Compliance with closing agreements and other IRS examination and compliance initiatives

22nd Annual Health Sciences
Tax Conference
Compliance with closing agreements and other
IRS examination and compliance initiatives

December 5, 2012

Disclaimer

► Any US tax advice contained herein was not intended or written to be
used, and cannot be used, for the purpose of avoiding penalties that may
be imposed under the Internal Revenue Code or applicable state or local
tax law provisions.

Page 2 Compliance with closing agreements and other IRS
examination and compliance initiatives

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Presenters

► Dennis Hesch ► Mike Rachael
Executive Vice President/Chief Ernst & Young LLP
Financial Officer Atlanta, GA
The Carle Foundation + 1 404 817 5676
Urbana, IL mike.rachael@ey.com

► Lucille White
Ernst & Young LLP
Chicago, IL
+ 1 312 879 2670
lucille.white@ey.com


Agenda

► Internal Revenue Service (IRS) 2012 work plan
► The Carle Foundation IRS audit experience
► Other recent IRS audit issues


IRS 2012 work plan

► Lois Lerner’s January 19 remarks at the University of
Texas School of Law Nonprofit Organizations Institute
► “… Unfortunately, our 2012 workplan is not quite ready for
prime time so it’s not out yet and I am not going to be
talking about it. You will find in your materials a copy of
last year’s workplan and if you haven’t looked at it, you
ought to take a look. If you’re working in this area, you
really ought to pay attention to what the workplan says
because we try to be extremely transparent with you and
let you know what we’re thinking … .”


IRS 2012 work plan

(cont.)
► “… Better understanding of who we are and what we do is
really important I think in terms of compliance. I am very
fortunate because the exempt sector as a whole is a very
compliant sector. My philosophy is, if I can provide you
with information on how to do your jobs correctly, then you
will follow that path … .”
►


IRS 2012 work plan

(cont.)
► “… For hospitals, the difference is the type of community
benefit that they provide. They are not exempt because
they provide health care. They are exempt because they
provide community benefit. I am guessing if I ask each
and every one of you to describe what community benefit
is, we would get as many answers as we have people
here because community benefit is this nebulous concept
that was developed 30 years ago and we really haven’t
looked at it … .”


IRS work plan — fiscal 2012 work plan

► In FY 2012, exempt organizations (EO) will continue to
implement new legislation.
► Auto-revocation for non-filers
► Requirements for tax-exempt hospitals
► Section 501(c)(29) organizations
► Accountable care organizations
► Reporting requirements



► “… Interestingly enough, Congress, in the Affordable
Health Care Act, has a requirement that all hospitals be
reviewed once every three years for their community
benefit activities. So we didn’t know they were going to do
that but it works out nicely that we have this Schedule H
because we can now do it and our Review of Operations
is the office that is doing that because those are not
audits. They are just reviews and we’re looking at 990s
and other information, to gather information for a report
that we owe Congress in the future … .”



► Compliance: using the Form 990:
► 501(c)(4), (5) and (6) self-declarers
► Political activity
► 990-T and unrelated business income tax (UBIT)
► Governance



► Compliance: using the Form 990:
► Lerner: “That’s a really good question. The question was, is there
a difference between the process we use when we look at an
organization that filed an electronic return versus a paper return
and the answer is absolutely not. We make our choices and
decisions in terms of what cases we’re going to look at based on
data. If you filed a paper return, I am looking at data because it
gets transcribed. If you file an electronic return, I am looking at
data. If I only have data on the electronic return and not on the
paper return, I won’t use that criteria as a selection. So they are
treated exactly the same.”



► Collaborative efforts:
► International
► Academic Institutions Initiative
► National Research Program
► EO examinations resource page on IRS.gov



► General work:
► Colleges and universities
► Disaster relief communications
► Group rulings
► Mortgage foreclosure assistance
► State-sponsored workers’ compensation organizations —
501(c)(27)s
► Private foundations
► EO services and assistance



► We’ve implemented several improvements that we hope
will result in a more positive examination experience.
► Fast Track Settlement (FTS) process
► FTS is administered by Tax Exempt and Government Entities (TE/GE)
and Appeals and provides an expedited process for the IRS and
taxpayers to resolve disputes at an early stage using an Appeals
official as a neutral party.
► EO Examinations unit located at the Ogden Service Center
► Resolving problems, like misapplied payments or incorrect imposition
of penalties, arising from examinations of exempt organizations.
► “Plain language” updates to some of our examination letters
► Adding contact information for the exam agent’s group manager in
case organizations or their representatives wish to elevate their
questions or concerns.


The Carle Foundation IRS audit experience

Carle organizational chart

The Carle
Foundation

The Carle The Carle Carle Health Hoopeston
Carle Holding Health Systems Carle Retirement
Foundation Development Care Incorporated Regional Health
Company, Inc. Insurance, Limited Centers, Inc (3) (2)
Hospital (1) Foundation Center/Hospital

Carle Risk
Health Alliance Carle Community Various Joint
Stratum Med, Inc. Management
Medical Plans, Inc. Health Corporation Venture Interests4
Company

Health
Alliance-Midwest, eValidata, Inc.
Inc.

Health Care Includes
Horizons Carle
of Illinois, Inc. Physician Group

HCH
Administration Inc.

HCH Obligated Group
Administration members
___________________________
1. d/b/a Carle Home Services, Carle Therapy Services, Carle Medical Supply, Carle Champaign Recovery Center, Danville SurgiCenter, Arabella Boutique, Carle Auditory Oral School,
Mills Breast Cancer Institute
2. d/b/a Carle Physician Group, Champaign Surgicenter LLC, Carle Foundation Physician Services LLC, Arrow Ambulance LLC, The Caring Place, and AirLife
3. d/b/a Windsor of Savoy, and Windsor Court
4. Joint Ventures include Advanced MRI, LLC and The Center for Orthopedic Medicine, LLC


The Carle Foundation — IDS

► Carle Hospital
► 345-bed Hospital is the primary teaching hospital for the School of Medicine at the
University of Illinois at Urbana-Champaign
► Service area — 29 counties in EC Illinois and six counties in WC Indiana
► Level I Trauma Center — only one in region, one of three downstate IL
► Level III Perinatal
► Magnet designation from ANCC
► Most Wired Award for 2012
► Advanced certification as a Primary Stroke Center from The JC
► Carle physicians
► More than 365 physicians and 170 advance practice providers
► 50 specialties
► Located in nine communities across central Illinois (14 Clinic sites)
► Health Alliance Medical Plans
► Over 320,000 members
► Ranked in Top 10 Health Plans by U.S.News and World Report


Integrated system — service area


Carle history — Part I


Carle history — Part II


IRS examinations

► Audits of exempt organizations
► The goal of the Exempt Organizations Examinations program is to
promote voluntary compliance by analyzing operational and
financial activities of exempt organizations. As in any IRS
examination of taxpayer returns, exempt organizations undergoing
examinations have certain rights, as explained in Publication 1.
► Issues in an audit may include an organization’s tax-exempt status
and private foundation classification, whether it paid employment
taxes and tax on unrelated business income when required, and
whether it filed required returns and reports. Procedures for
examinations are explained in greater detail in Publication 892.


Carle IRS examinations

► 2006 — IRS 990 audit of The Carle Foundation (TCF) and
various affiliates returns for 2002, 2003, 2004 and 2005.
Examine lasted nearly two and one-half years and ended
up with a Closing Agreement.
► 2006 — IRS audit of Carle Clinic Association’s (CCA)
consolidated federal tax returns for 2003, 2004 and 2005.
Examination lasted nearly two years and ended up in
appeals court.
► 2011 — IRS audit of Carle’s offshore captive insurance
company focused on excise tax.


Carle IRS examinations

► 2012 — IRS Form 13837 — Compliance Check
Information request
► 2012 — IRS audit of Carle Holding Company (formerly
CCA) for-profit 2010 federal return
► 2012 — IRS audit of Carle Risk Management Company
return for 2010
► 2012 — IRS 990 audit of TCF and Carle Foundation
Hospital (CFH) returns for the 12 months ended
June 30, 2010 and 6 months ended December 31, 2010


2006 — IRS 990 audit

► The IRS audited TCF and various affiliates’ returns for
2002, 2003, 2004 and 2005. Areas of focus were as
follows:
► Unrelated business income (UBI)
► Carle Retirement Center charity care policy
► Historical practice of for-profit Carle Clinic renting space from tax
exempt Carle Foundation
► Open Medical Staff Policy and the fact that most staff physicians
were Carle Clinic physicians
► Foundation Board make-up
► Medical leadership positions
► Physician coverage of hospital services (e.g., ED, Radiology,
Pathology)


2006 — CCA IRS audits for 2003, 2004 and
2005

► The IRS audited CCA’s consolidated federal tax returns
for 2003, 2004 and 2005. Concerns were raised on the
following:
► Deferred Compensation Plan and Deferred Fee Plan
► Deductibility of premium payments for general and professional
liability coverage
► Incurred but not reported (IBNR) tax deduction amount


2012 — IRS Form 13837 — compliance check
information request

► The IRS requests confirmation of compliance with the
terms of the 2008 Closing Agreement entered into as a
result of the 2006 audit of TCF and affiliates.
► Response sent to IRS in Dallas
► Facts have changed with TCF acquiring CCA in 2010
► Compliance with the Closing Agreement is also being reviewed as
part of current audit being run out of Chicago


2012 — IRS audit of Carle Holding Company
(formerly CCA) for-profit 2010 federal return

► This particular year had a lot of activity that is of interest to
the IRS:
► CCA sold assets and stock to TCF as of April 1, 2010
► CCA was on a cash basis and had to convert to accrual after the
sale; retroactive back to January 1, 2010
► Sale generated a loss that was carried back to generate a refund
► Refund triggered the audit
► Determination of fair market value and the purchase price
allocation is being reviewed by IRS transaction specialists
► Carle used multiple third parties to help determine fair market
value (FMV) for the sale, so FMV should ultimately not be
an issue


2012 — IRS 990 audit of TCF and CFH fiscal year ended
June 30, 2010 and six months ended December 31, 2010

► In September 2012, the IRS notified Carle that they were
selected for audit. After receiving a host of Information
Document Requests (IDRs), an opening conference was
conducted in October 2012.
► The IRS indicated that this audit was not random. It was
the result of an independent referral (not a whistle–
blower) regarding the use of community assets in
acquiring Carle Clinic Association. Therefore, they would
be focusing on the process for determining FMV.
► The IRS indicated that the second primary driver of the
audit was to follow-up on the compliance with the 2008
IRS Closing Agreement.


2006 — IRS 990 audit, additional detail

► The 2006 audit summary:
► Ended up taking over two and one-half years
► Consumed over 1,000 man hours
► Cost over US$1,000,000 in legal services
► Revocation of tax-exempt status was referenced frequently
► Final result was a Closing Agreement
► Closing Agreement dictated operational and bylaw changes



► UBI:
► UBI had been reported correctly
► UBI would continue to be reported
► A lot of time spent on this



► Carle Retirement Center, an assisted living center:
► Was it affordable to a substantial portion of the elderly community?
► An affordability study every two years
► Results of study could drive a rate reduction regardless of
cost of care
► Charity care
► Parent charges related debt financing



► Historical practice of CCA renting space from tax-exempt
Carle Foundation:
► CCA had historically leased space from TCF
► FMV was not an issue
► No change to the current rental arrangement
► Divestiture of ownership of TCF facilities:
► Five facilities
► Actively marketed
► Sold at public auction after five years
► 15% limit on rentable space in new buildings to CCA



► Open medical staff policy and medical leadership
positions:
► Open staff policy continues
► Required to actively market the open staff policy
► Medical leadership could not be provided by a contract with an
independent physician employer
► Medical leaders needed to be employed/W-2 by TCF



► TCF board composition:
► Was limited by the bylaws due to the fact that physicians had to be
a minority of the Board
► 5 of 11 were physicians at this time
► Bylaws changed so that no more than 20% could be related
to CCA
► Physicians were limited to 30% maximum



► Physician coverage of hospital services:
► Payor differences for physicians covering hospital services (e.g.,
ED, Radiology, Pathology) had to be reviewed by TCF
► TCF required to try and ensure no payor differentials
► TCF to request physicians to accept out-of-network payment as
payment in full


Lessons learned summary

► Lessons learned:
► Documentation of all relationships is critical
► FMV consideration is a must
► What may be a good business relationship, even if documented
and within FMV, may not matter
► Document all replies
► If an audit appears to be getting off track, pull in outside legal and
tax professionals
► Be patient, reviews can go on for a long time
► The possibility of revocation of tax-exempt status is powerful


Other recent IRS audit issues

► UBTI (Unrelated Business Taxable Income) cost
allocations:
► Transfer pricing (“best method” rule)
► Tax methods (e.g., depreciation, recurring items, unicap, intangible
property and repairs regulations)
► Substantiation (substantial causal relationship)
► Continuous loss activities:
► Profit motive
► Netting
► Foreign filings:
► Accuracy and completeness
► 2012 Offshore Voluntary Disclosure Program Initiative (OVDPI)


Other recent IRS audit issues

► Fixed, determinable, annual, periodical (FDAP) payments
to non-US persons
► Withholding at the source
► Worker classification
► 1099 vs W-2


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