Tax issues surrounding electronic health records incentive payments
TAX ALERT |
A great deal of consternation has existed about how health care providers should treat for tax purposes the incentive payments received for their "meaningful use" of electronic health records. In February 2013, the IRS Office of Chief Counsel released a memorandum, CCA 201307005 (the CCA), that provides answers on several tax issues related to these incentive payments. The CCA was issued in response to a request for assistance by the Director of the office of Indian Tribal Governments, an office within the Tax Exempt and Government Entities Division of the IRS. While the CCA may not be cited or used as precedent, it does provide very helpful guidance.1 Since the CCA provides a thorough analysis of the issues and reaches understandable conclusions, this article quotes passages from the CCA extensively.
The CCA states the following facts, on which its analysis rests:
The American Recovery and Reinvestment Act of 2009 (ARRA) authorizes the Centers for Medicare and Medicaid Services (CMS) to make incentive payments to eligible professionals and hospitals that are meaningful electronic health record (EHR) users. An EHR allows health care providers to record patient information electronically instead of using paper records. "Meaningful use" entails more than merely maintaining EHRs. To be eligible for incentive payments, CMS requires that providers demonstrate that they are using their EHRs in ways that can positively affect their patients' care. For example, providers must record patient data electronically and share that data either with the patient or with other health care professionals. Providers may also employ the EHRs to issue prescriptions electronically or to update immunization records.
Under the Medicare EHR incentive program, CMS makes incentive payments to individual providers, not to practices or groups. According to CMS, the incentive payment is based on the provider's meaningful use of the EHRs and does not constitute reimbursement for the expenses incurred in establishing EHRs. Prior to actual receipt of an incentive payment, a recipient may assign the payment to a third party, typically, the practice group of which the recipient is a member.
While the CCA continually alludes to the CMS as the payor of EHR payments, a January 2013 IRS bulletin that addresses the same topic states: "The funds for these incentive payments may be administered through the state's Medicaid agency or directly from CMS via a Medicare contractor." For purposes of simplicity, the term "CMS" as used in this discussion incorporates all payors of EHR incentive payments.2
The CCA addresses the following three issues:
- Whether recipients must include in gross income electronic health record incentive payments paid by the CMS pursuant to the ARRA
- Whether the CMS has a reporting requirement with regard to payments made under the EHR Incentive Program
- Whether the reporting requirement is altered if the payment is assigned to a third party
The conclusions reached in the CCA are:
- The recipients must include the incentive payments in gross income unless they receive the payments as a conduit or an agent of another and are thus unable to keep the payments. (Emphasis added.)
- CMS has a reporting requirement under section 6041 of the Internal Revenue Code with respect to the eligible providers.
- In the event of an assignment by the eligible providers to a third party, CMS would be obligated to report a payment to the eligible provider, even if the payment is assigned to a third party. The eligible provider would then likely bear a reporting obligation with respect to the assignment to a third party. CMS would not have a reporting obligation with respect to the third-party assignee unless CMS exercised managerial oversight with respect to, or had a significant economic interest in, the assignment.
The analysis of each of the issues in question is as follows:
Issue 1 asks whether the EHR incentive payments are includible in the recipients' gross income. Section 61(a) requires all income from whatever source derived to be included in a taxpayer's gross income unless it is specifically excluded. Several U.S. Supreme Court cases are cited in the CCA that stand for the propositions that all accessions to wealth are income, that the definition of gross income is construed broadly, and that the definition of excludible income is construed narrowly. In addition to specific exclusions from gross income, a taxpayer is not taxable on a return of capital.
The CCA states:
According to the payor, CMS, the incentive payment is based on the provider's meaningful use of EHRs and does not constitute reimbursement for the expenses incurred in establishing EHRs. Thus, an incentive payment is a clear accession to wealth and not a return of capital. Further, the payments do not fall within any exclusion provided by the Code. Consequently, a recipient must include incentive payments in gross income under section 61 of the Code unless he or she receives the payments as a conduit or an agent of the recipient's practice group, or someone else, and is thus not allowed to keep the payments.
The CCA goes on to state:
In the present case, if the provider is receiving incentive payments as an agent or conduit of the provider's practice or group, or someone else, the provider is not required to include the payment in his or her gross income as long as he or she turns the payment over to the other entity or person as required.
The answer to issue 1, then, is that the recipients must include the incentive payments in gross income unless they receive the payments as a conduit or an agent of another and are thus unable to keep the payments.
Issues 2 and 3 of the CCA deal with the reporting requirements of the CMS as the payor of the EHR payments and the reporting requirements of the providers who receive the payments. Section 6041 requires information to be reported to the IRS on Form 1099-MISC, Miscellaneous Income, with respect to aggregate payments made in the course of a trade or business in excess of $600 per year. Copies of these information returns must be sent to the recipients of such payments. The CMS is subject to this law; therefore, the CMS has a reporting obligation with respect to the eligible providers to whom the CMS makes payments exceeding $600 per year. Likewise, the assignment by an eligible provider of such payments to a third party would also meet this definition. Therefore, the eligible practitioner, pursuant to the same rules, would have a reportable payment to the assignee unless an exception applies.
The CCA explains this more fully:
Payment, for the purposes of section 6041, can occur even though funds are never transferred directly to the payee. Here, CMS transfers control of the funds to the eligible provider which constitutes a payment. The eligible provider may then transfer control of the funds, by assignment, to the third party, which is also a payment. Where the eligible provider assigns the payment to a third party, CMS would be the payor with respect to the eligible provider and the eligible provider would be the payee. Then, the eligible provider would be the payor with respect to the third–party assignee, and the third–party assignee would be the payee. Under section 6041, the payor bears the obligation to report a payment.
The CMS is not obligated to determine who will ultimately include the payment as income. The existence of a conduit relationship is irrelevant to the CMS's reporting requirement. The CMS is obligated to report the payment with respect to the eligible provider only. The CMS would not be a payor with respect to a third-party assignee unless the CMS makes payment directly to the third party and exercises managerial oversight with respect to, or has a significant economic interest in, the assignment.
Therefore, the answers to issues 2 and 3 are that the CMS would bear the Form 1099-MISC reporting obligation for the payment to the eligible provider, and the eligible provider would bear the Form 1099-MISC reporting obligation, if any, with respect to the assignment and payment to a third party.
Some practical aspects of taxability and information reporting requirements
As stated above, recipients must include EHR incentive payments in gross income unless they receive the payments as a conduit or an agent of another and are thus unable to keep the payments. Payments that are kept are simply includible in the recipients' income tax returns with no offset or related deduction. Also, since these recipients will not have passed on the payments to a third party, the recipients are not required to issue a Form 1099-MISC information return to any third party.
Where EHR incentive payments are passed on to a third party, the original recipient is required to issue a Form 1099-MISC information return to each third party to whom payments in excess of $600 are made. In this case, since the "unless" premise exists (see the answer to issue 1, above) and the incentive payments are not taxable to the original recipient, how should the payments made through the original recipient to the third party be mechanically treated in the income tax return forms of the original recipient? The CCA does not address this point, although it does state that such payments are not includible in the original recipient's gross income. If such payments are not included in gross income, they will not be included in net taxable income.
However, the IRS uses a matching program by virtue of which Forms 1099-MISC sent to taxpayers are matched to what those same taxpayers report as gross income. If there is a mismatch, the IRS sends a notice to the taxpayer who received the Form 1099-MISC, essentially asking why the taxpayer failed to include the income reported by the payor on the Form 1099-MISC. It can be cumbersome and very time-consuming for taxpayers to explain to the IRS that income indicated on a Form 1099-MISC is not taxable to the recipient of the payments reported there. Very often, taxpayers rely on their income tax return preparers to handle such matters with the IRS and must pay them additional fees to do so. How can an IRS mismatch notice regarding EHR payments be avoided in the first place?
From the authority that currently exists, it is not clear exactly where EHR payments should be reported on Form 1099-MISC–in box 3, or in box 7. Thus, there may be some choices in exactly how the payments and remittances to third parties could be reported in the income tax returns of the initial recipients, depending on which box of Form 1099-MISC is used by the payor to report the payments to the original recipients.
The following examples explain how, in slightly different ways, a mismatch might be avoided:
Example 1: Assume a provider working in a clinic receives a Form 1099-MISC from the CMS for $750, has paid that money on to the clinic in accordance with their contractual arrangements, and has sent a Form 1099-MISC to the clinic, with a copy to the IRS, in accordance with applicable requirements. It is clear according to the CCA that the provider is not required to include the $750 in gross income in the first instance. However, not doing so would likely result in a mismatch notice being sent to the provider by the IRS after it compares the CMS Form 1099-MISC for $750 to the provider's income tax return. A tax advisor, instead of not including anything in gross income, may advise the provider to include the $750 in the income section of Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), that is attached to the provider's Form 1040, U.S. Individual Income Tax Return, and to also include the payment of $750 from the provider to the clinic in the expenses section of the same Schedule C. In that way, the Form 1099-MISC sent by the CMS to the provider would be accounted for in the provider's income tax return, but the net amount reported in the provider's adjusted gross income and taxable income would be zero–$750 of income and $750 of offsetting expense. Such an approach could prevent a mismatch notice being sent to the provider by the IRS.
Importantly, if an original recipient of EHR payments remits those payments on to a third party and uses Form 1040, Schedule C to report the income and the remittance as described in the example above, the questions at items I and J near the top of page 1 of Schedule C must be answered. Those questions are
I. Did you make any payments in 2012 that would require you to file Form(s) 1099?
J. If "Yes," did you or will you file required Forms 1099?
It must be noted in this regard that Schedule C is part of the income tax return that is signed by the taxpayer under penalties of perjury to be true, accurate and complete. Therefore, using Schedule C requires accurate answers to these questions.
Example 2: Under the same facts as Example 1, a tax advisor alternatively may advise the provider to report the incentive payment of $750 as other income on line 21 of Form 1040 (instead of on Schedule C), with an offsetting negative adjustment to taxable income on a line of Form 1040, page 1 that is above line 37, adjusted gross income. This approach could also prevent a mismatch notice being sent to the provider by the IRS and would achieve the same adjusted gross income as that reported under the Schedule C approach. It is not clear, however, which line of Form 1040, page 1 could be used to reflect the offsetting negative adjustment.
In any event, a health care provider who receives EHR incentive payments and passes them on to a third party should keep the documents and records that can prove the amount of incentive payments (1) received from all payors, and (2) paid to the third parties (on a party-by-party basis), as well as copies of contractual documents that require payments to be relinquished to the third parties.
1 CCDM 33.1.2, Chief Counsel's Legal Advice Program.These documents are legal advice, signed by executives in the National Office of the Office of Chief Counsel and issued to Internal Revenue Service personnel who are national program executives and managers. They are issued to assist Service personnel in administering their programs by providing authoritative legal opinions on certain matters, such as industry-wide issues. See