By Karl A. Thallner, Jr., Esq
An Internal Revenue Service ruling that was recently made public provides rare but helpful guidance on physician recruitment arrangements by tax-exempt hospitals. The unreleased Private Letter Ruling (PLR) is dated July 31, 1998, but was not revealed until this past July. The 1998 PLR is important because it allows a hospital, at least under some circumstances, to recruit new physicians into existing medical practices and to provide recruitment incentives to physicians already practicing in the same community as the hospital.
As hospitals have extended their missions beyond their four walls to the promotion of the general health of the communities that they serve, increasingly they have sought to recruit physicians to provide needed but unavailable medical services in their communities. In many cases, start-up costs and business risks have made it difficult to find physicians willing to commit to serve these communities. Hospitals have been prepared to provide various types of financial assistance to attract these physicians, but these physician recruitment arrangements often raise difficult legal issues.
In the past, the IRS has provided limited and cautious guidance on how financial assistance aimed at recruiting physicians would affect a hospital’s tax-exempt status. In 1997, the IRS issued Revenue Ruling 97-21, which represented the IRS’ first direct guidance on physician recruitment by charitable hospitals. In that ruling, the IRS described and commented on five fact patterns involving physician recruitment. The first situation involved a rural hospital’s recruitment of an obstetrician/gynecologist who just completed a residency program; the second situation concerned an inner-city hospital’s recruitment of an out-of-area pediatrician; in the third situation, an inner city hospital was recruiting an obstetrician to provide care to indigent patients; and the fourth situation involved a metropolitan area hospital recruiting a diagnostic radiologist from another hospital in the same area.
The IRS determined that the hospital recruitment in each of these situations would not adversely affect the hospital’s tax exempt status. The fifth situation involved a hospital that had been convicted of violating the Anti-Kickback Statute as a result of the recruitment incentives it provided to physicians, and the IRS concluded that in that case the hospital had not complied with IRS requirements.
Due to the dearth of guidance on physician recruitment, the 1997 ruling provided a welcome framework for analyzing the legality of physician recruitment arrangements. However, because the 1997 guidance addressed only a limited number of fact patterns, it left unanswered many questions that arise frequently in physician recruitment. For example, left unanswered was whether a hospital could assist an existing medical practice recruit a new physician to join the practice, whether the approval of “cross-town recruitment” as contemplated by the fourth scenario would be limited to physicians who are not in a position to refer to the hospital, and whether physician retention (as opposed to recruitment) incentives are permissible. The 1998 PLR provides additional guidance in several areas, including the first two of these questions.
The 1998 PLR responded to two types of proposed recruitment activities presented by an undisclosed requesting hospital to the IRS. The first activity would involve the hospital’s recruitment of new physicians to join an established medical group to practice medicine full time in the community served by the hospital. In that situation, the hospital would enter into arrangements with the medical group whereby it would provide advances to assure a guaranteed level of monthly income to the new physician for up to three years.
In addition, the hospital would provide a signing bonus, reimbursement of reasonable relocation expenses, a payment for marketing activities and other incentives. The guaranteed income level would be based on compensation surveys that would show it to be reasonable. The medical group would have an obligation to repay prior advances to the extent that the physician’s net income exceeds the guaranteed amount during any calendar month of the guarantee period. In addition, the medical group would be required to repay the outstanding balance of all advances after the end of the guarantee period, but the hospital would forgive the repayment obligation if the physician continues to practice in the community for three additional years.
In the second proposed activity addressed in the 1998 PLR, the hospital would provide certain recruitment incentives to physicians currently practicing in the hospital’s service area. The recruited physicians would relocate their practices to community health centers developed by the hospital to provide specialized non-tertiary inpatient and outpatient services in growing areas served by the hospital and its health system. The physicians recruited would have been practicing in the service area for less than four years and would not have established a meaningful practice at their current practice sites.
The recruitment incentives would include advances to guarantee an income level for one year, an advance of funds necessary to terminate pre-existing office space lease obligation and other incentives. Like the proposed arrangements for new physicians, the advances would be subject to a repayment obligation and the potential for forgiveness if the physician maintains a full time practice in the community for three years.
In the 1998 PLR, the IRS concluded that the proposed recruitment arrangements would not adversely affect the hospital’s tax-exempt status. The IRS determined that the arrangements were necessary and reasonable to further the charitable mission of the hospital. The 1998 PLR can be relied upon only by the requesting hospital and only with respect to the particular facts. Nevertheless, the ruling speaks to previously unaddressed issues and provides useful information on the IRS’ views. Among the lessons that can be derived from the 1998 PLR are the following:
• A recruiting hospital must have objective evidence of the need for the services of the recruited physicians in the community and the reasonableness of the amount of support provided. The requesting hospital in the 1998 PLR had conducted a community needs assessment demonstrating the need for additional primary care physicians and other specialists in the areas in which the physicians would serve, and based the guaranteed income amount on market data that demonstrated it to be reasonable for the physicians’ services.
• For the first time, the IRS endorsed a charitable hospital’s recruitment of a new physician into an existing medical practice. Prior IRS guidance had been limited to recruitment of physicians to establish new practices.
• The 1998 PLR clarifies that loan forgiveness of as much as 100 percent of the advances made to guarantee a recruited physician’s compensation is permissible. On the basis of a prior settlement between a hospital and the IRS, some had thought that the IRS would condone forgiveness of only 50 percent of a hospital’s advances.
• Most of the recruitment arrangements approved in Revenue Ruling 97-21 involved a hospital’s subsidization of the physician’s practice for a “limited” but unspecified period. By approving arrangements that provide income guarantees for three years (in the case of recruitment of new physicians) and one year (in the case of cross-town recruitment), the 1998 PLR provides some clearer indication of the permissible duration of recruitment support.
• For the first time, the IRS endorsed a “cross-town” recruitment arrangement involving physicians who would be in a position to refer to the hospital. In Revenue Ruling 97-21, the most analogous scenario involving cross-town recruitment pertained to a diagnostic radiologist, who the IRS specifically said was not a source of referrals to the hospital.
• Although permitting the cross-town recruitment of referring physicians, the IRS continues to be concerned about incentives that might be aimed at influencing existing referral patterns significantly. The 1998 PLR was clearly based on the understanding that the physicians recruited from the community would have been practicing there for less than four years and had not established a significant patient base. Additionally, the recruited physicians would not be targeted as a source of referrals to the hospital, and would not be prohibited from establishing privileges or making referrals to other hospitals.
Although the 1998 PLR provides additional guidance on physician recruitment arrangements, it does not address several issues that may arise, including the following:
• The IRS has not addressed the permissibility of physician retention incentives. Thus, it is unclear, for example, whether a physician practicing in a community served by one hospital can be offered a financial incentive to stay in that community if, for example, a second hospital offers the physician a recruitment incentive to serve the second hospital’s community.
• The 1998 PLR does not address the compliance of the proposed recruitment arrangements with the new intermediate sanctions law. That law imposes an excise tax where a tax-exempt organization enters into an “excess benefit transaction” with a “disqualified person.” In most recruitment situations, the recruited physician is unlikely to be a disqualified person because he is unlikely to be able to exercise substantial influence over the organization. Nevertheless, the intermediate sanctions law enables the transaction parties to avail themselves of a rebuttable presumption of reasonableness if board approval and other procedural steps are followed. It may be prudent to ensure that those procedural steps are followed in physician recruitment arrangements.
• In addition to the tax issues, hospitals and physicians involved in recruitment arrangements must also take care not to run afoul of fraud and abuse laws. The Office of Inspector General of the Department of Health and Human Services has proposed a safe harbor from violation of the federal Anti-Kickback Statute for physician recruitment arrangements. That proposed safe harbor is limited to recruitment by a rural hospital or other entity in a rural area of a physician who would be relocating. Care should be taken to assess whether a particular recruitment arrangement could be assailed as violating the Anti-Kickback Statute.
• The federal Stark law prohibits referrals for certain services by a physician to an entity, such as a hospital, with which the physician has a financial relationship. An exception to the Stark referral prohibition exists for physician recruitment arrangements by a hospital, but the exception applies only if the physician is relocating to the hospital’s geographic area. Other exceptions may apply, depending on the nature of the recruitment arrangement. Recruitment arrangements should be developed with an eye to compliance with all applicable laws, including Stark.
Financial incentives can be an important tool for hospitals to attract physicians to provide needed health services in their communities. Limited guidance from the IRS has been available to clarify the types of recruitment arrangements that can be offered by tax-exempt hospitals, but the 1998 PLR provides some helpful additional instruction on these arrangements. In addition to compliance with tax laws, however, recruitment arrangements must also comply with fraud and abuse laws.
Karl A. Thallner, Jr., Esq., is a partner with the law firm of Reed Smith Shaw & McClay LLP, where he heads the health care law practice of the firm’s Philadelphia office.