Reg. § 1.501(r)-2 Failures to satisfy section 501(r).
(a) Revocation of section 501(c)(3) status Except as otherwise provided in and of this section, a hospital organization failing to meet one or more of the requirements of section separately with respect to one or more hospital facilities it operates may have its section status revoked as of the first day of the taxable year in which the failure occurs. In determining whether to continue to recognize the section status of a hospital organization that fails to meet one or more of the requirements of section with respect to one or more hospital facilities, the Commissioner will consider all relevant facts and circumstances including, but not limited to, the following:
(1) Whether the organization has previously failed to meet the requirements of section , and, if so, whether the same type of failure previously occurred.
(2) The size, scope, nature, and significance of the organization's failure(s).
(3) In the case of an organization that operates more than one hospital facility, the number, size, and significance of the facilities that have failed to meet the section requirements relative to those that have complied with these requirements.
(4) The reason for the failure(s).
(5) Whether the organization had, prior to the failure(s), established practices or procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with the section requirements.
(6) Whether the practices or procedures had been routinely followed and the failure(s) occurred through an oversight or mistake in applying them.
(7) Whether the organization has implemented safeguards that are reasonably calculated to prevent similar failures from occurring in the future.
(8) Whether the organization corrected the failure(s) as promptly after discovery as is reasonable given the nature of the failure(s).
(9) Whether the organization took the measures described in and of this section before the Commissioner discovered the failure(s).
(b) Minor omissions and errors
(1) In general A hospital facility's omission of required information from a policy or report described in or , or error with respect to the implementation or operational requirements described in through , will not be considered a failure to meet a requirement of section if the following conditions are satisfied:
(i) Such omission or error was minor and either inadvertent or due to reasonable cause.
(ii) The hospital facility corrects such omission or error as promptly after discovery as is reasonable given the nature of the omission or error. Such correction must include establishment (or review and, if necessary, revision) of practices or procedures (formal or informal) that are reasonably designed to promote and facilitate overall compliance with the requirements of section .
(2) Minor In the case of multiple omissions or errors, the omissions or errors are considered minor for purposes of this only if they are minor in the aggregate.
(3) Inadvertent For purposes of this , the fact that the same omission or error has been made and corrected previously is a factor tending to show that an omission or error is not inadvertent.
(4) Reasonable cause For purposes of this , the fact that a hospital facility has established practices or procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with the section requirements prior to the occurrence of an omission or error is a factor tending to show that the omission or error is due to reasonable cause.
(c) Excusing certain failures if hospital facility corrects and discloses A hospital facility's failure to meet one or more of the requirements described in through that is neither willful nor egregious shall be excused for purposes of this section if the hospital facility corrects and makes disclosure in accordance with rules set forth by revenue procedure, notice, or other guidance published in the Internal Revenue Bulletin. For purposes of this , a “willful” failure includes a failure due to gross negligence, reckless disregard, or willful neglect, and an “egregious” failure includes only a very serious failure, taking into account the severity of the impact and the number of affected persons. Whether a failure is willful or egregious will be determined based on all of the facts and circumstances. A hospital facility's correction and disclosure of a failure in accordance with the relevant guidance is a factor tending to show that the failure was not willful.
(d) Taxation of noncompliant hospital facilities
(1) In general Except as otherwise provided in and of this section, if a hospital organization that operates more than one hospital facility fails to meet one or more of the requirements of section separately with respect to a hospital facility during a taxable year, the income derived from the noncompliant hospital facility (“noncompliant facility income”) during that taxable year will be subject to tax computed as provided in section (or as provided in section if the hospital organization is a trust described in section ), but substituting the term “noncompliant facility income” for “taxable income,” if—
(i) The hospital organization continues to be recognized as described in section during the taxable year; but
(ii) The hospital organization would not continue to be recognized as described in section during the taxable year based on the facts and circumstances described in of this section (but disregarding of this section) if the noncompliant hospital facility were the only hospital facility operated by the organization.
(2) Noncompliant facility income
(i) In general For purposes of this , the noncompliant facility income derived from a hospital facility during a taxable year will be the gross income derived from that hospital facility during the taxable year, less the deductions allowed by chapter 1 that are directly connected to the operation of that hospital facility during the taxable year, excluding any gross income and deductions taken into account in computing any unrelated business taxable income described in section that is derived from the facility during the taxable year.
(ii) Directly connected deductions For purposes of this , to be directly connected with the operation of a hospital facility that has failed to meet the requirements of section , an item of deduction must have proximate and primary relationship to the operation of the hospital facility. Expenses, depreciation, and similar items attributable solely to the operation of a hospital facility are proximately and primarily related to such operation, and therefore qualify for deduction to the extent that they meet the requirements of section , section , or other relevant provisions of the Internal Revenue Code (Code). Where expenses, depreciation, and similar items are attributable to a noncompliant hospital facility and other hospital facilities operated by the hospital organization (and/or to other activities of the hospital organization unrelated to the operation of hospital facilities), such items shall be allocated among the hospital facilities (and/or other activities) on a reasonable basis. The portion of any such item so allocated to a noncompliant hospital facility is proximately and primarily related to the operation of that facility and shall be allowable as a deduction in computing the facility's noncompliant facility income in the manner and to the extent it would meet the requirements of section , section , or other relevant provisions of the Code.
(3) No aggregation In computing the noncompliant facility income of a hospital facility, the gross income from (and the deductions allowed with respect to) the hospital facility may not be aggregated with the gross income from (and the deductions allowed with respect to) the hospital organization's other noncompliant hospital facilities subject to tax under this or its unrelated trade or business activities described in section .
(4) Interaction with other Code provisions
(i) Hospital organization operating a noncompliant hospital facility continues to be treated as tax-exempt A hospital organization operating a noncompliant hospital facility subject to tax under this shall continue to be treated as an organization that is exempt from tax under section because it is described in section for all purposes of the Code. In addition, the application of this shall not, by itself, result in the operation of the noncompliant hospital facility being considered an unrelated trade or business described in section with respect to the hospital organization. Thus, for example, the application of this shall not, by itself, affect the tax-exempt status of bonds issued to finance the noncompliant hospital facility.
(ii) Noncompliant hospital facility operated by a tax-exempt hospital organization is subject to tax A noncompliant hospital facility described in of this section is subject to tax under this , notwithstanding the fact that the hospital organization operating the hospital facility is otherwise exempt from tax under section and subject to tax under section and that states such organizations are not liable for the tax imposed under section .
(iii) Noncompliant hospital facility not a business entity A noncompliant hospital facility subject to tax under this is not considered a business entity for purposes of .
(e) Instances in which a hospital organization is not required to meet section 501(r) A hospital organization is not required to meet the requirements of section (and, therefore, is not subject to any consequence described in this section for failing to meet the requirements of section ) with respect to—
(1) Any hospital facility it is not “operating” within the meaning of ;
(2) The operation of a facility that is not required by a state to be licensed, registered, or similarly recognized as a hospital; or
(3) Any activities that constitute an unrelated trade or business described in section with respect to the hospital organization.
[T.D. 9708, 79 FR 78998, Dec. 31, 2014; 80 FR 12762, Mar. 11, 2015]