Health Care Finance ForProfit vs' NotForProfit

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Health Care Finance For-Profit vs.
Not-For-Profit

• Developed and narrated by C. A. Galeener, PhD

This module is provided by the Texas Public
Health Training Center in part through a grant
supplied by the Public Health Training Center
Program, Health Resources and Services
Administration, U.S. DHHS
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Module preamble

• This module is part of a course that provides an
  intermediate level of competence in the Financial
  Planning and Management Skills competency domain.
  The material is from graduate level Healthcare
  Finance classes.
• The module should take about 60 minutes to
  finish. At the end you can test yourself on
  concepts.

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Module objectives

• At module completion you should understand
• - How for-profits (FPs) provide returns to
• society
• - Requirements for NFP status
• - Different kinds of NFPs and legal issues
• - How society subsidizes NFPs
• - Special considerations of NFP finance
• - The size of the NFP sector
• Nothing in this module should be construed as
  legal or tax advice.

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Roadmap
Public Sector
Private Sector
Not-for-Profit (NFP)
For-Profit (FP)
Government and Instrumentalities
Sole Proprietorships
Partnerships
Corporations
Organizational Forms
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For-profit enterprise relies on private ownership
concepts

• Why private ownership?
• Utility
• Efficiency
• Solve social dilemmas
• Barrier to rapacious government.

California Div Real Estate http//www.dre.ca.gov
/subs_sub.htm
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Rights of ownership

• Disposition
• Alienable vs. inalienable rights
• Real assets, financial assets, intellectual
  property

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How for-profit enterprise fulfills social purpose

• Profit maximization
• Ensures renewal
• Drives efficiency
• Provides return
• Pays taxes

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How for-profit enterprise fulfills social purpose

• Consumer utility enhanced
• Markets reflect the
• values of consumers
• Caveat negative
• externalities

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How for-profit enterprise fulfills social purpose

• Inefficient businesses disappear.
• Creative destruction
• Assets redeployed
• Innovation fostered
• Need to mitigate impact
• on workers displaced

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Strong FP oversight mechanisms

• Continuous, strong, vested
• Market feedback on management performance
• Financial analyst assessments
• Share values

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Examples of health-related for-profit businesses

• Quest Diagnostics, Inc.
• Pfizer Pharmaceuticals, Inc.
• Allergan, Inc.
• Houston Eye Associates
• Dr. E. Jones Family Practice
• Hospital Corp. of America, Inc.

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Roadmap
Public Sector
Private Sector
Not-for-Profit (NFP)
For-Profit (FP)
Government and Instrumentalities
Sole Proprietorships
Partnerships
Corporations
Organizational Forms
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Health NFP historical background

• Charitable activity grounded in
• religions/ cultures
• Early development of health facilities
• Hospitals in western Europe

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Modern legal framework

• Charitable Uses Act (1601)
• Poor Relief Law (1601)
• Impact on other legal systems
• Public benefit test

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U.S. tendency to form public associations

• Evident in the Republic very early
• Every man an aristocrat
• International NGOs

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Not-for-profits evolution

• Changing needs/ status as government has assumed
  the safety net role
• Social Security for elderly and disabled
• Medicare and Medicaid
• Poverty relief programs food stamps,
• WIC, SCHIP and others.
• Why do NFPs persist?

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Not-for-profits key concepts

• Many types of NFPs
• Tax effects on organization
• Differing donor tax effects
• How you get recognition as a NFP

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What is a NFP? (per the IRS)

• Tax exempt refers here to the status of the
  organization not the effect on donor.
• Two most common types
• 501(c)(3) poor relief, educational, etc.
• gt200K public charities file
• gt50K private foundations grant-making/
• operating

501(c)(4) social welfare organizations gt120K
file under this other types NFP
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501(c)(3) who can be exempt

• Organization Corporation, community chest, fund
  or foundation with activities recognized under
  501(c)(3) by the IRS
• Exempt purposes include charitable, religious,
  educational, scientific, literary, testing for
  public safety, fostering national or
  international amateur sports competition, and the
  prevention of cruelty to children or animals.

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Charitable purposewide-ranging but not
unlimited

• The term includes relief of the poor, the
  distressed, or the underprivileged advancement
  of religion advancement of education or science
  erection or maintenance of public buildings,
  monuments, or works lessening the burdens of
  government lessening of neighborhood tensions
  elimination of prejudice and discrimination
  defense of human and civil rights secured by law
  and combating community deterioration and
  juvenile delinquency.

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Examples of 501(c)(3)s

• Consumers Union educational
• Ford Foundation private foundation
• United Way public charity
• Campus Cat Coalition feral cat neutering
• Red River Athletic Conf. amateur sports
• Low Income Taxpayer Clinics defined by statute
  Fed matching funds available
• Howard Hughes Medical Research Foundation
  scientific

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A few 501(c)(3) statistics

• As of 2001, 501(c)(3) filers had
• 1.0Trillion in net worth
• 895B in total revenue
• 211B in contributions
• 122B in public contributions
• 89B in government grants
• 630B in program service revenue
• 861B in total expenses
• 739B in program expenses
• 109B in management/ general expenses
• Source IRS

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Source http//www.guidestar.org/news/features/fd
tn_expense_2005.pdf
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What 501(c)(3)s cannot do

• Pay earnings to private
• shareholders
• Distribute assets to
• individuals or for-profits
• Lobby for legislation
• Campaign for/ or against political candidates

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U.S. Hospitals as charitable entities

• Precedent set during Civil War
• 1923 charitable as relief of poverty
• 1956 financial ability standard
• 1969 community benefit standard
• Reference http//www.abanet.org/health/esource/
  vol1no8/flynn.html

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NFPs and taxation

• IRS -- NFPs exempt from federal tax
• State law -- exemption from state taxes
• Property tax exemption may be at county level

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Losing tax exempt status through self-dealing

• Excessive compensation
• Compensation on a basis
• Distribute excess earnings as bonuses
• Give away assets to insiders

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Most hospitals in U.S. are NFPs

• 2003 data (http//www.bizstats.com/empr
  odhealth.htm)
• Taxable 1345 with 40B revenue
• Exempt 5340 with 330B revenue

Health Care NFPs received 93.2 of revenues from
selling program services (2001, IRS).
Question Do FP and NFP hospitals behave
differently?
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501(c)(4) social welfare

• Must be at least community-wide
• Civic associations qualify tenant, homeowner
  and social clubs do not.
• Exempt from paying taxes on earnings donations
  generally not tax deductible
• May lobby for germane legislation
• - Dues allocated to lobbying not tax exempt
• - Other aspects of political process unclear

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Examples of 501(c)(4)s

• NAACP
• National Rifle Association
• National Organization of Women
• National Association of Cancer Patients
• Note the advocacy nature of these
• Often a 501(c)(4) controls a 501(c)(3)
  education foundation.

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NFPs and tax rules

• NFP income generally tax exempt.
• NFPs are liable for unrelated business income
  tax (UBIT).
• NFPs cannot just sit on large portfolios.

Question Why are hospital gift shops staffed by
volunteers?
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Society and NFP tax treatment

• Society subsidizes contributions.
• Untaxed business sector
• - gt 5.3 of NDP
• - NFPs producing private goods generate
• 3.4 of economys NDP.
• although business income not related to a
  nonprofits mission is subject to tax, much of it
  escapes taxation. (CBO, Taxing the Untaxed
  Business Sector, July 2005)

Question what would happen if the Feds taxed
NFPs on these gains?
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NFPs can finance cheaply

• For an investor in the 30 marginal tax bracket

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Test yourself on the material

• Select the best answer by clicking on the box.
  You will then find out if you were correct and
  the reasoning behind the correct answer.

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Whether a NFP is exempt from local property and
sales taxes is usually defined by
Common law
State law
Federal law
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Whether a NFP is exempt from local property and
sales taxes is usually defined by

Common law
State law
Federal law
State laws generally control what is/ is not
taxable at the state/ local level. Under our
federal system each layer of government carefully
watches its rights, particularly what is taxed.
The federal government, through the IRS,
recognizes what organizations are exempt from
federal taxes.
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Most hospitals in the U.S. are organized as

Corporations
Partnerships
Sole Proprietorships
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Most hospitals in the U.S. are organized as

Corporations
Partnerships
Sole Proprietorships
Most hospitals in the U.S. are organized as
not-for-profit corporations. Recall that
partnerships and sole proprietorships have
ownersand not-for-profits cannot have owners.
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501(c)(3) NFPs are prohibited from

Paying their employees significantly more than
going rates for comparable work.
Educational activities.
Seeking donations from corporations
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501(c)(3) NFPs are prohibited from

Paying their employees significantly more than
going rates for comparable work.
Educational activities.
Seeking donations from corporations
NFPs cannot distribute excess profits to anyone
including employees or they risk losing their
tax exemption. If they paid outrageously high
salaries they would be doing just that, and
society would be footing part of the bill through
the tax exemption of the NFP and the tax
deductibility of donations.
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Source of low cost NFP hospital financing

Unrelated business income
Contributions
Contributions and tax exempt bonds
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Source of low cost NFP hospital financing

Unrelated business income
Contributions
Contributions and tax exempt bonds
The correct answer is both contributions and tax
exempt bonds. There is a cost to generate
contributions but it is (or should be) low
relative to total contributions. Hospitals can
also typically issue bonds that are tax exempt to
the lender and so the hospital can borrow at
below market rates.
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The majority of NFP income comes from

Unrelated business income
Contributions
Program service revenue
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The majority of NFP income comes from

Unrelated business income
Contributions
Program service revenue
The correct answer is program service revenue
which is about three times as large as
contributions.
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Thank youYou have completed the Profits vs
Not-For-Profits module

• Other modules in the Health Care Finance Course
  you may find of interest may be accessed from
• www.txphtrainingcenter.org