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IRS Interim Tax Sanctions for physicians

By Joan M. Roediger, JD, LLM

While much has been written about Stark and the Anti-Kickback rules, little attention has been devoted to a tax law enacted in 1996 which applies to transactions between physicians and tax-exempt organizations such as hospitals and other tax-exempt organizations.

This law, which applies to all transactions with non-profit organizations after September 14, 1994, is commonly referred to as the “Interim Sanctions” provisions. Prior to the enactment of the Interim Sanctions provisions, the IRS’s only recourse, when it determined that a party to a transaction received an unfair benefit, given their position within the organization, was to revoke the tax-exempt status of the tax-exempt organization.

The Interim Sanctions provisions provide an intermediate checks and balance measure for the IRS to impose financial penalties upon the parties to the excess benefit transaction. Imposition of Interim Sanctions does not preclude loss of tax-exemption. Rather, imposition of Interim Sanctions may be imposed by the IRS in addition to the loss of the tax-exempt status.

Recent guidance, in the form of regulations, was issued by the IRS to assist in the interpretation of this law.

This law and regulations apply to persons who are in a position to exercise substantial influence over the affairs of a tax-exempt organization at any time during the five-year period preceding the date of the questionable transaction. These individuals are called “disqualified persons.”

While at first blush this may not seem applicable to most physicians, consider the guidance offered in the new regulations. The new regulations clarify that “substantial influence” is likely present where an individual (1) is a voting member of the organization’s governing body (e.g., Board of Directors or Board of Trustees); (2) is an executive officer of the organization such as CEO, COO or President; (3) has authority for managing the finances of the organization (e.g., Treasurer or CFO); or (4) has a material financial interest in a Medicare+Choice provider-sponsored organization which is owned, at least in part, by an exempt organization.

Substantial influence is also present when an individual’s compensation is primarily based on revenues from activities that the individual controls. Significant influence is further indicative where an individual manages a discrete segment or activity of the organization that represents a substantial part of the activities, assets, income or expenses of the organization, as compared to the organization as a whole. Consider the hospital-employed physician who is compensated based upon his or her revenues or the physician whose medical practice represents a large percentage of the hospital’s revenue. Based upon the guidance in the regulations, these physicians would likely be deemed disqualified persons, and thus subject to this law.

The new regulations have, however, established an exception called the “initial contract rule.” Under this exception, individuals who enter into a contract for a fixed payment with exempt organizations with which they have no previous relation, are not considered disqualified individuals, provided the transaction is negotiated at arm’s length. However, any non-fixed, or discretionary, payments to be made pursuant to the contract will be subject to analysis under the Interim Sanctions law.

Transactions that are subject to this law are known as excess benefit transactions. The Internal Revenue Code defines an excess benefit transaction as any transaction in which the economic benefit that is provided, directly or indirectly, by a tax-exempt organization to an individual exceeds the fair market value for the consideration received by the tax-exempt organization. Examples of transactions affecting physicians that may be subject to this tax are practice sales, practice divestitures, employment arrangements, medical director agreements, leases, practice plans, and independent contractor arrangements.

When determining if a transaction is an excess benefit transaction, the IRS will consider not only compensation received by the disqualified individual, but also any other benefit received by the individual, except the value of certain non-taxable fringe benefits and benefits provided to volunteers or charitable beneficiaries. This may include such items as salary, bonus, luxury travel or paid travel of a spouse, property given to the individual and certain insurances paid by a tax-exempt organization. Ironically enough, the regulations suggest that, notwithstanding the other legal implications, embezzled amounts by a disqualified individual are also to be considered as an economic benefit and are thus subject to this law.

In determining fair market value, the total compensation for the services provided should be compared with the amount that would ordinarily be paid for similar services by other similar organizations. Unfortunately, what constitutes “reasonable compensation” is often uncertain as every transaction must be evaluated separately given the applicable facts and circumstances.

Also note that the new regulations do not provide guidance regarding revenue sharing transactions. For physicians and tax-exempt organizations alike, this has been a subject of great confusion over the past few years. Both the IRS and OIG have issued conflicting opinions regarding the legitimacy of revenue sharing or gain sharing transactions. The IRS reserved the ability to issue regulations in the future that address revenue sharing.

The preamble to the new regulations suggests that fair market value can be evaluated by a tax-exempt organization by reviewing current comparability data. This data may be obtained from commercially prepared compensation surveys, internal information collected by the tax-exempt organization or by obtaining an independent opinion regarding the fair market value of the transaction.

The comparable data that is used must, however, be analogous to your particular situation. When using commercially, nationally prepared compensation surveys, review the information to see if it is truly comparable to your situation. Reliance on commercially prepared national compensation surveys may not qualify as sufficient comparable information. For instance, a commercially prepared survey may not include all of the aspects of compensation as required by the regulations, nor may it accurately reflect the market conditions of fair market value in your local medical community. Regardless of which resources are used in your fair market value determination, make sure you document what steps were taken to validate the fair market value of your transaction.

If a transaction is found to be an excess benefit transaction, a two-tiered tax will be imposed upon the recipient of the excess benefit. The first-tier tax is equal to 25 percent of the excess benefit. Additionally, the tax-exempt organization’s managers who participated in the excess benefit transaction knowingly, willingly and without reasonable cause, are subject personally to a 10 percent tax on the excess benefit up to a maximum of $10,000 per transaction.

If the disqualified individual does not pay the first-tier 25 percent tax within the prescribed time period, the second-tier tax, equal to 200 percent of the excess benefit, will be imposed on the disqualified individual. Note the second-tier tax is not applicable to organizational managers.

To prevent the likelihood of the imposition of this tax, transactions involving disqualified individuals with tax-exempt organizations will be granted a rebuttable presumption that a transaction is not an excess benefit transaction provided certain procedures are followed.

First, the authorized governing body of the organization must approve the transaction. This governing body must not include individuals that are related to or are subject to the control of the disqualified individual. Second, the applicable governing body must have relied upon appropriate data to determine the fair market value of the transaction in question. Finally, third, the governing body must have adequately and promptly documented its approval of the transaction and the basis for its determination that the transaction in question is reflective of the fair market value for the transaction.

As with many health care related laws and regulations, these regulations are extremely complex. If you are uncertain whether or not this law is applicable to you, seek professional guidance. It is important that you determine if this law is applicable to you and correct any possible excess benefit transactions prior to a tax audit. If prevented or mitigated prior to an audit, the interim sanction taxes to you, the physician, may be prevented. Also recognize that this tax in no way invalidates or supercedes any other applicable laws, including, but not limited to Medicare laws and regulations. Careful consideration of all applicable laws and regulations should be done with all health care transactions, including those with tax-exempt organizations.

Joan M. Roediger, J.D., L.L.M., is Of Counsel to the law firm Obermayer Rebmann Maxwell & Hippel LLP and is a Member of Obermayer’s Health Law Department.

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