Jordan Ellis
Hospitals are community mainstays, providing vital health care services to millions of people in thousands of communities. They are also major employers, directly employing over 6.6 million people in 2023 and supporting 25.9 million total jobs across the economy. In the United States, slightly more than half of the approximately 5,000 community hospitals are private, nonprofit organizations. These nonprofit hospitals are eligible for tax exemption under Section 501(c)(3) of the Internal Revenue Code if they meet certain federal requirements and demonstrate that they serve a public rather than a private interest. The total estimated value of tax exemption for nonprofit hospitals was about $28 billion in 2020, which has led to questions about whether these institutions provide enough charity care to justify their tax-exempt status.
| Characteristics | Values |
|---|---|
| Number of nonprofit hospitals in the US | 2,900 |
| Proportion of community hospitals that are private, nonprofit organizations | Slightly more than half |
| Requirements for tax exemption | Meet legal requirements, e.g. billing and collection limits; provide community benefits, e.g. an emergency room open to all |
| Estimated value of tax exemption for nonprofit hospitals in 2020 | $28 billion |
| Estimated value of federal tax-exempt status in 2020 | $14.4 billion |
| Estimated value of state and local tax-exempt status in 2020 | $13.7 billion |
| Estimated value of tax exemption from 2011 to 2020 | Increased from $19 billion to $28 billion |
| Estimated value of charitable contributions in 2010 | $5.3 billion |
| Estimated value of community benefits | 15.5% of hospitals' total expenses |
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What You'll Learn
Nonprofit hospitals' tax-exempt status
Nonprofit hospitals are exempt from federal, state, and local taxes. This tax exemption is worth billions of dollars to these hospitals. For instance, the total estimated value of tax exemption for nonprofit hospitals was about $28 billion in 2020. This represented over two-fifths (44%) of net income (i.e., revenues minus expenses) earned by nonprofit facilities in that year. The federal tax-exempt status alone was worth $14.4 billion in 2020, primarily due to the estimated value of not having to pay federal corporate income taxes ($10.3 billion). The state and local tax-exempt status was worth $13.7 billion in the same year.
To qualify for tax-exempt status, nonprofit hospitals must meet the requirements of Section 501(c)(3) of the Internal Revenue Code (IRC) and Revenue Ruling 69-545. Section 501(c)(3) provides exempt status for organizations that are, in general, religious, charitable, scientific, literary, or educational. Revenue Ruling 69-545 clarifies that the promotion of health is a charitable purpose that benefits the community as a whole.
To demonstrate that they are organized and operated for the charitable purpose of promoting health, hospitals must meet certain legal requirements and provide community benefits. Examples of community benefits include operating an emergency room open to all, regardless of ability to pay, and maintaining a board of directors drawn from the community.
There has been some debate over whether nonprofit hospitals provide enough "charity care" to justify their tax exemptions. However, it is important to note that these hospitals provide much more than charity care. They also offer research, training, and critical services like Level I trauma centers, burn units, and psychiatric care, which for-profit hospitals often avoid. Additionally, tax-exempt financing helps lower healthcare costs for patients and makes vital hospital services more accessible to communities.
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Requirements for tax exemption
Hospitals can be exempt from taxation if they meet certain requirements. Firstly, they must meet the legal requirements, such as setting billing and collection limits. Secondly, they must provide community benefits, such as operating an emergency room that is open to all, regardless of their ability to pay. This includes providing hospital care for all patients, including those on Medicare and Medicaid, and using surplus funds to improve facilities, equipment, patient care, and advance medical training, education, and research.
The Internal Revenue Service (IRS) has outlined the community benefit standard in Rev. Rul. 69-545, which is a test used to determine if a hospital is organized and operated for the charitable purpose of promoting health. This ruling provides examples of hospitals described under Section 501(c)(3) of the Internal Revenue Code, which grants tax exemption to organizations that are religious, charitable, scientific, literary, or educational. While the IRS does not specify the activities hospitals must undertake, it makes determinations based on facts and circumstances, giving hospitals broad latitude in determining their community benefits.
To qualify for tax exemption under Section 501(c)(3), an organization must meet both an organizational test and an operational test. It must be organized exclusively for one or more exempt purposes, as outlined in its organizational documents, and it must not empower the organization to engage in activities that are not in furtherance of exempt purposes. Additionally, under statutory requirements, an organization cannot qualify for Section 501(c)(3) if it engages in political activities or attempts to influence legislation.
The value of tax exemption for nonprofit hospitals is significant. In 2020, the estimated value was $28 billion, which included the benefit of not having to pay federal and state income taxes, as well as local property taxes. This increase in value coincided with the COVID-19 pandemic, during which nonprofit hospitals experienced a substantial increase in net income.
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Community benefit standard
The community benefit standard is a test used by the IRS to determine whether a hospital qualifies for tax exemption by being organized and operated for the charitable purpose of promoting health. This is based on Revenue Ruling 69-545, which outlines the following factors that demonstrate community benefit:
- Operating an emergency room open to all, regardless of ability to pay.
- Maintaining a board of directors drawn from the community.
- Providing hospital care for all patients, including those on public programs such as Medicaid and Medicare.
- Using surplus funds to improve facilities, equipment, and patient care.
- Using surplus funds to advance medical training, education, and research.
The community benefit standard also considers whether a hospital provides financial assistance to those unable to pay, and whether it offers free or subsidized care to the indigent. While the IRS does not specify the activities hospitals must undertake, it weighs all relevant facts and circumstances in its evaluation.
The lack of clarity around community benefit criteria creates challenges for the IRS in administering tax law. Hospitals have broad latitude in determining the community benefits they provide, but the inconsistent reporting format makes it difficult to assess compliance. To address this, the IRS updated its guidance in 2021, instructing employees to document whether a hospital satisfies the community benefit standard and establishing an audit code for tracking.
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Tax-exempt bond financing
Hospitals can be tax-exempt if they meet certain legal requirements and provide community benefits. For example, in the US, the IRS and the Department of the Treasury have specified that nonprofit hospitals are eligible for a tax exemption. This is because they promote health, which is considered a charitable purpose.
There are several types of tax-exempt bonds, including government bonds, private activity bonds, and qualified 501(c)(3) bonds. Private activity bonds are obligations that meet the private business test or the private loan financing test. Qualified 501(c)(3) bonds are issued to finance facilities for use by governmental bodies and for-profit organizations.
In 2017, the House of Representatives voted to approve the Tax Cuts and Jobs Act, which included legislation to eliminate hospitals' ability to access low-cost capital financing through tax-exempt private activity bonds and advance refunding bonds. This could have potentially devastating consequences for patients and their communities, as it would remove a key benefit of hospital tax exemption.
Overall, tax-exempt bond financing is an important tool for hospitals to access low-cost capital and maintain their tax-exempt status.
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Tax exemption value
Hospitals can be exempt from taxes if they meet certain legal requirements and provide community benefits. The Internal Revenue Service (IRS) has identified factors that demonstrate community benefits, but these are not requirements. This vagueness has led to scrutiny of nonprofit hospitals, with some questioning whether they provide enough community benefit to justify their tax exemption.
The total estimated value of tax exemption for nonprofit hospitals was about $28 billion in 2020. This represented over two-fifths (44%) of net income earned by nonprofit facilities that year. The estimated value of federal tax-exempt status was $14.4 billion in 2020, which accounts for about half (51%) of the total value of tax exemption. This is largely due to the estimated value of not having to pay federal corporate income taxes ($10.3 billion).
The total estimated value of state and local tax-exempt status was $13.7 billion in 2020, which represents about half (49%) of the total value of tax exemption. This includes the estimated value of not having to pay state or local sales taxes ($5.7 billion), local property taxes ($5.0 billion), or state corporate income taxes ($3.0 billion).
In addition, individuals may contribute more to tax-exempt hospitals because they can deduct donations from their income tax base ($2.5 billion). These hospitals can also issue bonds at lower interest rates because the interest is not taxed ($1.6 billion). The total estimated value of tax exemption (about $28 billion) exceeded total estimated charity care costs ($16 billion) among nonprofit hospitals in 2020.
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Frequently asked questions
Hospitals can be tax-exempt organizations if they meet certain requirements.
Requirements for a hospital to be a tax-exempt organization include demonstrating that it provides benefits to a broad segment of the community, operating to serve public interests, and meeting legal requirements such as billing and collection limits.
Hospitals benefit from tax exemptions by gaining access to tax-exempt bond financing, which lowers healthcare costs for patients. Additionally, tax exemptions help hospitals subsidize services that operate at a loss, such as inpatient psychiatric care and substance use disorder care.
Communities benefit from hospitals' tax-exempt status through access to vital healthcare services, economic value creation, and the provision of benefits and services unique to their location.
