SC Department of Revenue
non-profit update #6- 05/12/1997


Non-Profit Update #6 (Hospitals)
May 12, 1997

The Internal Revenue Service recently issued the long awaited Revenue Ruling 97-21 dealing with physician recruitment activities by tax-exempt hospitals. The Ruling deals with whether a hospital violates the requirements for tax exemption when it provides incentives to recruit private practice physicians to join its staff or to provide medical services in the community. The revenue ruling addresses the issue by considering five fact situations.

Situation 1: The hospital is in a county that has been designated a shortage area by the U.S. Public Health Service for primary medical care professionals. The hospital recruits a physician to become a member of its medical staff and to establish and maintain a full-time ob/gyn private practice in its service area. Under an agreement in accordance with guidelines established by the hospitalís board of directors, the hospital pays the physician a signing bonus, a portion of her malpractice insurance premium, provides office space below market rent for a limited term, and guarantees her mortgage on a residence in the county. Under a properly documented, reasonable agreement, the hospital lends the physician practice start-up financial assistance.

Situation 2: A hospital in an inner-city area with a shortage of pediatricians recruits a physician to relocate. He agrees to establish a pediatric practice, become a member of the hospital staff, and treat a reasonable number of Medicaid patients. Under a written agreement, the hospital reimburses the physician for moving expenses, for professional liability "tail" coverage for his former practice, and guarantees his private practice income for a limited number of years.

Situation 3: In an inner-city hospital, because of a shortage of obstetricians willing to treat Medicaid and charity care patients, indigent patients are having difficulty getting access to care. Under a written agreement, the hospital will reimburse the physician for the cost of one yearís malpractice insurance in return for an agreement by the physician to treat a reasonable number of Medicaid and charity care patients for that year.

Situation 4: A hospital with a need for diagnostic radiologists recruits a physician from the staff of another hospital in the same city. Under a written agreement, for the first few years that he is a member of its medical staff, the hospital guarantees the physicianís income and provides coverage for its radiology department.

Situation 5: Because of its physician recruitment practices, a hospital has been found guilty of knowingly and willfully violating the Medicare and Medicaid antikickback statute, for providing recruitment incentives that constituted payments for referrals. The activities resulting in the violations were substantial.

The IRS concludes in Rev.Rul. 97-21 that the hospitals in Situations 1, 2, 3, and 4 have not violated the requirements for exemption as section 501(c)(3) organizations as a result of the physician recruitment incentive agreements.

The IRS says that the transactions in Situations 1, 2, 3, and 4:

Further charitable purposes;

Donít result in inurement;

Donít result in the hospitals serving a private rather than a public purpose; and

Are assumed to be lawful for purposes of this revenue ruling

The IRS ruled that the hospital in Situation 5, however, does not qualify as a section 501(c)(3) organization because its unlawful physician recruitment activities are inconsistent with charitable purposes.

The ruling is silent on physician retention arrangements, perhaps reflecting the IRSís concern with abuses in this area. The ruling is also silent on the issue of forgiveness of certain obligations of the in-coming physician.

The ruling emphasizes the role of the Hospitalís Board. Two of the fact patterns note that the recruitment incentives are "in accordance with guidelines for physician recruitment that the Board of Directors establishes, monitors, and reviews regularly to ensure that recruiting practices are consistent with [the hospitalís] exempt purposes."


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