501(r) & Selling and Referring Accounts for Collection
Tax-exempt hospitals are in various stages of compliance with the final 501(r) regulations. Calendar year taxpayers should have adopted and implemented compliant policies and procedures prior to the start of the new year. Fiscal year taxpayers have until the start of their 2016-17 tax year to adopt and implement compliant policies and procedures.
Amidst all of the hard work and decisions that must be made to put these policies and procedures into place is the frequent business practice of referring accounts receivable to collection agencies or entering into financing arrangements involving the hospital’s accounts receivable with one or more financial institutions. It is important that these practices do not get lost in the fray.
Activities involving the selling or referring of patient debt to outside organizations most likely will not be directly addressed by compliant 501(r) policies other than listing them as potential actions the hospital may choose to take in the event of non-payment. However, these actions are still governed by the final regulations and may implicate the hospital’s tax-exemption.
The first step to compliance is understanding what is and is not an “extraordinary collection action” or “ECA.” Recall that hospitals may not take ECAs against patients unless and until they make “reasonable efforts” to determine whether a patient is FAP-eligible. These “reasonable efforts” are prescribed by regulation and are cumbersome and time consuming, many times prohibiting a hospital from taking any ECA against a patient for at least 120 days from the date of the first post-discharge bill. If a hospital takes an ECA against a patient without making these “reasonable efforts,” it will be in violation of section 501(r) of the Internal Revenue Code. Thus, it becomes crucial to understand the concept of an ECA in the context of collection agency actions and patient account financing.
The IRS has clearly stated that referring an account to a collection agency is not an ECA. This means that a hospital may send accounts to a collection agency at any time (provided that the hospital’s FAP states as much). However, this does not mean that when a hospital refers an account to a collection agency that its obligations with regard to 501(r) cease. Rather, the regulations clearly state:
“the hospital facility will be deemed to have engaged in an ECA against the individual to obtain payment for the care, or to have taken one or more of the steps necessary to have made reasonable efforts to determine whether the individual is FAP-eligible for the care, if any purchaser of the individual’s debt, any debt collection agency or other party to which the hospital facility has referred the individual’s debt . . . has engaged in such an ECA or taken such steps (whichever is applicable).”
This means that when a hospital sends an account to a collection agency, the collection agency’s actions on that account will be deemed to be an action of the hospital. If a collection agency takes an ECA prior to “reasonable efforts” having been made, the violation will be a violation of the hospital and would threaten the tax-exemption of the hospital. There are no safe harbors to this rule, and no contract between hospital and collection agency can remove this exposure. Regardless of what is in a collection agency contract, the hospital will be responsible for the acts and omissions of its collection agency with regard to 501(r) compliance.
Not only will the hospital be held accountable for the acts and omissions of its collection agencies with regard to 501(r) compliance, but the regulations also require that agreements between hospital and those parties to which the hospital refers accounts contain certain provisions in order for the “reasonable efforts” standard to even be satisfied. This means even if a hospital or its collection agency take all the required acts in the regulations necessary to satisfy the “reasonable efforts” standard, the standard will not be met unless the agreement between the parties contains certain elements. Those elements are as follows:
- The agreement is a legally binding written agreement that is designed to ensure that no ECAs are taken until “reasonable efforts” have been made to determine if the patient is FAP-eligible, and the hospital intends and actually does enforce the agreement.
- The agreement provides that if the individual submits a FAP application after the referral but before the end of the application period, the collection agency will suspend ECAs taken against the patient.
- The agreement provides that if the individual submits a FAP application after the referral but before the end of the application period and is determined to be FAP-eligible, the collection agency will do the following in a timely manner:
- Adhere to procedures set forth in the agreement that ensure the patient does not pay, and has no obligation to pay, the collection agency or the hospital more than he or she is required to pay for the care as a FAP-eligible individual.
- Take reasonable measures to reverse any ECAs taken against the individual.
- If the collection agency refers the debt to another agency, that agency must also sign an agreement with the aforementioned elements.
For these reasons, we strongly suggest hospitals (i) consider the risk associated with referring accounts to collections prior to satisfying the “reasonable efforts” standard, and (ii) ensure that all agreements with collection agencies satisfy the aforementioned standards. There may be other business risks and elements covered by such agreements (such as whether the hospital will be responsible for the agency’s costs associated with ECAs if and when ECAs must be reversed), but at a minimum, the agreements must satisfy these elements.
The sale of an account to a third party is considered an ECA, and thus may only be taken when and if the “reasonable efforts” standard has been satisfied. This means, absent other circumstances, if a hospital factors its accounts receivable or enters into a financing arrangement with a bank whereby the bank purchases the hospitals accounts or notes related thereto, it will be considered an ECA and (i) must only be taken after the “reasonable efforts” standard has been satisfied, and even then (ii) must only occur pursuant to an agreement that satisfies the elements described above.
However, the regulations provide that certain debt sales will not be considered ECAs if the hospital enters into a legally binding agreement with the debt purchaser that includes the following elements:
- The debt purchaser is prohibited from taking ECAs against the patient to obtain payment.
- The debt purchaser is prohibited from charging interest on the debt in excess of the rate in effect under IRC § 6621(a)(2) as of the date of the sale (currently 3%).
- The debt is returnable or recallable by the hospital upon the determination that the patient is FAP-eligible.
- If the individual is determined to be FAP-eligible and the debt is not recalled by the hospital, the debt purchaser may not require the individual to pay more than he or she is responsible to pay as a FAP-eligible individual.
If these elements are satisfied, the sale will not be an ECA, and the hospital can engage in the transaction prior to satisfying the “reasonable efforts” standard. However, as mentioned above, hospitals should recognize that any action of a debt purchaser will be deemed to be an action of the hospital. Furthermore, the sale of debt under this exception does not eliminate the hospital’s responsibilities as to satisfying the “reasonable efforts” requirements.
While hospitals understandably are taking and have taken extraordinary efforts to revise and implement compliant 501(r) policies, they should not forget that their relationships with collection agencies and financial institutions also impact 501(r) compliance. These arrangements should be reviewed to ensure that (i) the hospital understands and accepts the risks associated with any delegation of 501(r) activities to such entities, and (ii) that the arrangements satisfy 501(r) requirements.