Case Studies in Recruiting and Employing Physicians:

Can We Do This?

Prepared for:

Region VII HCCA Compliance Conference

August 1, 2003

Westin Crown Center

Kansas City, Missouri

By: Julie A. Knutson, J.D.

of

Baird, Holm, McEachen, Pedersen, Hamann & Strasheim LLP

1500 Woodmen Tower

Omaha, Nebraska 68102

402-636-8327

© 2003 Baird, Holm, McEachen, Pedersen, Hamann & Strasheim LLP

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EXECUTIVE SUMMARY

Financial incentives play an important role for community hospitals that wish to recruit or retain physicians. However, recruitment incentives subject hospitals to liability under federal laws governing unlawful referrals and kickbacks. Nonprofit hospitals are further subject to the IRS regulations for tax-exempt organizations.

  1. Tax-Exempt Issues. A private, nonprofit hospital that is tax-exempt under section 501(c)(3) of the Internal Revenue Code must be cognizant of the fact that the recruitment and compensation packages offered by the hospital could jeopardize the organization’s tax-exempt status if they are not reasonable or if they result in inurement or excess private benefit. The applicable rules prohibit exempt organizations from using charitable money to benefit private individuals unless the private benefit is merely incidental to the public benefit derived from the charitable activity. Violators of this private inurement rule are subject to immediate sanctions involving taxes and penalties.
  2. Anti-Kickback Statute. The Federal Anti-Kickback Statute prohibits direct or indirect payment of remuneration with the intent to receive referrals. A violation is a felony, punishable by fines and imprisonment, although a violation may also result in exclusion from the Medicare and Medicaid program. The anti-kickback law contains several safe harbors which limit the potentially broad reach of the statute. Failure to fall within a safe harbor does not mean that the statute is violated per se, but the arrangement will be subject to a factual review including fair market value and an analysis of intent.

Safe Harbors: Recognizing the need to attract physicians to rural area hospitals, a safe harbor was developed to allow the recruitment of physicians in specialty areas by means that might otherwise violate the statute. This physician recruitment safe harbor is not all-encompassing as specific conditions must be met, including the requirement that a majority of the physician’s revenue come from new patients who reside in a health professional shortage area.

In addition, there is a statutory exception for compensation paid under a bona fide employment arrangement.

  1. Stark. The Ethics in Patient Referral Act (generally known as Stark) further prohibits physicians who have a financial relationship with an entity from ordering or referring patients to the entity for any “designated health service” paid by Medicare and Medicaid unless an exception exists. Penalties for violations include refusal of payment for any related claim and possible False Claims Act liability. Under Stark, it is imperative that any transaction involving a financial relationship between the physician and the hospital be covered by an exception since a Stark violation, unlike a violation of the anti-kickback law, is not affected by intent.

Exceptions: One exception for physician recruitment requires the physician to relocate his or her practice in order to become a member of the hospital’s medical staff. Another exception for employment allows a productivity bonus arrangement if it is based on services performed personally by the physician and such bonus is not directly related to the volume or value of the physician’s own referrals.

Given the multiple regulations governing physician recruitment and employment, it is important to understand that a physician recruitment arrangement that complies with the requirements for maintaining tax-exempt status may violate the anti-kickback or Stark self-referral laws. Despite this lack of uniformity among the regulations, the IRS and OIG rulings and opinions have clarified and set forth general guidelines for compliance. Accordingly, the general rule as it pertains to physician recruiting and employment is that hospitals may expend reasonable funds to recruit needed health care practitioners to a community, particularly in medically underserved areas. Specifically, a hospital should be concerned with the following matters:

·  Maintaining the hospital’s tax exempt status by ensuring the manner and method for computing the recruited physician’s incentive and compensation packages do not subject the organization to intermediate sanctions or jeopardize exemption.

·  Avoiding any violation of the anti-kickback rules by ensuring that recruitment incentives or packages are not prohibited remuneration intended to induce referrals of Medicare or Medicaid business to the hospital.

·  Ensuring the financial relationship created by payment of recruitment incentives falls under an exception to the Stark (Ethics in Patient Referral) Act.

© 2003 Baird, Holm, McEachen, Pedersen, Hamann & Strasheim LLP

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LEGAL PARAMETERS FOR PHYSICIAN RECRUITMENT

The following summarizes the legal authorities governing physician recruiting in private, nonprofit hospitals tax-exempt under section 501(c)(3) of the Internal Revenue Code. The general rule is that hospitals and other nonprofit/tax-exempt community organizations may expend reasonable funds to recruit needed health care practitioners to a community, particularly in medically underserved areas. The primary legal considerations are:

·  Maintaining the hospital’s tax exempt status by making certain that the amount of recruitment incentives and the manner in which such incentives are furnished do not provide grounds for intermediate sanctions or jeopardize exemption.

·  Avoiding any violation of Medicare Fraud and Abuse (anti-kickback) rules by assuring that recruitment incentives are not prohibited remuneration designed to induce referrals of Medicare or Medicaid business to the hospital.

·  Qualifying any financial relationship created by payment of recruitment incentives under an exception to the Stark (Ethics in Patient Referral) Act.

·  In the case of public hospitals, avoiding violation of the powers of the public hospital under state law.

I. IRS Issues. Three relatively recent sources of guidance from the IRS and Treasury Department provide specific insight into IRS physician recruitment standards, particularly in the context of recruiting nonemployee physicians. Of these sources, however, only Rev. Rul. 97-21 constitutes binding authority.

A. Internal Revenue Manual Audit Guidelines. Although these audit guidelines are no longer current, they still have instructive value with respect to factors that the auditor should consider in investigating the reasonableness of the recruiting activities of a hospital under audit. The audit guidelines suggest that auditors be on the alert for any of the following arrangements:

1. Physicians being charged no rent or below-market rent for space in hospital-owned office buildings;

2. Hospitals providing physicians with private practice income guarantees;

3. Hospitals providing financial assistance to physicians for home purchases and/or the purchase of office equipment; and

4. Outright cash payments by hospitals to physicians to secure or retain their services.

Although none of the above-described arrangements are prohibited per se, they have been viewed by the IRS as potential areas of abuse and are scrutinized closely during audits.

The Hospital Audit Guidelines further provided that, in order to establish that any loans, income guarantees or other subsidies used as recruiting incentives further charitable purposes and are reasonable, the specialist must be able to determine that there is a need for the physician in the community served by the hospital. “Absent evidence of a compelling community need or a significant other benefit to the community, the recruitment contract should require full repayment (at prevailing interest rates). Evidence of need may include the previous absence of practitioners in a given specialty, government studies of health manpower, patient travel patterns, etc.” Id. at 333.3(4).

The IRS Hospital Audit Guidelines acknowledged the reasonableness of guarantees of private practice income under certain circumstances:

·  Income is guaranteed for a one or twoyear period;

·  The physician is relocating his or her practice to the hospital’s service area;

·  There is sufficient evidence of need for the physician in the community;

·  The level of income guaranteed is reasonable;

·  There is a reasonable and explicit ceiling on total outlays by the hospital;

·  There is an unconditional obligation to repay any amounts advanced by the hospital; and

·  Any forgiveness is demonstrably related to community benefit and treated as compensation.

B. Hermann Hospital Closing Agreement. In the closing agreement entered between Hermann Hospital of Houston, Texas, and the IRS on September 16, 1994, Hermann Hospital was required to adopt a number of specific hospital-physician recruitment guidelines developed by the IRS as a condition to maintaining its tax-exempt status. (The closing agreement was also conditioned on a payment of approximately $1,000,000 by the hospital to the IRS.) Although these requirements are specifically applicable only to Hermann Hospital, and other hospitals are not bound by the closing agreement, they are indicative of the IRS position with respect to justification of physician recruiting incentives.

1. Public Benefit Requirements. The closing agreement set out six examples of conditions, one or more of which must apply in order for Hermann Hospital to pay recruiting incentives based on public benefit:

a. A population-to-physician ratio in the community deficient in the relevant specialty relative to the ideal ratio contained in Graduate Medical Education National Advisory Committee (GMENAC) reports;

b. Demand for a particular health service in the community for which the physician is being recruited, coupled with the documented lack of availability of the service or long waiting periods;

c. Designation of the community or area where the physician will serve when the agreement is executed, as a Health Professional Shortage Area as defined in Sections 5.1 through 5.4 of Title 42 of the Code of Federal Regulations;

d. A demonstrated reluctance of physicians to relocate to the hospital due to the hospital’s physical location (intended to refer to a hospital in a rural or economically disadvantaged inner city area);

e. A reasonably expected reduction in the number of physicians in the relevant specialty in the service area due to anticipated retirements during the next three years; or

f. A documented lack of physicians serving indigent or Medicaid patients within the service area, provided the recruit commits to serving a “substantial number” of Medicaid and charity care patients.

2. Income Guaranties. The closing agreement with Hermann Hospital permitted income guaranties, but specified that:

a. The guaranty must be limited to a two-year period with no modifications.

b. Certain additional incentives were prohibited, presumably because when added to the income guaranty, the overall level of incentives was no longer reasonable.

c. Any advances must be treated as a loan with a reasonable market rate of interest, with forgiveness tied to at least four years of continuing community services.

d. There must be a ceiling on the total amount of advances.

e. The total incentive package must be reasonable.

f. The recruited physician must permit the hospital to inspect his or her financial records.

C. Revenue Ruling 97-21. On April 21, 1997, the IRS released Rev. Rul. 97-21, which restates IRS Announcement 95-25 with some revisions. The release of Rev. Rul. 97-21 is significant because revenue rulings are precedential authority and because the revenue ruling is somewhat more liberal than other recent guidance. The revenue ruling contains the following five situations:

1. Situation #1: Rural hospital recruitment of recent OB-GYN graduate. Located in Health Professional Shortage Area. Only hospital in 100-mile radius. Signing bonus, malpractice premium for a limited period, office space for a limited period at a below-market rent, guarantee of personal residence mortgage, loan for start-up on reasonable terms.

2. Situation #2: Inner city hospital recruitment of out-of-area pediatrician to establish a practice and treat a reasonable number of Medicaid patients. Medicaid patients having difficulty obtaining pediatric services. Reimbursement for moving expenses, reimbursement for tail coverage for prior practice, net income guarantee for a limited number of years.

3. Situation #3: Inner city hospital recruitment of an existing member of its medical staff to provide obstetrical care to Medicaid and indigent patients. Medicaid and indigent patients do not have access to OB care. Reimbursement of one year’s malpractice premium in return for an agreement to treat a reasonable number of Medicaid and indigent patients.

4. Situation #4: Metropolitan area hospital recruitment of a diagnostic radiologist from another hospital in the same area. Hospital needs four radiologists; two have recently left. One of the most qualified candidates is at an area hospital. Net income guarantee for first few years.

5. Situation #5: Metropolitan area hospital whose recruiting activities resulted in conviction of a hospital for violation of the anti-kickback law because recruiting payments were payments for referrals.

The fact situation approach is similar to a 1969 hospital revenue ruling. The first four situations were found not to violate Section 501(c)(3) standards. The fifth situation (in which kickback violations were found) was held to violate such standards. In connection with a showing of community need, this ruling appears to require either presence in a medically underserved area or a study showing needs in particular specialties. This ruling does not address physician retention programs and none of the situations deal with recruitment into an existing practice. There is no specification of fixed time periods for recruiting incentives; all refer to a “limited period of time.” The income guarantees in these situations did not require paybacks. In all situations, the incentives were approved in accordance with the formal board policy or with specific board approval. The factual assumption by the IRS in each of the situations is that none of the physicians are insiders or disqualified persons, and that they do not have substantial influence over the affairs of the hospital that recruited them. Intermediate sanctions are not specifically addressed by the ruling but are clearly applicable if there are excess benefit transactions.

The IRS describes the nature of the community benefit resulting from recruitment as follows: “The community benefit to which the recruitment incentive is compared is the value of the physician to the community. For example, a determination that the physician enhances the productivity of the hospital (other than by simply referring patients), provides a new service or brings a needed specialty to the community are indicative of community benefit that may justify a reasonable recruitment incentive. To demonstrate a need in the community for a particular physician’s services, the hospital should document such indicators as the previous absence of practitioners in a given specialty, governmental studies of health manpower, or patient travel patterns.”