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IRS Physician Recruitment Ruling

On April 22, the IRS released its long-promised revenue ruling dealing with physician recruitment by tax-exempt hospitals. While Revenue Ruling 97-21 contains few surprises, it does include more detailed information than was previously available both about the circumstances in which an exempt hospital may offer recruitment incentives and about the kinds of incentives that may be provided. One aspect of the ruling which is rather new is the emphasis it places on the importance of hospital board involvement in establishing recruitment policies and in monitoring recruitment contracts. As a result, some hospitals may wish to revise their procedures for reviewing and approving such agreements. The ruling also suggests that hospitals would be well advised to make use of compensation surveys when negotiating income guarantees.

IRS Approved Recruiting Payments

The ruling described four situations in which the IRS approved varying types of recruiting payments. These included the following:

One involved a hospital located in a very remote rural area that had been designated by the U.S. Public Health Service as a Health Professional Shortage Area for primary care professionals. The hospital recruited an obstetrician/gynecologist who was completing her residency to establish a full-time private practice in the area. The ruling approved a recruitment package providing a rather wide range of benefits, including:

  • a signing bonus;
  • payment of professional liability insurance premiums for "a limited period of time";
  • office space in a hospital-owned building at a below-market rental for "a limited period of time";
  • a hospital guaranty of the physician's home mortgage; and
  • a loan for the physician's start-up expenses "on reasonable terms."

In this case, however, there was no income guarantee.

The second situation involved a hospital located in an economically depressed inner- city area. The hospital's community need assessment identified a shortage of pediatricians in the service area and also found that Medicaid patients were having difficulty in obtaining pediatric services. The hospital recruited a practicing pediatrician from outside its service area to establish a new practice and join its staff, requiring that the physician treat a "reasonable number" of Medicaid patients. In that case, the hospital paid the premium for the physician's "tail" malpractice insurance coverage for his former practice and agreed to provide any funds needed to assure that the physician's net practice income reached specified levels "for a limited number of years." The ruling noted that the amount of net income guaranteed "falls within the range reflected in regional or national surveys regarding income earned by physicians in the same specialty."

The third situation did not deal with the recruitment of physicians, as such. Instead, the IRS approved arrangements under which a hospital located in an economically depressed inner-city area entered into a contract with an existing member of its medical staff to provide obstetrical care to a "reasonable number of Medicaid and charity care patients" in exchange for the payment of the physician's professional liability insurance premium for one year.

The fourth situation approved by the IRS involved a hospital in a medium to large metropolitan area that needed four diagnostic radiologists to provide services to its patients. When two of those radiologists left, the hospital conducted a search for replacements. One of the physicians identified by the search was practicing at another hospital in the area but, according to the ruling, did not admit patients to that hospital or to any other hospitals. The recruitment package consisted of a net income guarantee "for the first few years." Again, the amount guaranteed was within the range of compensation established by "regional or national surveys regarding income earned by physicians in the same specialty."

The IRS also provided an example of a metropolitan hospital with physician recruiting practices that had been found by a court to be in violation of the Medicare and Medicaid anti-kickback statutes. In that case, the IRS held that the hospital no longer qualified for tax-exempt status. This ruling, however, is inconsistent with previous IRS pronouncements indicating that unlawful activities, such as fraud and abuse violations, can provide grounds for revoking exemption.

Ongoing Uncertainty

It is somewhat frustrating that Revenue Ruling 97-21 does not clearly state what constitutes "limited number of years," a "reasonable number" of Medicaid or charity patients, etc. It contains general findings that the approved contracts "further the charitable purposes served by the hospital" and are "consistent with the requirements for exemption." In cases in which the physicians are providing charity care or specific services, it suggests (but does not state) that the value of the services to be provided should be roughly equivalent to the value of the benefits provided by the hospital. The ruling is also reasonably clear;

  • that normal expenses of physicians incidental to relocating may be reimbursed;
  • that income guarantees must be at levels comparable to the earnings of other physicians in the same specialty; and
  • that loans to physicians should be on commercially reasonable terms. (It is also worth noting that there is no requirement that all income guarantees must be repaid.)

It is much less clear, however, about what a reasonable recruitment bonus might be. While Revenue Ruling 97-21 requires that the recruitment arrangements be in writing and that they be negotiated at arm's length, it never mentions comparisons with the recruitment packages offered by other hospitals in similar situations. Despite that, an exempt hospital that is able to document information about the recruitment contracts being offered to physicians in a particular specialty "in the market" is likely to be better protected than one that is not.

Revenue Ruling 97-21 specifically states that none of the physicians being recruited were in a position to exercise substantial influence over the hospitals involved. As a result, none were "disqualified persons" subject to the recently enacted penalties imposed on "excess benefit transactions" under Section 4958 of the Internal Revenue Code. Nevertheless, the IRS conditioned its approval of the recruitment arrangements upon the use of board review procedures similar to those required for transactions with corporate insiders. In each case, the recruitment contracts on which favorable rulings were given were either approved by the hospital board, by a committee of the board assigned responsibility for reviewing physician contracts or by a designated officer who was directly supervised by the board. Therefore, even if Revenue Ruling 97-21 does not require a particular hospital to make significant changes in the terms of the contracts it has been offering to physicians it is seeking to recruit, the ruling may still require that the hospital modify its procedures for approving such agreements.

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