Tax Advisory: Five Lessons on Section 501 (c) (3) from the Nonprofit Hospital Billing Litigation
8/31/2006
Recent Litigation Based on Section 501(c)(3)
of the Internal Revenue Code
In June 2004, an aggressive band of trial lawyers unleashed a wave of federal class action lawsuits on behalf of uninsured patients at hundreds of nonprofit hospitals. The lawyers made several claims based in federal and state law, but their crown jewel was an allegation that hospital billing and collection procedures were inconsistent with Section 501(c)(3) status. Using the federal tax-exemption laws, the lawyers sought to force changes in hospital practice and recover damages tied to the amount of the organizations' purportedly ill-gotten tax savings. At its root, the trial lawyers pushed an argument that:
- Section 501(c)(3) represents a contract between tax-exempt hospitals and the government, of which uninsured patients are third-party beneficiaries;
- the contract requires charity care for the uninsured, regulates prices, and prohibits certain collection practices;
- individual patients are entitled to enforce the contract; and
- as a remedy, tax-exempt hospitals should be forced to adopt new charity care, billing, and collection policies and pay over all or a portion of the value of their tax-exemptions.
This argument has been roundly rejected by every federal court to consider the issue. Though the large controversy is far from over, the federal cases have left behind several important lessons regarding the fundamentals of Section 501(c)(3).
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