Nonprofit Hospitals
Statute Prevents State Agencies From Considering
Community Benefits When Granting Tax-Exempt
Status, While the Effects of Purchases and
Consolidations on Prices of Care Are Uncertain
August  Report -
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CALIFORNIA STATE AUDITOR
Bureau of State Audits
Doug Cordiner
Chief Deputy
Elaine M. Howle

care increased after a change in owners or operators for three of the four hospitals we reviewed.
Respectfully submitted,
ELAINE M. HOWLE, CPA
State Auditor
Blank page inserted for reproduction purposes only.
Nonprofit Hospitals
Statute Prevents State Agencies From Considering
Community Benefits When Granting Tax-Exempt
Status, While the Effects of Purchases and
Consolidations on Prices of Care Are Uncertain
August  Report -
Blank page inserted for reproduction purposes only.
viiCalifornia State Auditor Report 2011-126
August 2012
Contents
Summary 1
Introduction 5
Audit Results
Nonprofit Hospitals Use Different Methodsto Calculate the Costs
of UncompensatedCare Because No Statutory Standard or
MethodologyExists 13
Hospitals Have Different Income Requirements When They Decide
Who Is Eligible for Charity Care 16
Hospitals With the Same Policies Might Provide Different Amounts
of Charity Care Based on the Populations They Serve 19
The Change in Ownership for Nonprofit Hospitals Had Undetermined
Effects on Prices for Medical Services and Access to Care 21
Health Planning Adequately Monitors Hospitals’ Submission of Data
Required by State Law 27
Recommendations 28

programs in their community
benefit plans.
• Eachprovidesadierentlevelof
charity care because laws do not
require a specific level.
» Because of limited data, we could not
determine whether changes in prices for
health care services resulted directly from
changes in ownership or operatorship.
» Costs of uncompensated care increased
after a change in owners or operators for
three of the four hospitals we reviewed.
Summary
Results in Brief
e Legislature expects nonprofit hospitals to provide such
community benefits as free or reduced-cost medical care to the
poor in exchange for the State’s favorable tax treatment of these
hospitals. However, as noted in a  report by the California
State Auditor (state auditor), the amounts of community benefits
the hospitals provide cannot be used to justify their tax-exempt
status. Specifically, state law requires most tax-exempt hospitals
to prepare annual community benefit plans
1
that describe the
activities that the hospitals have undertaken to address community
needs and that report the amount of community benefits that the
hospitals provided during the year. Community benefits can include
health care services that hospitals render to vulnerable populations
and for which the hospitals do not receive full compensation. is
uncompensated care encompasses free care (full charity care)

California State Auditor Report 2011-126
August 2012
2
we reviewed considered as a component of their respective overall
community benefits the hospital’s expenses pertaining to bad
debt, which is the unpaid portion of bills for patients who have
the ability to pay but who are unwilling to do so. Instead, the 
community benefit plans for the four hospitals included the costs
of charity care and the unpaid costs of public programs, such as
the California Medical Assistance Program (Medi-Cal) and county
indigent programs. During our review, we also noted that one ofthe
four hospitals used its cost-accounting system to help quantify
the amount of community benefits it provided. Other hospitals
estimated these amounts using a ratio that converts the charges for
provided health care services to their actualcosts.
Each of the four hospitals we reviewed have different standards
for determining who can qualify for charity care. For example, a
family of four with an income at  percent of the federal poverty
level and no insurance may qualify for full charity care at one of the
four hospitals we reviewed, but the same family would qualify only
for partial charity care at the other three hospitals. e cause for
this disparate treatment stems from state law, which requires only
that nonprofit hospitals allow those whose incomes are at or below
 percent of the federal poverty level to apply for charity care.
erefore, a nonprofit hospital can establish for itself the level of
charity care it will provide patients based on the patients’ financial
status, so long as the hospital allows those at or below  percent
of the federal povertylevel to apply for at least partial charity care.
Although the amount of full or partial charity care provided by
nonprofit hospitals varies according to the hospitals’ policies, these

health care services. During our review, we noted that the new
owners at both hospitals brought with them their own unique codes
to group medical services and their related charges. As a result, it
was not possible to identify the charges of certain medical services
before and after a hospital was sold, and to determine whether there
were significant price changes in particular procedures or hospital
services. e Office of Statewide Health Planning and Development
(Health Planning), does not require hospitals to provide their
pricing data in a standardized format.
We also could not determine the effects on communities resulting
from reductions or terminations of services after new owners or
operators acquired the four nonprofit hospitals. We found that
the new owners or operators for three of the four hospitals made
some changes in services after the acquisition. However, they all
cited safety or cost concerns for their decisions. For example, Eden
Medical Center’s board of directors decided to closeSanLeandro’s
skilled nursing unit in . e hospital staff indicated that the
decision to close the skilled nursing unit occurred after Medicare
changed its reimbursement method. Further, hospital staff believed
that other facilities in the area would meet community needs for
such services.
On the other hand, costs of uncompensated care increased after
a change in owners or operators for three of the four hospitals
we reviewed. Laguna Beach was the only hospital that reported
a decrease in costs of uncompensated care in , a year after
it was acquired by Mission Hospital Regional Medical Center.
Between  and , the hospital reported a  million decrease
in unreimbursed Medi-Cal costs. According to the hospital’s
controller, the previous owner’s decision to discontinue labor
and delivery services in  and its skilled nursing unit in ,

should consider revising state law to allow Health Planning to assess
a penalty to those hospitals that do not comply.
Agency Comments
Health Planning concurs with our findings.
5California State Auditor Report 2011-126
August 2012
Introduction
Background
According to the Department of Public Health (Public Health),
of the  licensed health facilities were nonprofit corporations
as of June . State law provides that entities organized and
operated for nonprofit purposes can be exempt from paying the
State’s corporation income taxes (corporation taxes) and property
taxes. e Legislature has declared that in exchange for favorable
tax treatment by the government, nonprofit hospitals assume
a social obligation to provide community benefits in the public
interest. State law defines community benefits to be a hospital’s
activities that are intended to address community needs and
priorities, primarily through disease prevention and improvement
of health status. ese activities can include health care services
rendered to vulnerable populations for which hospitals do not
receive full compensation (costs of uncompensated care), such
as charity care, which is the portion of a patient’s bill that is
uncollectible due to the inability to pay. Community benefits can
also include the unreimbursed cost of other types of services, such
as child care, adult day care, medical research and education, and
nursing and other professional training.
Various state agencies oversee different aspects of nonprofit
hospitals’ operations, including monitoring the hospitals’
tax-exempt status, providing public transparency for the reported

assessors or Equalization considers the amounts of community
benefits the hospitals provide when granting tax exemptions to
nonprofit hospitals. Instead, they grant tax exemptions based on
other information about the organization, including the distribution
of its net earnings and the entities’ articles of incorporation.
Further, although federal law does not require a specific amount
of community benefits, the Internal Revenue Service (IRS) has
recently revised the forms that nonprofit hospitals must submit
annually to require additional information on hospitals’ activities
related to community benefits.
The Tax Board’s Role in Exempting Hospitals From State Corporation
Income Taxes
e tax board administers both personal income
and corporation taxes. State law authorizes the
tax board to issue the rulings and regulations that
are necessary and reasonable to carry out the
provisions related to organizations—including
hospitals—that are exempt from corporation
taxes. As the text box details, the statutory
requirements for hospitals to receive a corporation
tax exemption focus on the activities of the
organization and its distribution of net earnings.
To obtain an exemption from state corporation
taxes, hospitals must submit an application for
tax exemption to the tax board, along with a filing
fee of . In January  state law was amended
to allow the tax board to rely on the IRS’s prior
determination that an organization qualified for
tax exemption. As a result, a hospital that has
previously obtained federal exemption under

religious, hospital, charitable, or scientific purposes,
and the property is owned and operated by a
community chest, fund, foundation, limited-liability
company, or corporation organized and operated
for one of these purposes. An organization seeking
the property tax welfare exemption must file a claim
with Equalization for an organizational clearance
certificate (certificate). After reviewing the claim
for a certificate, Equalization determines whether
an organization qualifies for the exemption and
issues the certificate if the qualifications are met.
Once the organization has obtained a certificate,
it may file a claim for the welfare exemption with
the county assessor, who determines whether the
property meets the requirements in state law for the
exemption, including that the property is actually
being used for exempt purposes—as shown in the
text box.
Federal Requirements for Tax‑Exempt Hospitals
Enacted in March , the Patient Protection and Affordable
Care Act changed federal law to require that hospitals, in order
to receive exemption from federal taxes under Section (c)()
of the Internal Revenue Code, must conduct a community health
needs assessment and adopt an implementation strategy to meet
those needs; must have a written financial assistance policy; must
limit charges for emergency or other medically necessary care for
individuals eligible for assistance under the financial assistance
policy; and must not engage in extraordinary collection actions
before making reasonable efforts to determine whether the
individual is eligible for assistance under the financial assistance

Health Planning is responsible for collecting various data from
hospitals and making such data available to the public on its
Website or upon request. State laws designate Health Planning as
the office responsible for collecting an array of data from hospitals,
such as community benefit plans, fair pricing policies, and annual
financial information. Excluding small and rural hospitals, and
other hospitals meeting certain requirements, private nonprofit
hospitals are required by state law to develop and annually submit
to Health Planning a community benefit plan that describes the
activities they undertook to address community needs and to assign
and report economic values of those benefits. Further, state law
requires certain hospitals to maintain an understandable written
policy regarding charity care and discount payments for financially
qualified patients. e law mandates that such policies include
clearly stated eligibility criteria and procedures for those policies,
a description of the review process, and written policies for debt
collection practices—collectively referred to as a fair-pricing policy.
Each hospital required to maintain a fair-pricing policy is mandated
by state law to provide a copy of that policy to Health Planning on a
biennial basis.
State law also requires all licensed hospitals to submit to Health
Planning financial information, including a balance sheet
andincome statement. To ensure uniformity of accounting
and reporting procedures, state regulations require that health
facilities comply with the systems and procedures detailed in the
accounting and reporting manual published by Health Planning. In
addition, a state law, known as the Payers’ Bill of Rights,
3
generally
requires licensed general acute care hospitals, psychiatric acute

dispose of, or transfer control of a material amount of its assets.
State regulation specifies that such an agreement or transaction
involves a material amount of assets or operations when more than
 percent of the hospital’s assets or operations are involved, the
facility involved has a fair market value in excess of  million, or
the facility is a general acute care hospital. e attorney general’s
process for determining approval for the sale of a nonprofit
hospital may include preparing an independent health care impact
statement to identify the significant effects on the availability and
accessibility of health care services on the affected community. In
addition, the attorney general is required to hold at least onepublic
meeting to receive comments from interested parties. When
approving the transaction, the attorney general may require the
parties involved to meet certain conditions designed to mitigate
potential adverse effects on the community. Some conditions
required by the attorney general may include maintaining a certain
level of services and charity care costs for at least five years after the
transaction closes.
To ensure that the purchaser of a nonprofit hospital is adheringto
the conditions of consent, the attorney general has required
purchasers to submit annual compliance reports while such
conditions are in effect. e compliance reports generally address
how parties involved in the transaction are complying with each
condition placed by the attorney general when approving the
transaction. In addition to reviewing the compliance reports,
the attorney general may also review the hospital’s financial data
submitted annually to Health Planning as part of its monitoring.
California State Auditor Report 2011-126
August 2012
10

Audit Objectives and the Methods Used to Address Them
AUDIT OBJECTIVE METHOD
1 Review and evaluate the laws, rules, and regulations significant to the
audit objectives.
Reviewed such relevant state laws as the California Health and Safety
Code, the California Corporations Code, and the California Revenue
and Taxation Code, as well as such regulations as the California Code of
Regulations, Title 22. We also reviewed Section 501 of the United States
Internal Revenue Code, federal court decisions, and the Internal Revenue
Service (IRS) tax forms related to nonprofit hospitals.
2 For a sample of three to five nonprofit hospitals, review and assess
how each hospital calculates uncompensated care for the purpose of
demonstrating public benefit, and include the following:
a. The percentage of uncompensated care that is attributable
to each method of estimated costs (for example, charity care,
bad debt, and contractual adjustment for the county indigent
program) and how the value calculated from each method
isdetermined.
b. The criteria for determining bad debt, including whether a
hospital must demonstrate a reasonable effort to collect a
debt, and whether hospitals consider a patient’s income when
determining bad debt.
For the four hospitals we selected, we did the following:
• Reviewedtheirfairpricingpolicies,whichincludepoliciesrelatedto
charity care and bad debt collection.
• Visitedtheselectedhospitals,interviewedappropriatesta,
and reviewed documentation related to how hospitals make a
determination related to charity care, bad debt, and the county
indigent program, as well as the efforts that hospitals make to collect
bad debt, including whether they consider patients’ income.

1) Internet searches did not reveal any such hospitals within California.
2) Although Public Health has information on a hospital’s licensee—
the entity responsible for operating the nonprofit hospital—the
data it provided did not separately identify the nonprofit hospital’s
owner. As a result, we could not identify instances where a
nonprofit hospital’s licensee and owner were different entities.
3) We contacted a legislative advocate for the California Hospital
Association for a listing of nonprofit hospitals where the owner and
operator were different; however, the legislative advocate could
not provide such a listing.
• Oncewehadselectedfourhospitalsforreview,wegenerallyassessed
whether the purchase, consolidation, or change in operatorship
affected emergency room care and other services by reviewing each
hospital’s patient utilization data maintained by the Office of Statewide
Health Planning and Development (Health Planning). As applicable, we
also considered whether any reduction in service was consistent with
any conditions placed on the hospital by the attorney general. Finally,
we used financial information collected by Health Planning to assess
whether there were changes in each hospital’s cost of uncompensated
care and changes in each hospital’s prices for medical services.
continued on next page . . .
12 California State Auditor Report 2011-126
August 2012
AUDIT OBJECTIVE METHOD
4 Determine whether nonprofit hospitals with multiple facilities provide
charity care and other public benefits in all communities in which the
facilities reside, and ascertain whether the nonprofit hospitals provide
care and benefits in a manner that is consistent across communities
and that warrants the hospitals’ nonprofit status.
• Reviewedthestatutorycriteriaforgrantingtaxexemptionstononprot

2007audit report.
• Determinedthestatusofrecommendationsbyreviewingthereports
the state auditor issued between 2008 and 2012 detailingthe
implementation of the state auditor’s recommendations and
the recommendations not fully implemented after one year. We
also performed limited work at the Franchise Tax Board to verify
implementation of our previous recommendations.
Sources: The California State Auditor’s analysis of Joint Legislative Audit Committee audit request number 2011-126, the planning documents, and
analysis of information and documentation identified in the table column titledMethod.
13California State Auditor Report 2011-126
August 2012
Audit Results
Nonprofit Hospitals Use Different Methodsto
Calculate the Costs of UncompensatedCare Because
No Statutory Standard or MethodologyExists
e four hospitals we reviewed use slightly different
methods to calculate and report the cost of health
care services that they provide without receiving
compensation (costs of uncompensated care).
Although state law defines for state planning and
reporting purposes some types of activities that may
be considered community benefits, it does not
require hospitals to include these costs as part of
their community benefits. Although there is some
guidance available from two national organizations
to help hospitals define their community benefit
activities, both differ in what should be included
when defining costs of uncompensated care. e
four hospitals we reviewed indicated that they
follow the community benefit guidelines established

State law defines community benefit as a hospital’s activities
that are intended to address community needs and
priorities. These activities may include any of the following:
1. Health care services rendered to vulnerable populations,
including, but not limited to, charity care and the
unreimbursed cost of providing services to the uninsured,
underinsured, and those eligible for Medi‑Cal, or other
government‑sponsored programs.
2. Community‑oriented wellness and health promotion.
3. Prevention services, including, but not limited to, health
screening,immunizations,schoolexaminations,and
disease counseling and education.
4. Adult day care.
5. Child care.
6. Medical research and education.
7. Nursing and other professional training.
8. Home‑delivered meals to the homebound.
9. Sponsorship of free food, shelter, and clothing for
thehomeless.
10. Outreach clinics in socioeconomically depressed areas.
11. Financial or in‑kind support of public health programs.
12. Donation of funds, property, or other resources that
contribute to a community priority.
13. Containment of health care costs.
14. Enhancement of access to health care or related services
that contribute to a healthier community.
15. Services offered without regard to financial return
because they meet a community need, as well as other
services, including health promotion, prevention, and
socialservices.

programs, such as Medi-Cal, in their calculation of community
benefits. One hospital we reviewed also reported community
benefits resulting from participation in its county’s health program
for the medically indigent. Mission Hospital Laguna Beach (Laguna
Beach) and its parent facility, Mission Hospital Regional Medical
Center (Mission Hospital), entered into an agreement with Orange
County to provide hospital services to all indigent persons covered
by the agreement. According to the agreement, indigent persons
covered must meet certain eligibility criteria including being a
legal resident of Orange County, having income at or below 
percent of the federal poverty level, and not otherwise being eligible
for Medi-Cal. Nevertheless, as Figureshows, the unreimbursed
Medi-Cal costs account for most costs of uncompensated care for
the hospitals we reviewed.
e categories hospitals use to compute the costs of uncompensated
care for the purposes of demonstrating community benefit are
similar to those the Internal Revenue Service (IRS) requires hospitals
to include on its Form , Schedule H, Hospitals (Schedule H). e
purpose of this schedule is to provide information on the activities
and policies of, as well as the community benefits provided by, the
nonprofit hospitals. e schedule specifically requests hospitals
toreport community benefits at cost. e IRS requires hospitals to
report charity care costs, unreimbursed costs for Medicaid, and the
The four hospitals we reviewed
follow CHA guidance when
reporting their community benefits
and do not include unreimbursed
costs of Medicare as part of
thecosts of uncompensated care,
even though state law allows it.

50
60
70
80
90
100%
$91,227,000 $25,404,000 $25,832,000 $29,307,872
Sources: The 2010 community benefit plans and the Internal Revenue Service (IRS) forms of the four hospitals we visited.
* AccordingtotheIRSForm990,ScheduleHinstructions,ameans‑testedgovernmentprogramisagovernmentprogramforwhicheligibility
depends on the recipient’s income or asset level.

†
The four hospitals we reviewed—California Pacific Medical Center St. Luke’s Hospital, El Camino Hospital Los Gatos, Mission Hospital Laguna Beach,
and SanLeandro Hospital—report their community benefits as part of the total community benefits delivered by their parent organizations, whose
costs appear here.
However, because there are no statutory standards for calculating the
costs of uncompensated care, the four hospitals we reviewed use various
methods to determine the cost of uncompensated care. Although state
law requires hospitals to include in their community benefit plans the
economic value of community benefits, such as uncompensated care, it
does not prescribe a specific methodology for calculating the economic
value of such benefits. Further, CHA guidance acknowledges that a
uniform methodology for calculating community benefit cannot be
achieved because some facilities use a cost-accounting method—a system
for recording and reporting measurements of the cost of manufacturing
goods or performing services in the aggregate and in detail—while
California State Auditor Report 2011-126
August 2012
16
others use a cost-to-charge ratio—a ratio that converts patient

determine that amount, El Camino Hospital used its cost-accounting
system to determine the cost associated with providing Medi-Cal
services—roughly . million. e hospital then reduced that cost
by . million in payments the hospital received or expects to receive
related to those services. e four hospitals’ approaches to determining
the cost of their charity care follow roughly the samemethodology.
Hospitals Have Different Income Requirements When They Decide
Who Is Eligible for Charity Care
State law requires hospitals to maintain an understandable written
charity care policy, as well as a written policy regarding discount
payments for financially qualified patients. According to Health
Planning, charity care results in free medical care for the patient,
whereas a discount payment policy refers to instances where the
hospital will reduce a medical bill based on the patient’s financial
To determine the uncompensated
cost of Medi‑Cal, the four hospitals
first determined the total cost
of Medi‑Cal services by using
their cost‑accounting system, by
applying a cost‑to‑charge ratio to
the charges for such services, or by a
combination of the two methods.
17California State Auditor Report 2011-126
August 2012
circumstances (partial charity care). e four hospitals we reviewed
generally included both full and partial charity care in a single policy
and used different income levels to determine whether patients
qualified for one of the two types of charity care. State law requires
that hospitals allow uninsured patients or patients with high medical
costs who are at or below  percent of the federal poverty level to

Percentage of federal poverty level
500 600%
California Pacific
Medical Center St. Luke’s Campus
El Camino Hospital Los Gatos*
Mission Hospital
Laguna Beach
San Leandro Hospital
Sources: The most recent charity care policies for the four hospitals we visited and the 2012 Federal Poverty Guidelines from the U.S. Department of
Health and Human Services’ Web site.
* According to the charity care policy for El Camino Hospital Los Gatos, an insured patient will qualify for full charity care if the patient’s net annual
income is less than 400 percent of the federal poverty level and if his or her annual out-of-pocket expense exceeds 10 percent of the total
annualincome of the patient or the patient’s family and the maximum government rate exceeds the insurance company payment.