March 12, 2018

The hospital 'winners and losers' in the new tax reform law

Daily Briefing

    The recently enacted tax reform law could widen the gap among for-profit hospitals and between for-profit hospitals and nonprofit hospitals, according to industry experts.

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    Among other provisions, the law, which President Trump signed in December 2017, permanently cuts the corporate tax rate to 21%.

    Tax changes' projected effects on for-profit hospitals

    Moody's Investors Service, which examined the potential effects the law could have on 11 for-profit health systems, projected that those systems could see between $700 million and $800 million in tax savings under the new law, when compared with the old tax code.

    However, Moody's and other industry experts say the tax code changes are likely to have varying effects on different for-profit hospitals and health systems. For instance, for-profit hospital systems with strong financial footing will benefit from the lower corporate tax rate, while those with high shares of debt will suffer from limitations on the deductibility of interest, Modern Healthcare reports.

    Jessica Gladstone, an SVP with Moody's Investors Service, said the law "sort of increasingly bifurcates the winners and the losers in the for-profit hospital industry."

    Moody's predicted HCA and Universal Health Services (UHS) would see significant savings, and according to Modern Healthcare, those health systems, along with LifePoint Health, during recent investor calls have said they expect to see significant tax breaks under the law. For instance, Modern Healthcare reports that HCA expects to pay about $500 million less in cash taxes under the law's new corporate tax rate this year, while UHS CFO Steve Filton has said UHS likely will save up to $150 million in cash taxes this year.

    However, for-profit hospitals that have significant debt, such as Community Health Systems and Tenet Healthcare, have been quieter regarding the tax law's potential effects. According to Modern Healthcare, the tax reform law limits the amount of interest expense companies can deduct to 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA) through 2021. That limitation will hurt highly leveraged companies with interest expenses that are a high proportion of their EBITDA, Gladstone said.

    Tax reform law also could widen gaps between nonprofits, experts say

    Different nonprofit hospital systems also could see very different effects from the tax reform law, the Wall Street Journal reports.

    One notable provision for hospitals, according to the Journal, is the new 21% tax on the salaries of executives at nonprofits whose salaries exceed $1 million, excluding some physicians. Nonprofits will be required to pay the tax on the five highest salaries at each tax-exempt entity the business has registered with the IRS.

    That means health systems that have consolidated into one organization might owe the excise tax on fewer employees than those that maintain several tax-exempt entities, the Journal reports. For instance, Banner Health—which has consolidated its 28 hospitals into one nonprofit entity—would have owed tax on five of the 11 individuals it employed with salaries surpassing $1 million in 2015, according to the Journal. Meanwhile, Trinity Health—which includes 40 separate nonprofit entities—would have been taxed on the five highest salaries exceeding $1 million under each separate entity, according to the Journal. A Trinity Health spokesperson said as many as 15 Trinity officials' salaries might qualify for the tax under the new law.

    How hospitals might spend savings under tax reform law

    Some hospitals are beginning to consider how to reinvest their projected savings, Modern Healthcare reports.

    Filton said of UHS' plans, "Now that we have a lower after-tax rate of return hurdle, we feel like there are some projects and opportunities we think are compelling today that we didn't necessarily think were compelling two months ago. We're sort of revaluating those."

    In addition, HCA has said it plans to use the tax savings to increase capital spending by nearly 30% through 2020, and invest up to $300 million over the next three years on workplace initiatives, such as educational and expanded family leave programs, Modern Healthcare reports.

    But some industry experts say the broader savings are unlikely to reach patients.

    Rodney Whitlock, a former GOP health policy aide, said, "Companies lower prices on shoes, phones, cars (comparatively or versus inflation) to get your business. Health care pricing doesn't work that way. So the natural pressure to use the tax code to lower pricing ... isn't there in health care."

    An Axios analysis of quarter four financial reports and investor calls from 21 publicly traded health care companies found the companies expect to gain $10 billion in tax savings in 2018 under the law, with most of the money being allocated toward acquisitions, dividends, share buybacks, and paying down debt (Bannow, Modern Healthcare, 3/1; Evans/Fuller, Wall Street Journal, 2/6; Owens, Axios, 3/5).

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