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By Monica E. Oss

When Health Affairs published its article on the “most profitable” acute care hospitals, it created quite a stir (see Non-Profit Hospitals Dominate Top 10 Most Profitable Ranking In 2013). The focus of the discussion? The “top ten” list was dominated (seven of ten) by non-profit facilities. I thought most of the discussion that followed this article missed the point. The issue of “non-profit profitability” is an important one – with what I see as three key issues:

  1. There is a difference between “non-profit” and “tax-exempt”
  2. Non-profits do need to make profits
  3. Tax-exempt non-profits will increasingly need to document their “community benefit”

There is a difference between “non-profit” and “tax-exempt” – Although these terms are often used interchangeably, they are not. I asked the experts on our team to clarify. “A non-profit is an organizational status, usually defined by the state where they are incorporated, reserved for organizations that have a purpose of serving the public good, and not to create a profit,” said OPEN MINDS senior associate Ken Carr.” They are nonprofit because of their public purpose, and because they do not distribute profits to shareholders. They can still generate a profit, but it must be reinvested in the organization to serve their mission. With regard to tax-exempt status, a tax-exempt organization meets requirements of the IRS or state laws that may exempt them from income, property and other forms of taxes.”

James Stewart, chief executive officer of Grafton and OPEN MINDS advisory board member, expanded on this, “Non-profit status generally refers to an ‘income tax’ status at the federal level, which most often grants the same status at the ‘state income tax’ level. However, tax exempt status often varies by state. At the state level, most language revolves around charity status which can lead to exemption of property and excise taxes depending on state. In some states, like Virginia, that status can be different county-by-county based on that particular counties determination.”

Non-profits do need to make “profits” – Successful organizations need to bring in more revenue than expenses, including organizations that are designated as non-profit. In a for-profit organization, a key use of profits is to repay investors who, as shareholders, have put up the capital needed to create and operate the organizations – as well as having capital to invest in future service lines and other strategic initiatives. Non-profit organizations may not have investors to repay, but they have the same capital needs for strategic initiatives. In fact, one of the key challenges for non-profit executive teams is coming up with the capital needed to finance collaborations and new service line developments (see Need Financing For Your Next Big Service? and The Financing Challenge For Providers With Increasing Managed Care & Value-Based Contracting).

Tax-exempt non-profits will increasingly need to document their “community benefit” – The looming policy question is whether tax-exempt non-profit organizations provide enough “community benefit” to justify their tax-exempt status. There are the concerns and complaints about the fiscal management and about high executive compensation in tax-exempt non-profit organizations. And, as we see the uninsured population drop in many states (see Only 9% Of Americans Were Uninsured During First Half Of 2015 – All-Time Low) and more behavioral health treatment covered under the parity laws, the amount of “free” services provided by health care organizations is dropping (see Expansion Of Insured Americans By PPACA Cut Uncompensated Care Costs By $7.4 Billion In 2014 and The Changing Landscape Of Bad Debt & Charity Care). And recent court decisions have held that serving the Medicaid and Medicare populations, even at a loss, does not constitute community benefit (see PPACA & Tax-Exempt Status – More On The Horizon and Illinois Denies CMHC Request for Property Tax Exemption—Serving Medicaid Clients Not Considered Charitable Care) – though the recent IRS ruling on ACOs on that specific issue was a bit confusing (see The IRS’ ACO Tax-Exempt Issue & The Implications For Provider Networks). What we do know is that tax-exempt non-profit health and human service organizations need timely, accurate, and transparent financial reporting.
With the majority of U.S. health and human services delivered by non-profit organizations, these issues of policy and practice surrounding the financing are not going to go away. In fact, the controversy and the debate is likely to intensify. On one hand, non-profit organizations do need profits – and cash reserves – to continue to participate in a landscape that is increasingly based on assuming some degree of risk in payer contracts. On the other hand, “business as usual” in the financial management of non-profit organizations is likely coming to an end. Donors, liability-conscience board members, and the “tax man” are increasingly insisting on more transparency in financial reporting. And, where that doesn’t happen, a highly competitive health and human service market will force the issue.

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