IRS provides guidance on physician recruitment by hospitals.

• Author: Whitman, Kelcy M.

In Rev. Rul. 97-21, the IRS provides guidance on incentives that a tax-exempt hospital may offer to recruit private practice physicians to join its medical staff or provide medical services to the community. The Service presents five situations with different incentive packages, ruling on whether or not the recruiting incentives offered to the physician endangered the hospital's tax-exempt status under Sec. 501(c)(3). This ruling formalizes the guidance in Ann. 95-25.

To maintain its tax exemption under Sec. 501(c)(3), a hospital must provide recruitment incentives to physicians in a way that does not cause it to violate the operational test of Regs. Sec. 1.501(c)(3)-1. A hospital that recruits a medical staff physician who is to perform services for or on behalf of the organization successfully satisfies the operational test by showing that the compensation paid to the physician is reasonable compared to the services the physician is providing in return. All benefits paid, including those to induce the physician to join the staff, must be considered as part of compensation. Whether a violation of this test has occurred is determined based on all the facts and circumstances.

When a tax-exempt hospital recruits a medical staff physician who will provide services to members of the surrounding community (but not necessarily for or on behalf of the organization), a somewhat different analysis must be applied. Four requirements must be met for the hospital to have complied with the operational test in such situations:

1. The hospital cannot substantially engage in an activity, unless it furthers its exempt purpose and bears a reasonable relationship to the accomplishment of such purpose.

2. The organization must not undertake any activities that result in the inurement of the hospital's net earnings to a private individual.

3. The hospital should not participate in any substantial activity that causes it to be operated for the benefit of a private interest.

4. The organization cannot participate in any substantial unlawful activities.

Rev. Rul. 97-21 describes five different situations to illustrate whether the incentives provided represent private inurement and whether a private, rather than a public, purpose is being met. In all situations, the following assumptions are being made:

*The physicians do not have a substantial influence over the affairs of the hospital recruiting them.

*The physicians are not considered "disqualified persons" under...