Consequences of physician recruitment incentive agreements.

• Author: Wise, Spence L.

A tax-exempt hospital has two important operational objectives: (1) to accomplish the hospital's exempt purposes (i.e., promoting the health of the general public, etc.) and (2) to achieve financial stability. Without the attainment of financial stability, long-term success in achieving the exempt purposes will not be possible. Both of these objectives are often dependent on the hospital's ability to recruit private practice physicians to join its nonemployee medical staff or to provide services on behalf of the hospital. Like any other business organization, a tax-exempt hospital must compete in the marketplace to obtain the services of physicians who possess needed skills. The acceptance by a physician of a compensation arrangement that includes a recruitment incentive package is the final step in the hospital's successful search. Normally, recruitment incentive packages are pursuant to written agreements negotiated at arm's length and approved by the hospital's board of directors or its designees. Once accepted, they offer few operational problems. However, recruitment incentive packages often present substantial tax problems to a tax-exempt hospital. Hospitals exempt from Federal income tax qualify under Sec. 501(a) as organizations described in Sec. 501(c)(3) and must continue to operate in accordance with the standards for exemption set forth in Rev. Rul. 69-545. The question often asked by the Service is whether a tax-exempt hospital has violated the requirements for its exemption when it provides incentives to recruit a physician.

The IRS recently offered some insight into this problem with the release of Ann. 95-25. This proposed revenue ruling offers four tests that must not be violated by an exempt hospital offering physician recruitment incentives and outlines five recruitment incentive situations.

Ann. 95-25

Under this proposed revenue ruling, a hospital must provide recruitment incentives in such a manner that will not cause the organization to violate the organizational and operational tests of Regs. Sec. 1.501(c)(3)-1. This determination should be based on all relevant facts and circumstances. A violation will result from a failure to comply with any of the following requirements:

1. The organization may not engage in substantial activities that do not further the hospital's exempt purposes or that do not bear a reasonable relationship to the accomplishment of those purposes. The issue is whether the particular activity is...