IRS to Allow More MD Directors on Nonprofit Boards
By: JAMES B. PLATT
Summer 1996
The Internal Revenue Service is considering a change to its policy regarding physician representation on the boards of tax-exempt organizations. Since 1993, organizations applying for tax exemption under Section 501(c)(3) have had to limit the representation of employed physicians to 20% of their boards. Although this "80/20 safe harbor" is not found in the tax laws or regulations, most hospitals, clinics and other integrated health care organizations seeking exemption have followed it rather than to go to court against the IRS.
At a recent conference, the director of the IRS Exempt Organizations Division announced that the Service is developing a new approach. Physician employees could now comprise more than 20% of the members of the board if certain safeguards are in place:
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Physicians could not make up a majority of the board. Physician employees could, however, make up 49% of the board.
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A written conflict-of-interest policy must be in place. That policy should include procedures for determining what is a conflict of interest and how the conflict will be handled. The policy would prevent directors from voting on matters in which they have a personal financial interest and prevent compensated physicians from serving on compensation committees. The conflict-of-interest policy would also apply to any committees having the authority of the board to act in certain areas.
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Records must be kept (perhaps as a part of the minutes) that show when conflicts arose and how they were handled. This record-keeping policy must be incorporated in the bylaws.
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Board members must sign statements that they have read the conflict-of-interest policy.
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Periodic audits of the organization's business activities should occur, including a review of the reasonableness of compensation, practice acquisitions, and PHO and MSO arrangements. It is unclear who must conduct this review and how extensive the review must be.
The new approach is being considered because the IRS recognized that there are several long standing health care organizations with proven track records that have more than 20% physician directors. More details about the new approach will be included in the Service's 1997 Continuing Professional Education Textbook, to be published next fall.
Although the new approach is welcome news for organizations seeking greater physician input, many questions remain.
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Will the conflict-of-interest requirement be more stringent than what the IRS has allowed in the past?
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Who will perform the periodic audit and what will be done with the information that is uncovered? How can that information be protected by the attorney-client privilege?
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May nonvoting physicians serve on the board (and the compensation committee) and not be counted along with the employed physicians on the board? In a few instances, the IRS has also allowed nonphysician executives to serve as voting members without being counted with the voting physicians. The new approach appears to include executives along with the employed physicians in the 49% category.
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Under what circumstances may an organization have even more than 49% physician representation? By recognizing the exempt status of many organizations with broader physician governance, the Service may be willing to consider more than 49% in circumstances where the organization has had a good track record.
Organizations that are considering 501(c)(3) status may want to compare this new approach with past 80/20 rules to see if the opportunity for more physician governance is worth the additional safeguards. Existing exempt hospitals and clinics may do the same, although IRS approval should be obtained before making any major changes.