Donating Health Information Technology: Tax Issues Create Uncertainty for Donors
by Bernadette Broccolo and Heidi Echols, McDermott Will & Emery LLP , Chicago, IL
Effective October 10, 2006, the U.S. Department of Health and Human Services (" HHS") published final anti-kickback safe harbors and Stark regulatory exceptions for the donation (or below-market transfer) of health information technology and related services to referral sources (the " Final Regulations"). In general, the Final Regulations permit hospitals and other permitted donors to donate up to eighty-five percent (85%) of the cost of software and related information technology and training services (" HIT") that are necessary and used predominantly to create, maintain, transmit or receive electronic health records. The Final Regulations are detailed and complex and require compliance with numerous technical matters, including the requirement that the software be interoperable and that the donor and the recipient document the donation in a written agreement.
Nevertheless, the Final Regulations do present a road-map for compliance for certain entities that wish to promote the adoption of electronic health records through donations to physicians. However, HHS did not coordinate the Final Regulations with the Internal Revenue Service (" IRS"). In the absence of precedent and HHS / IRS coordination and guidance, there remains uncertainty regarding the impact of these donations on tax exemption matters and on physician income. Therefore, tax-exempt donors should act only after careful consideration of their donation and their relationship with the targeted recipient to avoid unintended tax consequences.
Private Benefit and Private Inurement Issues
Donors who are tax-exempt organizations must address whether providing HIT at an eighty-five percent (85%) discount to a taxable entity is consistent with the private inurement and private benefit prohibitions of section 501(c)(3) of the United States Tax Code (" Code"). The public policy underlying the new EHR anti-kickback safe harbor and Stark exception also supports the position that HIT donations serve a public, rather than a private, purpose. In general, the donation of EHR technology that augments an integrated hospital record is more likely to be seen as meeting the hospital's charitable purposes than donations of stand-alone EHR technology for a physician's office. In addition, donations of EHR that will result in an integrated network of data throughout a community are more likely to be seen as improving patient care in the community, again advancing the hospital's charitable purposes. However, the IRS has not yet addressed whether it will adopt this position and, if so, under what types of circumstances. To develop support for this position in the interim, tax-exempt donors should consider developing detailed business plans to document the community benefit objectives for donating the EHR software, including, for instance: (a) reduction of medical errors, (b) the delivery of more efficient health care, and (c) enhancement of the quality of care by supporting clinical decisions with more comprehensive patient information.
In addition to donations of software packages that provide EHR functionality, the Final Regulations also permit the donation of software packages that include other functionality related to the care and treatment of individual patients (e.g., billing, scheduling and other practice functions) so long as the predominant functions are EHR functions. Until the IRS issues guidance specifically addressing the exemption implications of donating items and services that assist a physician with practice management and operations, however, the more conservative approach will be for tax-exempt donors to elect not to fund practice management functions.
Income Reporting Issue
HIT donations to independent physician practices may be viewed as income to the physicians that should be reported by the donor through the issuance of a Form 1099 to the physicians for the value of the donated HIT. Issuance of a Form 1099 could give rise to potential additional tax liability for physicians, depending upon available deductions. A fear of additional tax liability could have a chilling effect on a physician's willingness to receive the donations.
From a tax reporting perspective, the analysis of whether to issue 1099s turns on whether the provision of the covered technology may qualify as a working condition fringe. A "working condition fringe" is defined as any property or services provided to an employee of the employer to the extent that, if the employee paid for the property or services, the payment would be allowable as a deduction under Code Section 162 or 167. Such property or services may be used only in connection with the employer's purposes. For purposes of working condition fringe benefits, the term "employee" includes independent contractors who perform services for the employer. If the physicians who will receive the donated technology can take the position that they are independent contractors for the donor, it is possible that the working condition fringe argument is valid for the applicable donation.
The Income Tax Regulations make clear that the property or services must be deductible with respect to the trade or business of being an employee of the employer. The IRS has broadly interpreted this requirement to mean that the employer derives a substantial business benefit from the provision of the fringe benefit.
Again, however, the IRS has not spoken to the question of whether the donation of EHR-related items and services is a "working condition fringe." At a minimum, a decision not to issue 1099s to physicians prior to issuance of such guidance should supported by documentation (e.g., in a detailed business plan or otherwise) showing: (1) how the donation of the covered technology to the physicians furthers the donor's charitable purposes, (2) what public benefit is created through the donation, and (3) what substantial business purposes are being served by the donor's offering the technology to the physicians. As with respect to the tax-exemption considerations discussed above, exclusion of the value of donated items in any case may be more difficult for practice management software functionality.
Given the tremendous amount of uncertainty in this area and the lack of IRS precedent in this area, the most conservative approach would be to issue 1099s to taxable physician practices and to advise physicians of the intent to do so prior to making the donation so that the physicians can seek their own tax advice in the area.