DATELINE: February 12, 2009, Chicago
Today, the IRS released the long awaited Hospital Compliance Final Report. Coming in at 191 pages, it represents a massive undertaking by the agency. Much of it focuses on the controversial subject of charity care and community benefit. We will leave those sections to those who are more versed in that important topic. We turn our attention to page 122 of the report, which focuses on one of Senator Charles Grassley’s favorite topics. The IRS based its study on a questionnaire sent to 544 nonprofit hospitals and results from audits of 20 hospitals that responded to the survey and were then selected for audit--not much of a reward for voluntary compliance.
The IRS reported that the average and median salary paid to the top management official was...
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$408,927 and $323,858, respectively, while the average and median other compensation was $81,504 and $34,611. These numbers do not strike us as particularly high based on a gut reaction. Think about the skills required of a hospital administrator: (i) must know how to management in a highly regulated environment; (ii) must manage a large and diverse workforce; (iii) must respond to constant environmental changes ranging from changes in reimbursement rates to fights over property tax exemption to new equipment and procedures; (iv) must market to consumers; (v) must address quality control and sanitation; and (vi) must balance budgets and raise funds. Individuals with these skills don’t work for $10 an hour.
Based on the responses to the questionnaire, the IRS concluded that reliance on the rebuttable presumption in Treasury Regulation Section 53.4958-6 is “widespread.” For those of you who are not tax jocks, what this means is that most of the hospitals that responded are following a rational and objective process when they set compensation for key employees and the principal officers.
Let's examine some of the details. Seventy-three percent (73%) of the respondent hospitals had a compensation policy. Ninety-eight percent (98%) of respondent hospitals report that compensation is approved in advance by individuals who do not have conflicts of interest. Another question asked who sets executive compensation. Here things become murkier because respondents could indicate more than one category. Sixty-three (63%) of hospitals reported that the board did, 56% pointed to a compensation committee, 31% to officers, and 32% to others. As hospital revenue increased, there was more reliance on compensation committees than boards.
Eight-seven (87%) of hospitals reported relying on published compensation surveys, 28% on internal surveys, 48% on outside unrelated experts, 36% on related outside experts (one troubling number), and 21% on phone surveys. The percentages exceed 100% because respondents could and apparently were encouraged to check each applicable basis for developing comparables. In selecting comparability data, 91% looked at data for people with comparable education and experience, 99% look at data for comparable specific responsibilities, 93% focused on comparable geographic regions, 97% focused on data from hospitals providing the comparable services, and 90% focused on data for hospitals with comparable numbers of beds, admissions, or outpatient visits. But hospitals didn’t just look at the data. Virtually all indicated that they set compensation levels within the range of the comparability data that they collected.
The 20 audited hospitals were selected largely because key personnel were paid larger amounts of compensation relative that paid by comparable hospitals (based on size and nature of services). On average, the total paid to the identified highly compensated individuals by the hospitals and related entities was $810,720, with the median at $578,808. Although these hospitals were targeted because of high compensation, nearly all of the examined hospitals set their actual compensation within the range of the comparability data. In 85% of the cases, the hospitals satisfied the rebuttable compensation under intermediate sanctions. The IRS did not assert excess benefit taxes in any cases where the hospital satisfied the rebuttable presumption.
In the executive summary, the IRS offered the following observations:
Both the community benefit and reasonable compensation standards have proved difficult for the IRS to administer. Both involve application of imprecise legal standards to complex, varied and evolving fact patterns. Some have suggested that these standards need to be revised. As these discussions occur, and despite the limitations described above, the study provides important information.
The area of executive compensation poses similar challenges. Amounts reported appear high but also appear supported under current law. For some, there may be a disconnect between what, as members of the public, they might consider reasonable, and what is permitted under the tax law. The IRS will continue its enforcement work in this area through examinations and other compliance initiatives. As part of this work, the IRS will seek a better understanding of the impact of certain aspects of existing law, including the permitted use of for profit comparables, and the rule excepting the initial contract between the organization and the executive.
We sense a bit of ambivalence here. The IRS and others see relatively high levels of compensation here. Although some people (not necessarily within the IRS) have a strong visceral reaction to high compensation, the IRS determined that the compensation levels reported were largely supportable. The IRS also notes the need for continued enforcement, but points to what is characterizes as difficult and imprecise standards. We agree that there is a need for continued enforcement, but we disagree with any assertion that the standards are difficult or imprecise. The standards outline a specific and objective methodology for setting compensation. It takes hospitals time to apply them and the IRS time to evaluate the results, but the standards are clear.
Our observation: Its time to move on and stop criticizing the intermediate sanctions and the methodology used to determine executive compensation. As we read the results, hospitals are doing exactly what the law asks. In fact, they are doing more than is required becausethe rebuttable presumption is not a requirement, but rather a semi-safe harbor. It also appears that the best practices that the rebuttable presumption encourages are properly targeted. After all, there were no adjustments in the case of hospitals audited that complied with the requirements for invoking the presumption.
We would like to know what the critics find wrong with the intermediate sanctions. Could the problem be that critics don't make as much money as hospital executives? That’s not the criteria. The issue is quite simple: Nonprofit hospitals must qualify for tax-exempt status. Those who work for hospitals are members of a highly-fluid labor force. People get paid for working. Just because people work for a nonprofit tax-exempt hospital should not require them to provide a subsidy to the organization by working for less than market rates.
There also is clear lesson for all directors of all charities. Make sure you do what is necessary to satisfy the rebuttable presumption under the intermediate sanctions and then set executive salaries within the range of comparables. Actually, the executives should be the ones demanding that the organization satisfy the requirement for involing the rebuttable presumption. After all, they are the ones who must pay any excess benefits back when the IRS successfully challenges the reasonableness of compensation.
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