposes a manager-level accuracy-related penalty equal to 5% of the underpayment of UBTI, capped at $20,000.

Excise Taxes and Intermediate Sanctions
Currently, organizations may rely on the rebuttable presumption of reasonableness with respect to excess-benefit transactions to shift the burden of proof on the reasonableness of a transaction to the IRS. This occurs if there is approval by authorized independent persons, comparability data is used, and the basis for the decision is documented contemporaneously. The proposed legislation would eliminate the rebuttable presumption of reasonableness, thereby requiring organizations to prove the reasonableness of the transaction upon IRS challenge. However, these processes would allow an organization to establish it has met minimum standards of due diligence.

The standards of due diligence come into play under a proposed entity-level excise tax. If an excise tax is imposed on a disqualified person under the intermediate sanction rules, the proposed legislation would impose a new excise tax on the organization of 10% of the excess benefit. This can be avoided if the organization meets the standards of due diligence or establishes to the satisfaction of the Secretary that other reasonable procedures were used to ensure no excess benefit was provided.

In addition, the intermediate sanction rules would be expanded to cover investment advisors and athletic coaches by considering these individuals disqualified persons.

Executive Compensation
The proposal would subject organizations with covered persons who receive more than $1 million in compensation to a 25% excise tax on the amount paid in excess of $1 million. This proposal would apply to the top officers of the company in addition to the five highest compensated employees of the organization. For a hospital, this could be a significant impact depending on compensation structures with physicians and key executives.

Tax-Exempt Status
Under the proposed rules, supporting organizations classified as Type II and Type III would be eliminated. This means only organizations that are controlled by one or more publicly supported organizations, a Type I, would be able to maintain public charity status by virtue of their relationship with another publicly supported organization. Many health care foundations and parent companies currently maintain public charity status as a supporting organization to the hospital or nursing home.

As you can see, the proposed tax reform legislation is wide-sweeping for tax-exempt organizations. While it is somewhat unlikely these provisions will all be passed into law in the proposed form, it is very likely we will see some changes to the rules surrounding hospitals and tax-exempt organizations. All organizations should evaluate these proposed changes and start discussions internally with management and the board if they will have a significant impact.

Please contact your Eide Bailly representative to learn more.