Why Many Nonprofit (Wink, Wink) Hospitals Are Rolling in Money

One owns a for-profit insurer, a venture capital company, and for-profit hospitals in Italy and Kazakhstan; it has just acquired its fourth for-profit hospital in Ireland. Another owns one of the largest for-profit hospitals in London, is partnering to build a massive training facility for a professional basketball team, and has launched and financed 80 for-profit start-ups. Another partners with a wellness spa where rooms cost $4,000 a night and co-invests with “leading private equity firms.”

Do these sound like charities?

These diversified businesses are, in fact, some of the country’s largest nonprofit hospital systems. And they have somehow managed to keep myriad for-profit enterprises under their nonprofit umbrella — a status that means they pay little or no taxes, float bonds at preferred rates, and gain numerous other financial advantages.

Through legal maneuvering, regulatory neglect, and a large dollop of lobbying, they have remained tax-exempt charities, classified as 501(c)(3)s.

“Hospitals are some of the biggest businesses in the U.S. — nonprofit in name only,” said Martin Gaynor, an economics and public policy professor at Carnegie Mellon University. “They realized they could own for-profit businesses and keep their not-for-profit status. So the parking lot is for-profit; the laundry service is for-profit; they open up for-profit entities in other countries that are expressly for making money. Great work if you can get it.”

Many universities’ most robust income streams come from their technically nonprofit hospitals. At Stanford University, 62% of operating revenue in fiscal 2023 was from health services; at the University of Chicago, patient services brought in 49% of operating revenue in fiscal 2022.

To be sure, many hospitals’ major source of income is still likely to be pricey patient care. Because they are nonprofit and therefore, by definition, can’t show that thing called “profit,” excess earnings are called “operating surpluses.” Meanwhile, some nonprofit hospitals, particularly in rural areas and inner cities, struggle to stay afloat because they depend heavily on lower payments from Medicaid and Medicare and have no alternative income streams.

But investments are making “a bigger and bigger difference” in the bottom line of many big systems, said Ge Bai, a professor of health care accounting at the Johns Hopkins University Bloomberg School of Public Health. Investment income helped Cleveland Clinic overcome the deficit incurred during the pandemic.

When many U.S. hospitals were founded over the past two centuries, mostly by religious groups, they were accorded nonprofit status for doling out free care during an era in which fewer people had insurance and bills were modest. The institutions operated on razor-thin margins. But as more Americans gained insurance and medical treatments became more effective — and more expensive — there was money to be made.

Not-for-profit hospitals merged with one another, pursuing economies of scale, like joint purchasing of linens and surgical supplies. Then, in this century, they also began acquiring parts of the health care systems that had long been for-profit, such as doctors’ groups, as well as imaging and surgery centers. That raised some legal eyebrows — how could a nonprofit simply acquire a for-profit? — but regulators and the IRS let it ride.

And in recent years, partnerships with, and ownership of, profit-making ventures have strayed further and further afield from the purported charitable health care mission in their community.

“When I first encountered it, I was dumbfounded — I said, ‘This not charitable,’” said Michael West, an attorney and senior vice president of the New York Council of Nonprofits. “I’ve long questioned why these institutions get away with it. I just don’t see how it’s compliant with the IRS tax code.” West also pointed out that they don’t act like charities: “I mean, everyone knows someone with an outstanding $15,000 bill they can’t pay.”

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Hospitals get their tax breaks for providing “charity care and community benefit.” But how much charity care is enough and, more important, what sort of activities count as “community benefit” and how to value them? IRS guidance released this year remains fuzzy on the issue.

Academics who study the subject have consistently found the value of many hospitals’ good work pales in comparison with the value of their tax breaks. Studies have shown that generally nonprofit and for-profit hospitals spend about the same portion of their expenses on the charity care component.

Here are some things listed as “community benefit” on hospital systems’ 990 tax forms: creating jobs; building energy-efficient facilities; hiring minority- or women-owned contractors; upgrading parks with lighting and comfortable seating; creating healing gardens and spas for patients.

All good works, to be sure, but health care?

What’s more, to justify engaging in for-profit business while maintaining their not-for-profit status, hospitals must connect the business revenue to that mission. Otherwise, they pay an unrelated business income tax.

“Their CEOs — many from the corporate world — spout drivel and turn somersaults to make the case,” said Lawton Burns, a management professor at the University of Pennsylvania’s Wharton School. “They do a lot of profitable stuff — they’re very clever and entrepreneurial.”

The truth is that a number of not-for-profit hospitals have become wealthy diversified business organizations. The most visible manifestation of that is outsize executive compensation at many of the country’s big health systems. Seven of the 10 most highly paid nonprofit CEOs in the United States run hospitals and are paid millions, sometimes tens of millions, of dollars annually. The CEOs of the Gates and Ford foundations make far less, just a bit over $1 million.

When challenged about the generous pay packages — as they often are — hospitals respond that running a hospital is a complicated business, that pharmaceutical and insurance execs make much more. Also, board compensation committees determine the payout, considering salaries at comparable institutions as well as the hospital’s financial performance.

One obvious reason for the regulatory tolerance is that hospital systems are major employers — the largest in many states (including Massachusetts, Pennsylvania, Minnesota, Arizona, and Delaware). They are big-time lobbying forces and major donors in Washington and in state capitals.

But some patients have had enough: In a suit brought by a local school board, a judge last year declared that four Pennsylvania hospitals in the Tower Health system had to pay property taxes because its executive pay was “eye popping” and it demonstrated “profit motives through actions such as charging management fees from its hospitals.”

A 2020 Government Accountability Office report chided the IRS for its lack of vigilance in reviewing nonprofit hospitals’ community benefit and recommended ways to “improve IRS oversight.” A follow-up GAO report to Congress in 2023 said, “IRS officials told us that the agency had not revoked a hospital’s tax-exempt status for failing to provide sufficient community benefits in the previous 10 years” and recommended that Congress lay out more specific standards. The IRS declined to comment for this column.

Attorneys general, who regulate charity at the state level, could also get involved. But, in practice, “there is zero accountability,” West said. “Most nonprofits live in fear of the AG. Not hospitals.”

Today’s big hospital systems do miraculous, lifesaving stuff. But they are not channeling Mother Teresa. Maybe it’s time to end the community benefit charade for those that exploit it, and have these big businesses pay at least some tax. Communities could then use those dollars in ways that directly benefit residents’ health.

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