Health Law Section September 1998 Newsletter Articles

 

IRS Offers Guidelines on Physician Recruitment
by Margaret G. Klein

Report from the Chair
by Howard Levine

Professional Limited Liability Companies
by E. Stephen Jett

HCQIA Immunity for Hospital Prevails Over Antitrust Claim
by Harry B. Ray

Hospitals, Schools & Other Exempt Organizations Should Act Promptly to Correct Defects in Section 403(b) Plans
by Whitney Durand

One of the most significant recent developments in the health law field is the Internal Revenue Service (IRS) settlement agreement with Hermann Hospital in Houston, Texas, signed on Sept. 16, 1994.
As part of the settlement, the IRS required that the closing agreement be made public, a sign that the agency wanted to send a strong “cease and desist” message to all hospitals involved in questionable physician recruitment activities.1 The IRS’s insistence on publication was not designed merely to punish Hermann.
For a long time, hospitals and their attorneys have been looking for guidance in the area of physician recruitment and retention of existing staff physicians. They were unsure how far they could go when offering incentives and how severe the penalties would be for a violation of the anti-kickback statute or the prohibition against private inurement under Section 501(c)(3). Last year’s eagerly awaited draft “safe harbors” provided little assistance, since they dealt with physician recruitment in rural areas. To the surprise of many health care attorneys, the government’s views on physician recruitment incentives have now been made public by means of a settlement involving a single taxpayer.
Hermann Hospital is a 560-bed, not-for-profit facility in Houston which decided to “come clean” and voluntarily disclose to the IRS certain perceived problems with its physician recruitment practices in fiscal years 1989 through 1992. There was little doubt that these activities constituted prohibited private inurement or private benefit in violation of Section 501(c)(3) requirements. The hospital realized that its tax-exempt status could be in jeopardy, since the violations were clear-cut and rather egregious— “perhaps the worst we had seen to date,” in the words of one assistant IRS commissioner.
The hospital had offered generous recruitment packages including income guarantees, office personnel salary support, free office space, subsidized parking, malpractice insurance, telephone allowances, equipment loans, and loan guarantees, most of the time with no repayment obligation and no requirement to perform specified duties in return. Not only were these benefits provided to recruits from outside the area, they were offered to physicians already practicing in
Houston, and in addition the hospital was providing lucrative incentives to full-time faculty at the University of Texas Medical School. Some of the
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hospital’s out-patient departments were operated like private practice offices for the physicians.
The settlement negotiated with the IRS after 14 months of review and discussion included stiff penalties that enabled Hermann Hospital to avoid revocation of its tax-exempt status. The hospital agreed to pay almost $1 million, the amount which it would have paid in the fiscal year ending September 1991 had it been a taxable entity, plus $9,700 in additional penalties. It also agreed to adhere to a stringent set of guidelines that were to be published in one or more Houston area newspapers and through one or more national tax services. The hospital agreed to make it known that it had been conducting improper recruiting activities and that it had voluntarily sought negotiations with the IRS.
The guidelines begin with the following key definitions:
Existing Physician: Non-employee physician having medical staff privileges at hospital.
Newly-Recruited Physician: Non-employee physician not yet having medical staff privileges at hospital.
Permissible Recruit: Physician who either (i) is a recent graduate of a residency or fellowship program, whether or not in the hospital’s community, or (ii) has not previously practiced in hospital’s community or been affiliated with another hospital serving all or part of the hospital’s community.
Permissible Incentive: A provision of cash, credit, goods, services, or other valuable rights to a physician in exchange for the physician’s agreement to relocate into or remain within hospital’s community ... if provided in accordance with the specific rules set forth below. (Specific warnings are given against “prohibited inurement” and “more than incidental private benefit” for the physician, which must be avoided at all costs.)
Under Section II of the guidelines, the hospital agreed to provide no incentives to physicians other than permissible ones, which include:
• Loans or loan guarantees with an executed promissory note, adequately secured and paying market interest rates (such as prime plus 1 or 2 percent).
• Income guarantees for two years or less, with terms agreed to in advance in writing.
• Subsidies for medical office space rent, overhead expenses or rental of equipment, so long as no other incentives, such as an income guarantee or loan forgiveness, are made.
In connection with providing these incentives, the hospital could require physicians to fulfill any or all of the following obligations:
• Relocation to the hospital’s service area.
• Establishment of a full-time private practice.
• Continued presence in the community for a specified period.
• Maintenance of license to practice.
• Acceptance of Medicaid and charity patients.
• Emergency room duty or other rotations.
• Performance of community or medical teaching.
• Performance of necessary administrative duties.
• Maintenance of staff privileges.
• Maintenance of a practice in the specialty for which recruited.
Most important, recruitment incentives are not deemed permissible unless the hospital demonstrates a community need for the physician. For example, the hospital could point to a deficient population ratio to physician ratio in the specialty being recruited, or could show a documented lack of availability of the service in question, or long waiting periods. If the U.S. Department of Health and Human Services (HHS) had designated the area as a Health Professional Shortage Area, or if there were a demonstrated reluctance of physicians to relocate to the hospital because of its location, this would also help. Another factor might be a reasonably expected reduction in the number of medical specialists due to anticipated retirements, or a documented lack of physicians serving indigent patients.
The guidelines list forbidden items, such as retention incentives to existing practitioners, signing bonuses, and certain recruiting fees and costs.
It should be kept in mind that these guidelines, along with the closing agreement, are not to be regarded as a legal precedent. No one but Hermann Hospital is entitled to rely on the specifics of the agreement, and IRS officials have cautioned against reading too much into the guidelines.
Despite such remarks, however, it is generally agreed that the guidelines offer something of a safe harbor. Transactions falling within the guidelines are not likely to cause problems, whereas transactions outside the guidelines would create risk.
Several additional points merit discussion, although space limitations preclude a detailed treatment. The following is merely a sampling of the issues raised by the agreement.
One feature is the lack of any tie-in with the anti-kickback statute. T.J. Sullivan, the IRS’s special assistant for health care issues, has noted that the IRS is well aware of the implications of the anti-kickback statute in the physician
recruitment area, but did not feel that it was necessary to require compliance with a federal criminal statute as part of the settlement.
The attorney for Hermann Hospital, R. Todd Greenwalt of Vinson and Elkins in Houston, pointed out that tax code application tends to be rather mechanical, while the anti- kickback statute is an intent-based criminal statute. Nothing in the closing agreement suggested that any transactions intended to induce patient referrals, stated Greenwalt.
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D. McCarty Thornton, associate general counsel in HHS’s Inspector General’s Office, told BNA that the statement of tax law in the Hermann Hospital case “is not conclusive as to what is necessary to avoid liability under the anti-kickback statute.”
Some attorneys have commented on the fact that the prohibition against physician incentives applies only to nonemployed physicians which means that a different standard would apply to hospitals seeking to recruit or retain employee physicians. This will give hospitals added encouragement to employ doctors, except where the corporate practice of medicine doctrine is strictly followed. (The viability of the doctrine in Tennessee remains unclear at this point.)
At the NHLA’s conference on tax issues in non-profit health care organizations on Oct. 27, the program’s co-chair, Attorney Robert S. Bromberg of Cincinnati, Ohio, discussed what he perceived to be an unfair advantage given to for-profit hospitals as a result of the Hermann Hospital agreement. He was concerned that the best new physicians starting out in practice would potentially “be driven into the arms of the for-profit sectors since most of them are heavily saddled with debt after completing medical school and residency.”
Other commentators have expressed concern that by preventing hospitals from offering incentives to keep physicians on their staff rather than let them move away from the area or join a for-profit hospital, the guidelines are illogical and contradict numerous prior private letter rulings by the IRS. It would be unfortunate if the result of the Hermann Hospital agreement was to encourage physician mobility and payment of higher and higher recruitment incentives. For example, costs of health care in the community might increase, or access to care would be reduced, particularly for the indigent population.
TBA Health Care Law Section member Frederick B. Fields, general counsel at St. Mary’s Medical Center in Knoxville, believes that the guidelines can obviously be a big help to administrators “trying to figure out how to walk through what has become a posted mine field.” Fields points out that they should be studied carefully, and that all recruiting agreements should be reviewed to ensure that they fit. Finally, he recommends that the documentation process should be followed precisely to prevent problems in the future. u
Margaret G. Klein is a partner with London and Amburn P.C. in Knoxville. She is currently serving as editor of Health Law.
Notes
1 Because the closing agreement and the physician recruitment guidelines have been published in full in the BNA Health Law Reporter, Vol. 3, No. 41, Oct. 20, 1994, and in the November 1994 issue of the NHLA Health Law Digest, they will not be included here. Readers who wish to obtain copies can contact the author for further information.

By all reports our own Annual Health Care Law Forum Seminar in October 1994 was the most successful yet. John R. Voigt did his usual good job of organizing the seminar, and I would like to give a special thanks to him for the effort he put into that organization and to all of our section members who participated for their special efforts in the presentations during the seminar.
As has become the custom, our annual meeting was held at the seminar because more of our members attend that meeting than attend the TBA annual convention in June. As a consequence, we elected new section directors and a new chair-elect at that time to take office in June 1995. The current and future officers and directors are as follows:

1994-1995 Officers & Directors
Chair: Howard Levine, Chattanooga
Chair-Elect: Richard (Dick) Knight, Nashville
Director: Patricia Meador, Nashville
Director: Dale Amburn, Knoxville
Director: Steven West, Memphis
1995-1996 Officers & Directors
Chair: Richard (Dick) Knight, Nashville
Chair-Elect: Patricia Meador, Nashville
Director: Dale Amburn, Knoxville
Director: Steven West, Memphis
Director: John Voigt, Nashville

Margaret Klein has graciously taken over for Dale Amburn as our newsletter editor, and she is working very hard to produce the newsletter associated with this report. Please help her with articles whenever possible. I would like to also give a special thanks to Dale Amburn for producing our section’s newsletter in the past.
We always like suggestions for seminar topics and speakers as well as newsletter topics and articles; so please contact Margaret Klein, John Voigt or me (as well as any of the other directors) with your thoughts. Robin Atwood is the director of sections for the Tennessee Bar Association and is our liaison for any questions you may have with regard to the section. u

Last year, the Tennessee legislature enacted the Tennessee Limited Liability Company Act, T.C.A. §48-201-101 et seq., creating a new form of business entity, the limited liability company (LLC). An LLC is a “cross” between a partnership and a corporation. It is taxed much like a partnership, in that no federal income tax is paid by the LLC itself; rather, the tax is paid by the members of the LLC on their share of the LLC income. Further, an LLC is exempt from the Tennessee franchise and excise tax which applies to corporations. However, in lieu of paying the franchise and excise tax, an LLC must pay an annual fee to the State of Tennessee in the amount of $50 per member, with a minimum annual fee of $300 per year and a maximum of $3,000 per year.
While an LLC is taxed much like a partnership, thereby avoiding most of the taxes that a corporation (other than an S Corporation) pays at the “corporate” level, members of an LLC enjoy the same limitations on their personal liability that shareholders in a corporation have, but that partners in a general partnership do not have. Thus the term “limited liability company.” Whereas the partners in a general partnership are all personally liable for all of the debts and other obligations of the partnership, members of a limited liability company, generally speaking, are not personally liable for obligations of the LLC.
Thus, in many respects an LLC enjoys the best characteristics of both partnerships and corporations—the tax advantages of partnerships and the limited liability of corporations.
As part of the Limited Liability Company Act passed by the Tennessee legislature, there is now available to physicians and other professional practitioners in Tennessee a “professional limited liability company” (PLLC) form of doing business. A PLLC is similar to a professional corporation (PC) in terms of limited liability of the members but, as indicated above, it is taxed like a partnership. Undoubtedly many professional practitioners will find the PLLC form of doing business advantageous. However, there are reasons that a PLLC will not be useful to many professional practitioners:
1. A PLLC requires at least two members. Just as a partnership must have at least two partners, an
LLC or PLLC must have at least two members who jointly own the professional practice.
2. Professionals who presently conduct their practice as a professional corporation may
encounter serious tax problems if they switch to a PLLC. Under the new LLC law, an existing
professional partnership may convert directly to a PLLC without any tax consequences. However, a PC
cannot convert directly to a PLLC. It would be necessary to liquidate the existing PC, then
distribute the assets to the shareholders who would in turn use those assets to start the new PLLC.
Liquidation of the PC would trigger income tax to the shareholders on their respective shares of the
capital gain in the value of the corporation since the shareholders began the PC or otherwise purchased
their stock in the PC. Although the tax on the gain may be limited to the current capital gains tax rate of
28 percent (which some think will be reduced this year), the tax could still be very substantial. If
accounts receivable are distributed, their value will be taxable income to the corporation when
distributed. Thus, it seems unlikely that liquidation of the PC followed by formation of a PLLC would
make sense from a tax standpoint.
3. Not all tax questions concerning Tennessee LLCs have been resolved. Tennessee’s new LLC
law was carefully drafted by skilled attorneys, and it is expected that partnership-type treatment will be
available to LLCs formed under the new law. However, the Internal Revenue Service(IRS) has
not yet issued a ruling approving partnership tax treatment for Tennessee LLCs. A request for such a ruling is pending. While the possibility seems fairly remote that the IRS will question the availability of
partnership-type taxation to properly-formed Tennessee LLCs, there can be no assurance until a
formal ruling has been handed down, if then. Nonetheless, many professionals and other business
people are going ahead with plans to use the LLC form of business entity under the assumption that
the IRS ruling will be favorable or that any problems raised by the IRS will be resolved.
The PLLC law is quite similar to the Tennessee Professional Corporation Act (PC Act). Like the PC Act, substantial authority is given to the governing boards of the various professions such as the Board of Medical Examiners, Board of Dentistry, Board of Accountancy, etc. Any professional practice desiring to operate as a PLLC should be sure that the governing board has approved practicing as a PLLC and that any conditions set by the governing board are met.
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So far, only the Board of Medical Examiners has issued proposed rules relating to PLLCs. These proposed rules were issued Oct. 31, 1994, and may be found at page 47 in the November 1994 issue of the Tennessee Administrative Register. The proposed rules require that all members, governors and officers (other than secretary and treasurer) of a Tennessee medical PLLC or a foreign medical PLLC practicing in Tennessee be licensed Tennessee physicians.
Further, the rules require foreign or domestic medical PLLCs to file an annual statement of qualification with the Board of Medical Examiners setting forth certain information required by T.C.A. §48-248-602(a) as well as the Tennessee medical license number and expiration date of each physician in the PLLC.
There will eventually be many situations in which the limited liability company form of doing business will be useful to physicians and other professional practitioners, particularly startup practices and those practices which are now operating as general partnerships. However, the conversion to a PLLC should be studied carefully with the assistance of able legal and accounting advisors. u
E. Stephen Jett is a partner with the firm of Stophel & Stophel P.C. in Chattanooga, where he chairs the firm’s Health Care Practice Group.

Both the physician and his legal counsel received their comeuppance in the case of Smith v. Ricks, 31 F.3d 1478 (9th Cir. 8-11-94). The physician-plaintiff, Dr. Smith, lost his staff privileges at Good Samaritan Hospital after undergoing a very intensive and lengthy peer review process. The peer review process included nine days of hearings over a four-month period by a Judicial Review Committee convened in accordance with the Medical Staff Bylaws.
A court reporter was present during each session of the hearings and turned out more than 1,300 pages of transcripts. Dr. Smith and the hospital were represented at these hearings by physicians and legal counsel. The decision of the Judicial Review Committee for a rigorous two-year preceptorship, instead of termination, was seen as too lenient by the hospital and it appealed to the Good Samaritan Board of Trustees. The Board of Trustees conducted two hearings, which resulted in the termination of Dr. Smith’s staff privileges.
Dr. Smith filed a complaint in the U.S. District Court for the Northern District of California, alleging violations of the Sherman Antitrust Act and the Clayton Antitrust Act. The complaint alleged a conspiracy theory which included most of the individuals who participated in the peer review proceedings.
Summary judgment was granted by the district court on the basis that the hospital and the physicians were immune from antitrust liability under the Health Care Quality Improve-ment Act of 1986 (HCQIA). Under HCQIA, a hospital and those participating in a peer review process are immune from liability if it is shown that (1) the professional review action complied with the fairness standards set out in HCQIA; (2) the results of the professional review action were reported to state authorities in compliance with HCQIA; and (3) the professional review action commenced on or after Nov. 14, 1986, the effective date of HCQIA.
The district court also held the hospital was entitled to reasonable attorney’s fees and costs, and imposed Rule 11 sanctions against the doctor’s attorney. Under HCQIA, defendants are entitled to reimbursement of the cost of the suit attributable to the claim if the claim or the claimant’s conduct during the litigation was frivolous or without foundation. Although the case was dismissed on summary judgment, the attorney’s fees allowed in that case were $281,344.78, which the appellate court noted were significantly less than the fees the defendants actually incurred. An additional $21,777 was awarded in costs. The district court also imposed $2,000 in Rule 11 sanctions against the doctor’s counsel.
Not only did the 9th Circuit Court affirm the findings of the district court in all respects, but it also exercised its discretion by ordering that the costs and fees of the defendants be paid by the doctor’s legal counsel with regard to the appeal (as opposed to the doctor). The 9th Circuit Court found that plaintiff/appellant’s legal counsel was “directly responsible for making frivolous legal arguments, both in his own appeal and Dr. Smith’s appeals.”
The Smith case is well worth reading, not only from the standpoint of how the antitrust laws interface with HCQIA, but also from the standpoint of the details it provides regarding how the peer review process was undertaken in that case. This case should be a great source of comfort to hospitals and physicians involved in the peer review process. It should also give legal counsel considerable pause before filing any lawsuit against a defendant who is arguably protected under HCQIA. u
Harry B. Ray is a partner with the firm of Stophel & Stophel P.C. in Chatta-nooga, where he is a member of the firm’s Health Care Practice Group.

Who would have thought that none of 49 hospitals and universities audited by the Internal Revenue Service (IRS) would comply totally with requirements pertaining to tax-deferred plans under Section 403(b) of the Internal Revenue Code?
Anyone who has ever dealt with their complexity and the dispersed responsibilities for compliance — that’s who.
Due to widespread publicity, most exempt organizations are now aware that the IRS plans to audit extensively such plans. However, many have not yet charted courses to determine whether their plans comply with legal standards in form and, of special importance, in operation.
Hospitals, universities and other Section 501(c)(3) organizations should start soon to detect and correct errors. Then they should decide to accept promptly the IRS’s expected offer of lesser sanctions for voluntary reporting of noncompliance. Otherwise, they and their employees face the possibility of draconian penalties.
There are three reasons why problems may exist. First, as many as six calculations follow from the decision of a teacher or nurse to reduce salary and let the employer purchase an annuity or shares in a mutual fund. Their complexity is an invitation to error. (The author’s recent search for suitable software was unsuccessful, and his client was unwilling to engage an actuarial firm with the capability of making all computations. As a consequence, he developed a spreadsheet for the first five, leaving to the client the sixth calculation.)
Second, the administration of such plans is confusing. Depending upon the type of plan and its actual operation, as many as seven parties may have duties. Where rules should be stated is not always apparent. Some requirements, such as the statement of the minimum distribution rules and the joint and survivor annuity provisions, probably should be satisfied in both the annuity contract or custodial agreement and the plan document. Monitoring compliance is another problem. As a practical matter, the employer may have far less control over impermissible withdrawals than the insurance company or mutual fund sponsor.
Third, very little attention has previously been given to Section 403(b) plans by the IRS and the U.S. Department of Labor. They cannot even be submitted to the IRS for determination letters. Sponsors of such plans, and the employers which make them available, may thus have relaxed their own efforts to comply.
At this point, an employer fearful of the consequences of an audit by the IRS ought to take the initiative and look for the problems which the IRS has identified as prevalent. A five-step approach seems warranted.
The first focus would be upon defects in documents and reports. The IRS has announced that salary reduction agreements which have been inadequately drafted, and unfiled or erroneous Forms 5500, are encountered frequently.
The second step would be the selection of employees regarding whom errors are most likely to have been made. These could include highly compensated employees, employees near retirement age and employees who have retired recently. A corollary step entails a decision about the number of years to be examined. This usually will be the number of years still open to audit by the IRS, typically three.
A third important determination is whether distributions have been made at proper times. Of particular interest are in-service withdrawals where financial hardship must be demonstrated. Another concern is whether distributions have commenced on or before April 1 of the year after a person attains age 70 1/2.
A fourth inquiry involves the coverage and nondiscrimination rules. Almost all employees must be given the opportunity to make salary reduction contributions if any are allowed to do so. Occasionally, groups such as trainees are
accidentally omitted. Discrimination can occur, for
example, when employer matching contributions are based
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on compensation above statutory limits, or an insufficient number or percentage of employees actually benefit from the plan.
The fifth area for examination is compliance with the several limits on contributions.
The enforcement tools available to the IRS are many and drastically different in their impact.
If an excessive contribution has been made, the IRS could treat either the excess or the entire contribution as includable in the income of the employee. The employer is subject to penalties for failure to withhold the proper amount of tax. Worse still, the entire plan could be disqualified, leading all employees to pay tax on contributions made and the income earned on them. The same results could occur if the salary reduction agreement is defective.
Violations of nondiscrimination rules should result in adverse tax consequences only for the highly compensated employees who are affected. Section 403(b)(12) of the Internal Revenue Code, however, literally applies to plans and not to contracts or accounts.
Likewise, distributions started too early or too late should result in penalties applicable only to the employees receiving those payments. Whether they will be limited is a matter for negotiation or litigation.
Having discovered failures of compliance, an employer usually should decide to avoid the potentially devastating consequences by a voluntary agreement in advance of audit. While the IRS has not yet made a formal announcement of the availability of its voluntary compliance program to Section 403(b) plans, it is expected to do so soon. This program should permit taxpayers to advance a number of arguments against imposition of penalties as drastic as statutes seem to require.
The absence of a determination letter process, the scarcity of regulations and other authorities, and the apparently extensive noncompliance suggest that fault lies as much in the statutes themselves as in the actions of taxpayers who must apply them.
Public policy in favor of retirement plans generally ought to limit the death penalty of disqualification to situations where especially egregious conduct is involved.
Because individual annuities and custodial accounts are involved, it is possible to apply sanctions to particular employees who have benefited from noncompliance rather than to all employees or the employer.
Taking the side of the employee, one can argue that the IRS has a convenient target in the employer and an appropriate tool in the form of back withholding tax liabilities. Thus, employees generally, or at least those uninvolved in noncompliance, ought to be absolved of liability. Indeed, the IRS has indicated that it will take this tack.
Finally, the uncharted and potentially hostile territory of administrative appeals within the IRS and litigation suggests the wisdom of closing agreements after audits by the IRS occur and voluntary agreements before they do. Appellate officers of the IRS must consider only the risk of loss during litigation, and judicial decisions favorable to the IRS seem likely. u
Whitney Durand is a partner in the Chattanooga firm of Miller & Martin.