Health Care Finance

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Business goals

Healthcare finance cannot be practiced in isolation. Rather, it must be guided by the goals of the organization. That concept is exactly what Jon Matthews, a recent healthcare management graduate, had in mind as he thought about two job interviews scheduled to take place within the next several days. The openings were for an entry-level management position at Southwest Healthcare, a for-profit (investor-owned) multispecialty group practice, and the same position at St. Jerome’s Hospital, a not-for-profit organization. To prepare for the interviews, Jon studied the organizations and their goals. He wondered if the different ownership status of the providers resulted in a significant difference in mission, goals, and financial behavior.

Thanks to his healthcare management classes, Jon had a rough idea of the characteristics of different ownership types. Still, he thought long and hard about whether St. Jerome’s is even a business. After all, as a Catholic hospital, it has a long history of providing charity care to so- ciety’s less fortunate. Also, it has no well-defined owner group, so it can be thought of as being “owned” by the community at large.

On the other hand, Southwest is owned by its physicians and does not have the same tradition of serving the poor. Has the obligation to make money for the physician- owners influenced Southwest’s mission and goals, creating differences between it and St. Jerome’s? If so, does this mean its approach to financial decision making differs? Jon wanted to answer these questions before he began his interviews.

By the end of this chapter, you will know more about the various types of provider organizations, their goals, and how these goals influence the finance function. See if your take on the situation is the same as Jon’

After studying this chapter, you will be able to

➤ Define the concept of a business in financial terms.

➤ Describe the alternative legal forms of business.

➤ Articulate the key differences between for-profit and not-for-profit businesses.

➤ Explain how business goals are influenced by the form of organization and ownership.

➤ Briefly discuss the implications of tax laws for individuals, for-profit businesses, and not-for-profit corporations.

2.1 inTrODUcTiOn

Most of the basic concepts of healthcare finance are the same regardless of the specific sector (e.g., hospital versus long-term care versus medical practice) and organizational setting. However, some aspects of healthcare finance are influenced by the unique nature of particular types of healthcare organizations. In this chapter, we present the context in which health services finance is practiced.

First, we consider the nature of businesses. Is the provision of health services a business, and if so, how are such businesses formed, and what are the implications of being a business as opposed to a pure charity? Then, we explore the consequences of being a health services business that is organized as a not-for-profit corporation. Does not-for- profit status influence an organization’s goals and objectives, and, if so, does it affect the practice of finance?

These, along with a brief look at the impact of taxes, are some of the issues we explore in this chapter.

2.2 cOncepT OF a bUSineSS

What is a business? If this question were asked of a group of accountants, the answer probably would involve financial statements, such as the income statement and balance sheet, which we cover in Chapters 11 and 12. If the question were posed to a group of lawyers, the answer likely would include legal forms of business, which we describe in the next section. From a financial (economic) perspective, a business can be thought of as an entity—its legal form does not matter—that (1) obtains financing, or capital, from the marketplace; (2) uses those funds to buy land, buildings, and equipment, that is, assets; (3) operates those assets to create goods or services; and (4) sells those goods or services to create revenue. To be financially viable, a business has to generate sufficient revenue to pay all of the costs associated with creating and selling its goods or services. Although this description of a business is surprisingly simple, it tells a great deal about the basic decisions that business managers must make. One of the first decisions is what legal form the business will take. The next decision is how the business will raise the capital it needs.

CRITICAL CONCEPT

Business Versus Pure Charity

A business is an entity that raises capital in the marketplace; invests those funds in assets; and uses those assets to cre- ate goods or services, which it sells. Businesses differ from pure charities in the sense that businesses sustain them- selves by revenue obtained from sales, while pure charities are sustained primarily by contributions. In a sense, pure charities, as well as government agencies, are budgetary or- ganizations in that their funding is constrained by external forces (contributions or appropriations), and each year they must operate within the budget. Businesses, however, are not so constrained; they can influence their “funding” by selling more products or services.

to get started. Should it borrow the money (use debt financing), raise the money from owners (or from the community if not-for-profit), or use some combination of the two sources? Next, once the start-up capital is raised, what assets (facilities and equipment) should be acquired to create the services (in the case of healthcare providers) that will be offered to patients?

Note that businesses are profoundly different from pure charities. A business, such as a hospital or medical practice, sustains itself financially by selling goods or services. Thus, it is in competition with other businesses for the consumer dollar. A pure charity, such as the American Heart Association, on the other hand, does not sell goods or services. Rather, it obtains funds by soliciting contributions and then uses those funds to supply charitable (free) services. In essence, a pure charity is a budgetary organization in that the amount of contributions fixes its budget for the year. Similarly, a government agency has a budget that is fixed by appropriations.

Of course, pure charities and government agencies must operate in a businesslike manner, but they do not operate like businesses because they do not obtain their operating funds by selling goods or services. Of course, some healthcare providers do solicit contribu- tions, and many provide some charitable care, but health services organizations primarily sustain themselves by selling services.

FOR YOUR CONSIDERATION

Businesses, Pure Charities, and Government Entities

A healthcare business relies on revenues from sales to create financial sustainability. For example, if a hospital’s revenues exceed its costs, cash is being generated that can be used to provide new and improved patient services, and the hospital can continue to meet community needs. On the other hand, pure charities, such as the American Red Cross, rely on contributions for revenues, so the amount of charitable services provided (which typically are free) is limited by the amount of contributions received. Finally, most governmental units are funded by tax receipts, so, as with charities, the amount of services provided is limited, in this case by the taxing authority’s ability to raise revenues. Yet, in spite of differences, all three types of organization must operate in a financially prudent manner.

What do you think? From a finance perspective, how different are these types of organizations? How does the day-to-day functioning of their finance departments vary? Is finance more important in one type of organization than in another?

SeLF-TeST QUeSTiOnS

1. Briefly describe a business from a financial perspective.

2. What is the difference between a business and a pure charity?

2.3 LegaL FOrmS OF bUSineSSeS

Because the focus of this book is on the practice of finance within healthcare businesses, a good starting point is to understand the different legal forms of businesses. Many health services manag- ers work for corporations, including not-for-profit corporations, because these businesses often are large and require extensive management struc- tures. However, some healthcare managers choose to work for medical practices that are organized as proprietorships or partnerships—and hybrid forms (which have features of both partnerships and cor- porations) are becoming common in medical prac- tices as well. Health services managers need to be familiar with all legal forms of businesses, regardless of the form of their own organization. To illustrate this point, hospital managers, whether at for-profit or not-for-profit hospitals, work closely with the physician staff, so knowledge of how physicians organize their practices is useful.

Proprietorship

A simple form of busi- ness owned by one person. Also called sole proprietorship.

prOprieTOrShipS anD parTnerShipS

A proprietorship (or sole proprietorship) is a business owned by one person. Going into business as a proprietor is easy—the owner merely begins business operations. However, most cities require even the smallest businesses to be licensed, and state licensure is re- quired for most healthcare professionals.

The proprietorship form of organization is easily and inexpensively formed, is sub- ject to few government regulations, and pays no corporate (business) income taxes. All earnings of the business, whether reinvested in the business or withdrawn by the owner, are taxed as personal income to the proprietor. In general, a sole proprietorship will pay lower total taxes than a comparable taxable corporation because corporate profits are taxed twice—once at the corporate level and again by stockholders (owners) at the personal level when profits are distributed as dividends or when the stock is sold.

A partnership is similar to a proprietorship, but it is owned by two or more in- dividuals. Partnerships may operate under different degrees of formality, ranging from informal oral agreements between the partners to formal agreements filed with the state in which the partnership conducts business. Like a proprietorship, the major advantage of the partnership form of organization is its low cost and ease of formation. In addition, the tax treatment of a partnership is similar to that of a proprietorship: The partnership’s earnings are allocated to the partners and taxed as personal income, regardless of whether the earnings are actually paid out to the partners or retained in the business.

Partnership

An unincorporated business that is created and owned by two or more people.

Proprietorships and partnerships have several disadvantages, including the following:

◆ Selling an ownership interest in the business is difficult. There is no well- established market for selling an ownership stake in a proprietorship or partnership.

◆ Proprietors and partners have unlimited personal liability for the debts of the business, which can result in losses greater than the amount invested in the business. In a proprietorship, unlimited liability means that the owner is personally responsible for the debts of the business. In a partnership, it means that if any partner is unable to meet his or her obligation in the event of bankruptcy, the remaining partners are responsible for the unsatisfied claims and must draw on their personal assets if necessary to fulfill that obligation.

◆ The life of the business is limited to the life of the owners.

For these reasons, proprietorships and most partnerships generally are restricted to relatively small businesses.

The three disadvantages of proprietorships and partnerships listed above lead to the fourth, and perhaps most important, disadvantage from a finance perspective: the difficulty that proprietorships and partnerships have in attracting large amounts of capital. This is no particular problem for a small business or when the proprietor or partners are wealthy, but in most situations the difficulty of attracting capital becomes a handicap if the business needs to grow substantially to take advantage of market opportunities. Thus, many for-profit businesses start out as sole proprietorships or partnerships but then ultimately convert to corporations.

FOr-prOFiT cOrpOraTiOnS

A for-profit (investor-owned) business may be organized as a corporation, but a not-for-profit business must be organized as a corporation. In this section, we focus on the advantages and disadvantages of for-profit corporations. Not-for-profit corporations, along with additional facets of for-profit corporations, are discussed in section 2.4 of this chapter.

A for-profit corporation is a legal entity that is separate and distinct from its owners and managers. The creation of a separate business entity provides these primary advantages:

◆ A for-profit corporation has unlimited life and can continue in existence after its original owners and managers have died or left the company.

◆ Transferring ownership in a for-profit corporation is easy because ownership is divided into shares of stock that can be easily sold (assuming the business is large and its stock is frequently traded).

◆ Owners of a for-profit corporation have limited liability. To illustrate, suppose Kate Anderson made an investment of $10,000 in a partnership that subsequently went bankrupt, owing $100,000. Because the partners are liable for the debts of the partnership, Kate could be assessed for a share of the partner- ship’s debt in addition to the loss of her initial $10,000 contribution. In fact, if the other partners were unable to pay their shares of the indebtedness, Kate could be held liable for the entire $100,000. However, if the $10,000 had been invested in a corporation that went bankrupt, Kate’s potential loss would be limited to her initial $10,000 investment. (Note that in the case of small, financially weak corporations, the limited liability feature of ownership is often fictitious because bankers and other lenders require personal guarantees from the stockholders.)

With these three major advantages—unlimited life, ease of ownership transfer, and limited liability—for-profit corporations can more easily raise money in the financial markets than sole proprietorships or partnerships can.

For-profit corporations have two primary disadvantages. First, corporate earnings typically are subject to double taxation—once at the corporate level, and again at the personal level, when dividends are paid or the stock is sold. Second, setting up a corporation and fulfilling the subsequent requirement to file periodic state and federal reports are more costly and time-consuming activities than are required to establish a proprietorship or partnership.

While participants in a proprietorship or partnership can begin operations without much legal paperwork, the founders, or their attorney, of a corporation must prepare a charter and a set of bylaws before launching operations. Today, attorneys have standard electronic forms for charters and bylaws, so they can set up a “no frills” corporation with modest effort. Indeed, a number of websites help founders perform most of the set-up work themselves. Still, setting up a corporation remains relatively difficult compared to a proprietorship or partnership, and it is even more difficult if the corporation has nonstandard features.

For-profit corporation: A legal business entity that is separate and distinct from its owners and manager

The value of any for-profit business, other than a small one, generally is maximized if it is organized as a corporation for the following reasons:

◆ Limited liability reduces the risks borne by the owners (stockholders). With all else the same, the lower the risk, the higher the value of the ownership investment.

◆ A business’s value is dependent on growth opportunities, which in turn are dependent on the business’s ability to attract capital. Because corporations can obtain capital more easily than other forms of business can, they are better able to take advantage of growth opportunities.

◆ The value of any investment depends on its liquidity (a liquid investment), which means the ease with which it can be sold for a fair price. Because an ownership interest in a for-profit corporation is much more liquid than a similar interest in a proprietorship or partnership, the corporate form of organization creates more value for its owners.

For tax purposes, standard for-profit corporations are called C corporations. However, if they meet certain requirements, one or a few individuals can form a for- profit corporation and elect to pay taxes as if the business were a proprietorship or partnership, hence avoiding double taxation. Such corporations, which differ only in how the owners are taxed, are called S corporations (the name comes from subchapter S of the tax code). Although S corporations are similar to two of the hybrid forms (dis- cussed next) in terms of taxes, the hybrid forms provide more flexibility and benefits to owners.

hybriD FOrmS

In addition to the two basic forms of organization—proprietorship/partnership and corporation—several hybrid forms of business are used by healthcare businesses.

To begin, two specialized types of partnerships have different characteristics from those of a standard partnership. First, limiting some of the partners’ liabilities is possible by establishing a limited partnership, wherein certain partners are designated general partners and others are limited partners. The limited partners, as with the owners of a corporation, are liable only for the amount of their initial investment in the partnership, while the general partners have unlimited liability. However, the limited partners typically have restricted or no control; control rests solely with the general partners. Limited partnerships are quite common in some industries (think real estate). They are not very prevalent in the health services industry because finding one partner who is willing to accept all of the business’s risk and another partner who is willing to relinquish control is difficult.

Liquid investment

An investment that can be sold quickly at a “fair” price.

C corporation

A traditional for-profit corporation.

S corporation

A for-profit corporation with a limited number of stockholders that, after filing an application with the Internal Revenue Service, is taxed as a proprietor- ship or partnership.

Hybrid form

A legal business entity that has features associated with both partnerships and for-profit corporations.

Limited partnership

A partnership in which the general partners have most of the control and unlimited liability while the limited partners have little control and liability that is limited to their initial contribution.

A limited liability partnership (LLP) is available in many states. In such a partner- ship, the partners have joint liability for all of its actions, including personal injuries and indebtedness. However, all partners enjoy limited liability regarding professional malpractice because partners are only liable for their own individual malpractice actions, not those of the other partners.

A limited liability company (LLC) has some characteristics of both a partnership and a corporation. The owners of an LLC are called members, and they are taxed as if they are partners in a partnership. However, a member’s liability is similar to that of a stockholder of a corporation because liability is limited to the member’s initial contribution in the business. Personal assets are only at risk if the member assumes specific liability, such as signing a personal loan guarantee.

A professional corporation (PC), called a professional association in some states, is a corporate form of organization common among physicians and other individual and group practice healthcare professionals. All 50 states have statutes that prescribe the requirements for such businesses, providing the usual benefits of incorporation but not relieving the participants of professional liability. Indeed, the primary motivation behind a PC, which is a relatively old business form compared to the LLP and LLC, was to provide a way for professionals to incorporate yet be held personally liable for professional malpractice.

Limited liability partnership (LLP)

A partnership that limits the professional (malpractice) liability of its members.

Limited liability company (LLC)

A corporation that com- bines some features of a partnership with others of a corporation.

SeLF-TeST QUeSTiOnS

1. What are the three basic forms of business organization, and how do they differ?

2. What are the different types of partnerships? 3. What is the difference between a C corporation and an S corporation?

2.4 aLTernaTive FOrmS OF OWnerShip

Unlike other industries, not-for-profit corporations play a major role in the healthcare industry. As we note in Chapter 1, about 60 percent of the hospitals in the United States are private not-for-profit hospitals. Only 15 percent of all hospitals are for- profit (investor owned); the remaining 25 percent are government operated. Not- for-profit ownership is also common in nursing home, home health care, and health insurance businesses. In this section, we compare and contrast the features of for-profit and not-for-profit corporations. We begin by offering additional detail on for-profit corporations.

Professional corporation (PC)

A type of corporate business organization in which the owner/ managers retain professional (medical) liability. Called a professional association in some states.

aDDiTiOnaL inFOrmaTiOn On FOr-prOFiT cOrpOraTiOnS

Publicly held company

A for-profit corporation whose shares are held by the general public (a large number of share- holders) and traded on an exchange, such as the New York Stock Ex- change, or in the-counter market.

When you think of a corporation, you probably think in terms of an investor-owned (for-profit) corporation. Large businesses, such as Microsoft, IBM, and General Electric, are investor-owned corporations. In healthcare, HCA and Tenet Healthcare are for-profit corporations in the hospital industry. Other healthcare examples include Apria Healthcare, which offers home health services, and Brookdale Senior Living, which provides long-term care.

Investors become owners of for-profit corporations by buying shares of common stock in the company. When stock is sold by the company, the funds raised from the sale go to the corporation. However, stock owners (stockholders) can sell their shares to other individuals. These sales typically take place on exchanges, such as the New York Stock Exchange, or in the over-the-counter market, which is composed of a large number of stock- brokers connected by a sophisticated electronic trading system. When shares are bought and sold by individuals through exchanges, the corporations whose stocks are traded receive no funds from the trades. Corporations receive funds only when the shares are first sold to investors.

Investor-owned corporations may be publicly held or privately held. The shares of publicly held companies are owned by a large number of investors and are widely traded. For example, Health Management Associates, which owns and operates roughly 65 hospitals, has about 250 million shares owned by some 30,000 individual and institutional stockholders. Another example is Kindred Healthcare, which owns and operates about 240 nursing homes and 120 long-term, acute care hospitals and has about 52 million shares owned by some 8,000 stockholders. Drug companies, such as Merck and Pfizer, and medical equipment manufacturers, such as St. Jude Medical (which makes heart valves), are all publicly held corporations.

Conversely, the shares of privately (closely) held companies are owned by just a handful of investors and are not publicly traded. In general, the managers of privately held companies are major stockholders. For example, HCA, the nation’s largest for-profit hospital chain, with about 160 hospitals, was a publicly held company until November 2006. At that time, the outstanding stock of the company was purchased by a small group of investors, taking the company private. In reality, privately held companies are more similar to

Privately (closely) held company :

A for-profit corporation whose stock is owned by a small number of individuals—usu- ally the business’s managers—and is not publicly traded.

CRITICAL CONCEPT

Investor-Owned (For-Profit) Corporation

Privately (closely) held company A for-profit corporation whose stock is owned by a small number of individuals—usually the business’s managers—and is not publicly traded.

Investor-owned corporations are for-profit businesses whose ownership (stock) is either publicly traded (owned by a large number of investors) or privately held (owned by a small number of investors). The stockholders of for-profit corporations exercise control of the business by voting for the board of directors. Stock- holders have a claim on the residual earnings of the business, which is the amount of revenue that remains after all expenses have been paid. All or a portion of the residual earnings may be paid out to stockholders as dividends or may be used to repurchase shares currently owned by stockholders. For-profit corporations must pay taxes, including property and income taxes.

partnerships than to publicly held companies. Often, the privately held corporation is a transitional form of organization that exists for a short time between a proprietorship or partnership and a publicly owned corporation. A closely held corporation may be motivated to “go public” either by the need for additional capital or by the desire of the owners to “cash out.” In the case of HCA, the new owners sold off poorly performing hospitals, improved the operations of the remaining hospitals, and in 2011 took the company public again. By doing so, the stockholders who took the company private both recovered their investment in the hospital chain and earned a tidy profit.

Stockholders (shareholders) are the owners of investor-owned corporations. As owners, they have these basic rights:

◆ The right of control. Common stockholders have the right to vote for the corporation’s board of directors, which oversees the management of the company. Each year, a company’s stockholders receive a ballot, called a proxy, which they use to vote for directors and to vote on other issues proposed by management or stockholders. In this way, stockholders exercise control. In the voting process, stockholders cast one vote for each common share held.

◆ A claim on the residual earnings of the firm. A for-profit corporation sells goods or services and realizes revenue from the sales. To produce this revenue, the corporation must incur expenses for materials, labor, insurance, debt capital, and so on. Any excess of revenue over expenses—the residual earnings—be- longs to the shareholders of the business. Often, a portion of these earnings is paid out in the form of dividends, which are cash payments to stockholders, or stock repurchases, whereby the company buys back shares held by stock- holders. However, management typically elects to reinvest some (or all) of the residual earnings in the business, which presumably will produce even higher earnings in the future. (If you are interested in more information about how corporate earnings are distributed to stockholders, see Chapter 16, which is available online at ache.org/books/FinanceFundamentals2.)

◆ A claim on liquidation proceeds. In the event of bankruptcy and liquidation, shareholders are entitled to any proceeds that remain after all other obligations of the business have been satisfied. In most liquidations, however, little or nothing is left for stockholders.

In summary, for-profit corporations have three key traits. First, the owners (the stockholders) of the business are well defined and exercise control of the firm by voting for directors. Second, the residual earnings of the business belong to the owners, so management is responsible only to the stockholders for the profitability of the firm. Third, investor-owned corporations are subject to taxation at the local, state, and federal levels.

Stockholders (share- holders)

The owners of a for- profit corporation by virtue of holding one or more shares of the company’s stock.

Residual earnings

The earnings (profits) of a business after all expenses have been paid.

nOT-FOr-prOFiT cOrpOraTiOnS

If an organization meets a set of stringent requirements, it can qualify for incorporation as a not-for-profit (tax-exempt) corporation. Such corporations are sometimes called nonprofit corporations. Because nonprofit businesses (as opposed to pure charities, such as the American Red Cross) need profits to sustain operations, and because it is hard to explain why nonprofit corporations should earn profits, the term “not-for-profit” is used here, as it is more descriptive of such health services corporations.

Tax-exempt status is granted to healthcare businesses that meet the tax definition of a charitable corporation as defined by Internal Revenue Service (IRS) Tax Code Sec- tion 501(c)(3). Hence, such corporations are also known as 501(c)(3) corporations. The IRS Tax Code defines a charitable organization as “any corporation, community chest, fund, or foundation that is organized and operated exclu- sively for religious, charitable, scientific, public safety, literary, or educational purposes.” Because the promotion of health is commonly consid- ered a charitable activity, a corporation that provides healthcare services can qualify for tax- exempt status, provided that it meets the other requirements.

In addition to the charitable purpose, a not-for-profit corporation must be organized and operated so that it operates exclusively for the public, rather than private, interest. Thus, no profits can be used for private gain and no direct political activity can be conducted. Also, if the corporation is liquidated or sold to an investor- owned business, the proceeds from the liquidation or sale must be used for a charitable purpose. Because individuals cannot benefit from the profits of not-for-profit corporations, such organizations cannot pay dividends. However, prohibition of private gain from profits does not prevent parties, such as managers or physicians, from benefiting through salaries, perquisites, contracts, and so on.

Not-for-profit corporations differ significantly from investor-owned corporations. Because not-for-profit corporations have no shareholders, no single body of individuals has ownership rights to the firm’s residual earnings or exercises control of the firm. Rather, control is exercised by a board of trustees, which, for all practical purposes, is not constrained by external parties (such as shareholders). However, unlike for-profit corporations, the boards of not-for-profit corporations are typically dominated by community leaders, who presumably are motivated to ensure that the organization meets community needs.

CRITICAL CONCEPT

Not-for-Profit (Tax-Exempt) Corporation

Not-for-profit healthcare businesses must be incorporated under the provisions of Section 501(c)(3) of the IRS Tax Code. Because such corporations have no owners, none of their profits can be paid out as dividends. In essence, not-for-profit businesses are “owned” by the community at large and are controlled by a board of trustees, which generally includes community representation. In general, not-for-profit corporations are exempt from local, state, and federal income and property taxes.

Not-for-profit corporations are generally exempt from taxation, including both property and income taxes, and have the right to issue tax-exempt debt. (The ability to issue tax-exempt debt means that not-for-profit corporations pay relatively low interest rates on their debt financing.) Finally, individual contributions to not-for-profit organizations can be deducted from taxable income by the donor, so not-for-profit corporations have access to tax-subsidized contribution capital. (The tax benefits enjoyed by not-for- profit corporations, including the benefits associated with tax-exempt debt, are discussed in more detail in section 2.6, on tax laws.)

For-profit corporations must file annual income tax returns with the IRS. The equivalent filing for not-for-profit corporations is IRS Form 990, Return of Organization Exempt from Income Tax. Its purpose is to provide both the IRS and the public with financial information about not-for-profit organizations, and it is often the only source of such information. It is also used by government agencies to prevent organizations from abusing their tax-exempt status. Form 990 requires significant disclosures related to governance and boards of directors. In addition, not-for-profit hospitals are required to file Schedule H to Form 990, which includes financial information on the amount and type of community benefits (primarily charity care) provided, bad debt losses, Medicare patients, and collection practices. IRS regulations require not-for-profit organizations to provide copies of their three most recent Form 990s to anyone who requests them, whether in person or by mail, fax, or e-mail. Form 990s are also available to the public through several online services.

The financial problems facing federal, state, and local governments have caused politicians to take a close look at the tax subsidies provided to not-for-profit hospitals. Several bills that require hospitals to meet minimum levels of care to the indigent to retain tax-exempt status have been introduced in the US Congress. Such efforts by Congress have prompted the American Hospital Association to issue guidelines for the provision of charity care, which include (1) giving discounts to uninsured patients of “limited means” (self-pay patients often pay much higher rates than those paid by insurers); (2) establishing a common definition for community benefits, which encompasses the full range of services provided to the population served, such as health education and community outreach; and (3) improving transparency, or the ability of outsiders to understand a business’s governance structure and policies, including executive compensation.

In addition to congressional action, legislators in more than 20 states have proposed bills that mandate the amount of charity care provided by not-for-profit hospitals and the billing and collections procedures applied to the uninsured. For example, Texas has established minimum requirements for charity care that, in effect, hold not-for-profit hospitals accountable to the public for the tax exemptions they receive. The Texas law specifies four tests, and each hospital must meet at least one of them. The test that most hospitals use to comply with the law requires that at least 4 percent of patient revenue be spent on charity care. Under a proposed Illinois law, not-for-profit hospitals would be required to devote

Form 990

A form filed by not- for-profit organizations with the Internal Revenue Service that reports on the organization’s governance and charitable activities.

Schedule H

An attachment to Form 990 filed by not-for- profit hospitals that provides additional information on the hospital’s charitable activities.

Community benefits

Initiatives taken by providers, such as education programs, that enhance the health and well-being of the community.

Transparency

The ability of outsiders to know what is happening within a business.

At least 8 percent of their operating costs on charity care and to establish discounts to the uninsured on the basis of income level.

Finally, money-starved municipalities in several states have attacked the prop- erty tax exemption of not-for-profit hospitals that have “neglected” their charitable missions. For example, tax assessors in several states have forced selected hospitals to pay property taxes, arguing that the hospitals had strayed too far from their charitable purpose. Such “voluntary” payment of property taxes by a not-for-profit entity, which is becoming more common, is called payment in lieu of taxes (PILOT). According to one estimate, if all not-for-profit hospitals paid taxes comparable to their investor- owned counterparts, local, state, and federal governments would garner an additional $4 billion in tax revenues.

FOR YOUR CONSIDERATION

Making Not-for-Profit Hospitals Do Good

Many people have criticized not-for-profit hospitals for not “earning” their charitable ex- emptions. In 2010 the Illinois Supreme Court concluded that Provena Covenant hospital, located in Urbana, Illinois, was not a charitable institution for property tax purposes. The court’s opinion reasoned that the primary use of the hospital property was to provide medical services for a fee, while “charity” means providing a gift to the community. The opinion further pointed out that (1) the charity care being provided was subsidized by payments from other patients; (2) many patients granted partial charity care still paid enough to cover costs; and (3) the hospital’s community benefit activities, such as a residency program and an education program for emergency responders, also benefited the hospital and thus were not truly gifts to the community. Therefore, the hospital property was not in charitable use.

Most not-for-profit hospitals today are, of course, primarily supported by payments for services rather than by charitable contributions. Under the opinion’s reasoning, the property tax exemption may be hard to maintain. However, a partial dissent by two justices suggests that this case is not the end of the issue. The dissent argues that the plurality opinion impinges on the legislative function of setting specific standards for tax exemption, and the issue should be settled by legislative action rather than by courts.

What do you think? Should not-for-profit hospitals lose their property tax or in- come tax exemptions if they do not provide “sufficient” charity care? Should legislatures set standards that hospitals must meet to maintain their tax-exempt status? If so, how might such standards be specified?

SeLF-TeST QUeSTiOnS

1. What are the major differences between investor-owned and not-for-profit corporations?

2. What pressures recently have been placed on not-for-profit hospitals to ensure that they meet their charitable mission?

2.5 OrganiZaTiOnaL gOaLS

Healthcare finance is practiced with some objective in mind. Finance goals must be consistent with, and support, the overall goals of the organization. Thus, we discuss goals by which to establish a framework for financial decision making within health- care organizations.

SmaLL FOr-prOFiT bUSineSSeS

In a proprietorship or partnership, a small privately owned corporation, or any other form of for-profit small business, the owners generally are also the managers. In the- ory, the business can be operated for the exclusive benefit of the owners. If the own- ers want to work hard every day to maximize income and wealth, they can. On the other hand, if they want to devote every Wednesday to playing golf, they can do that instead. (Of course, the business still has to satisfy the needs of its customers or else it will not survive.)

Typically, in small businesses, goals of income (wealth) and other benefits (such as leisure time) are blended in such a way as to satisfy the owners’ wishes. It is in large, publicly held corporations, in which owners and managers are separate parties, that orga- nizational goals become important guideposts for managers.

Large FOr-prOFiT bUSineSSeS

From a finance perspective, the primary goal of large publicly held corporations is gen- erally assumed to be shareholder (owners’) wealth maximization, which translates to stock price maximization. Investor-owned corporations do, of course, have other goals. Managers, who make the actual decisions, are interested in their personal welfare, in their employees’ welfare, and in the good of the community and society at large. Still, the goal of stock price maximization is a reasonable operating objective on which to build financial decision rules.

The primary obstacle to shareholder wealth maximization in large investor-owned corporations is the agency problem. An agency problem exists when one or more individuals hire another individual or group of individu- als (agents) to perform a service on their behalf, thereby delegating decision-making authority to those agents. Such a problem occurs between stockholders and managers of large investor- owned corporations because the managers typi- cally hold only a small proportion of the firm’s stock, and hence they benefit relatively little from stock price increases. On the other hand, managers benefit substantially from such actions as increasing the size of the firm to justify greater salaries, bonuses, and fringe benefits; awarding themselves generous retirement plans; and spending excessively on office space, personal staff, and travel—actions often detrimental to shareholders’ wealth. Many situations arise in which managers are motivated to take actions that are in their, rather than the stock- holders’, best interests.

Shareholders recognize the agency problem and counter it by creating compensation incentives, such as stock options and performance-based bonus plans, that encourage managers to act in shareholders’ interests. Additionally, other factors, such as the threat of takeover or removal, keep managers focused on shareholder wealth maximization.

Of course, managers of investor-owned corporations can have motivations that are inconsistent with shareholder wealth maximization. Still, sufficient incentives and sanctions exist to motivate managers to view shareholder wealth maximization as an important goal. Thus, shareholder wealth maximization is a reasonable goal for financial decision making within investor-owned corporations in spite of the agency problem.

Interestingly, a new form of for-profit corporation, now available in about ten states, including California and New York, allows managers to consider social and environmental goals ahead of stock price. Such a corporation, called a benefit corporation (B corporation), is primarily intended to allow corporate boards and managers to sacrifice shareholder value for the greater good. Benefit corporations must specify their social and environmental goals in the company’s bylaws. Furthermore, such corporations must publish an annual “benefit report,” which measures how well these goals are being met. An example of a B corporation in the healthcare field is Transplant Connect, which provides medical records and clinical management systems software that support organ, tissue, and eye donation and transplantation.

CRITICAL CONCEPT

Shareholder (Owners’) Wealth Maximization

The primary goal of large investor-owned businesses is share- holder wealth maximization, or maximization of owners’ wealth. For corporations, this goal translates to stock price maximization. Of course, many other managerial goals exist, such as the fair treatment of all parties to the business. Still, when alternative courses of action are considered, the impact on shareholder wealth typically plays the dominant role in the decision-making process.

Agency problem

The problem that arises when the managers of a for-profit corporation are separate from the owners. In this situation, managers are motivated to act in their own interests as op- posed to the interests of stockholders.

Benefit corporation (B corporation)

A type of for-profit corporation that allows managers to consider social and environ- mental goals ahead of stockholder wealth maximization.

nOT-FOr-prOFiT cOrpOraTiOnS

Although not-for-profit corporations have no stockholders, a number of parties, called stakeholders, have a financial interest in the organization. For example, a not-for-profit hos- pital’s stakeholders include the board of trustees; managers; employees; physicians; credi- tors; suppliers; patients; and potential patients, who may include the entire community. (An investor-owned hospital has the same set of stakeholders, plus owners, who dictate the goal of ownership wealth maximization.) While managers of investor-owned businesses have to please primarily one class of stakeholders (the owners) to keep their jobs, managers of not-for-profit businesses must please all of the organization’s stakeholders because no single, well-defined group exercises control.

Some people argue that managers of not-for-profit corporations do not have to please anyone at all because they tend to control the actions of the board of trustees, who are expected to exercise oversight. Others argue that managers of not-for-profit firms have to please all of the firm’s stakeholders to a greater or lesser extent because all are necessary to the successful performance of the business. Of course, even managers of investor-owned firms should not attempt to enhance shareholder wealth by treating other stakeholders unfairly, as such actions ultimately are detrimental to shareholders.

Typically, the goal of not-for-profit corporations is stated in terms of a mission statement. For example, here is the current mission statement of New River Memorial Hospital, a 250-bed, not-for-profit acute care hospital:

New River Memorial Hospital, along with its medical staff, is a recognized, in- novative healthcare leader dedicated to meeting the needs of the community. We strive to be the best comprehensive healthcare provider through our commitment to excellence.

Although this mission statement provides New River’s managers and employees with a framework for developing specific goals and objectives, it does not provide much insight into the goals of the hospital’s finance function. For the hospital to accomplish its mission, its managers have identified the following five financial goals:

1. The hospital must maintain its financial viability.

2. The hospital must generate sufficient profits to continue to provide the current range of healthcare services to the community. This means that current buildings and equipment must be replaced as they become obsolete.

3. The hospital must generate sufficient profits to invest in new medical technologies and services as they are developed and needed.

Stakeholder

A party that has an interest—typically financial—in an organization. For example, owners (in for-profit businesses), managers, patients, and suppliers are some stakeholders of health- care businesses.

4. Although the hospital has an aggressive philanthropy program in place, it does not want to rely on this program or government grants to fund its operations.

5. The hospital will strive to provide services to the community as inexpensively as possible, given the above financial requirements.

In effect, New River’s managers are saying that to achieve the hospital’s commit- ment to excellence as stated in its mission statement, the hospital must remain financially strong and profitable. Financially weak organizations cannot accomplish their stated mis- sions over the long run. What is interesting is that New River’s five financial goals are probably not much different from the finance goals of Jackson Regional Medical Center (JRMC), a for-profit competitor.

Clearly, JRMC has to worry about providing a return to its shareholders, and it re- ceives only a small amount of contributions and grants. However, to maximize shareholder wealth, JRMC also must maintain its financial viability and have the financial resources to offer new services and technologies. Furthermore, competition in the market for hospital services will not permit JRMC to charge appreciably more for services than its not-for- profit competitors charge.

? SeLF-TeST Q

1. What is the difference in organizational goals between investor-owned and not-for-profit businesses?

2. How does a benefits corporation (B corporation) differ from a traditional for-profit corporation?

3. What is the agency problem, and how does it apply to investor-owned firms?

4. What factors tend to reduce the agency problem?

2.6 TaX LaWS

The value of any investment—whether a security, such as a stock in an individual’s retirement account, or a business’s investment in new diagnostic equipment—depends on the usable cash flows that the investment is expected to provide. Because taxes affect usable cash flows, both individuals and managers of for-profit healthcare businesses must be concerned about taxes.

US tax laws are complicated and are constantly changing. Indeed, some tax law provisions automatically expire over time if not renewed by congressional action. Consequently, covering even the most basic features of tax laws in an introductory healthcare finance book is nearly impossible. Still, healthcare managers must understand those features of the tax system that directly affect financial decision making.

perSOnaL (inDiviDUaL) TaXeS

Individuals must pay personal (individual) taxes to federal and state (in most states) authorities that can approach 50 percent of income. Income from proprietorships and partner- ships, as well as interest, dividends, and capital gains on securities investments, is reduced when personal taxes are taken into account.

To illustrate the impact of personal taxes, assume that Dr. Cynthia Morgan’s tax rate is 35 percent and she receives $200,000 in partnership income from her medical practice. Using the letter T to represent tax rate, she must pay T × $200,000 = 0.35 × $200,000 = $70,000 in taxes on that income, which leaves her with only $200,000 – $70,000 = $130,000 in usable (after-tax) income. This tax analysis leads to the following useful impact of taxes equation:

AT = BT – (T × BT ) = BT × (1 – T ),

where AT = after tax and BT = before tax. Thus, Dr. Morgan’s after-tax income can be calculated as follows:

AT = BT × (1 – T ) = $200,000 × (1 – 0.35) = $200,000 × 0.65 = $130,000.

Note that this equation can be applied to interest rates as well as dollar amounts. (See Problem 2.3 at the end of the chapter as an example.) Clearly, taxes will influence personal investment decisions, so any tax implications on investment alternatives must be considered in the decision process. This deliberation is especially important when two investments under consideration have differential tax implications.

Personal (individual) taxes

Taxes paid by individuals to federal and state (in most states) authorities on wages, interest, dividends, capital gains, and proprietor- ship and partnership income.

Capital gains

The profit that is generated when securities (or other investments) are sold for more than their purchase price.

cOrpOraTe TaXeS

Corporate tax laws affect both for-profit and not-for-profit businesses, but in different ways.

Corporate taxes

Income taxes paid by for-profit (taxable) corporations to federal and state authorities.

For-Profit Corporations

In addition to personal taxes paid by individuals, investor-owned (for-profit) corporations must pay both federal and state corporate taxes, which can exceed 40 percent of taxable income. For-profit corporations pay taxes on earnings before dividends are distributed, so corporate income is subject to double taxation. (Income is taxed once when corporations pay their income taxes and again when stockholders pay their income taxes on dividends and capital gains.) Small corporations can avoid double taxation by filing with the IRS as an S corporation, which, for tax purposes only, prorates the corporate income among the owners to be taxed as personal income. Also, hybrid forms of business avoid double taxation. (See the Industry Practice box on page 46 for more information on corporate taxes.)

Not-for-Profit Corporations

Not-for-profit corporations, for the most part, are not subject to income, property, or sales taxes. The exemption from taxes is, by far, the biggest benefit granted to not-for-profit health services organizations. In addition, such organizations enjoy two other tax benefits.

First, not-for-profit organizations are able to borrow funds (use debt financing) in which the interest payments are exempt from the lender’s personal taxes. Thus, if Jake Jaworski buys a $5,000 bond issued by New River Memorial Hospital, a not-for-profit corporation, the interest paid by the hospital to Jake is not subject to personal taxes.

To illustrate the advantage of being able to issue tax-exempt debt, first assume that Jake owns some bonds issued by JRMC, a for-profit hospital. These bonds have an interest rate of 10 percent, so Jake receives 0.10 × $100 = $10 in annual interest for every $100 worth of bonds he owns. If Jake pays 40 percent in federal and state income taxes, each $10 of interest provides him with AT = BT × (1 – T ) = $10 × (1 – 0.40) = $10 × 0.6 = $6 of usable (after-tax) interest.

However, if the bonds had been issued by New River, Jake would not have to pay taxes on the interest and hence would keep the entire $10. If investors truly require a $6 after-tax (usable) return, New River can issue debt with an interest rate of only 6 percent and, with all else the same, investors (such as Jake) in the 40 percent tax bracket would be as willing to buy these bonds as they are the JRMC 10 percent bonds.

CRITICAL CONCEPT

Impact of Taxes

The impact of taxes on income can be calculated with a simple equation:

AT = BT × (1 – T ),

where AT = after taxes, BT = before taxes, and T = tax rate. For example, if your taxable income is $75,000 and your federal and state tax rate is a combined 25 percent, then BT = $75,000, T = 25% = 0.25, and your after-tax income is $56,250:

AT =BT×(1–T) = $75,000 × (1 – 0.25) = $75,000 × 0.75 = $56,250.

INDUSTRY PRACTICE Corporate Taxes

For-profit, as well as not-for-profit, corporations are organized (chartered) under state laws. More than 60 percent of large for-profit corporations are chartered in Delaware, which over the years has provided a favorable legal environment for corporations. (A business does not have to locate its headquarters, or even operate, in the state of incorporation.)

The taxable income of a corporation is composed of revenues less allowable deductions. Revenues may be derived from any source, including the sale of products or services, rents, royalties, interest and dividends on securities investments, and gains from the sale of assets. Allowable deductions include ordinary business expenses, such as salaries and wages, contributions to retirement and employee benefit programs, sup- plies expenses, interest paid on debt capital, marketing, and other expenses. Note that dividends paid to shareholders are not a deductible expense, so they must be paid with after-tax dollars.

The amount of federal income taxes paid (for tax year 2012) is based on the fol- lowing table:

Taxable Income Tax Rate%

$0–$50,000 15

$50,001–$75,000 25

$75,001–$100,000 34

$100,001–$335,000 39

$335,001–$10,000,000 34

$10,000,001–$15,000,000 35

$15,000,001–$18,333,333 38

Over $18,333,333 35

Suppose Southwest Healthcare, a for-profit multispecialty group practice, had $250,000 in taxable income. Using the rate table above, we calculate Southwest’s tax liability as $80,750:

Tax = 0.15($50,000) + 0.25($25,000) + 0.34($25,000)

Tax = 0.15($50,000) + 0.25($25,000) + 0.34($25,000) + 0.39 ($250,000 – $100,000)

+ 0.39 ($250,000 – $100,000) = $7,500 + $6,250 + $8,500 + $58,500

= $7,500 + $6,250 + $8,500 + $58,500 = $80,750.

= $80,750.

Thus, the interest rate that New River must set on its debt issues to entice lenders is lower than the rate that JRMC must set because of the tax exemption on debt issued by not-for-profit corporations. This exemption appears to give not-for-profit healthcare businesses a big advantage over for-profit businesses, but we have not told the full story. For-profit providers can deduct their interest payments on debt financing from taxable income and hence gain a tax benefit that, over time, reduces the effective interest rate on for-profit hospital debt to about the same amount as paid by similar not-for-profit (tax- exempt) providers.

INDUSTRY PRACTICE Corporate Taxes

Although the incremental tax rates in the table bounce around (go up to 39 then down to 34 then up to 35 percent, and so on), the rates follow a rational pattern. In effect, the rate table produces a flat tax rate of 34 percent for taxable incomes between $335,001 and $10 million, and then a flat rate of 35 percent for all income above $18,333,333. (A flat rate is a single rate applied to all income.)

Note that Southwest’s marginal tax rate (the rate on the next dollar of income) is 39 percent. Thus, in any analyses that involve additional taxable income, the appropriate rate is 39 percent (at least up to $335,000 in taxable income). But Southwest’s average tax rate is only 32.3 percent: $80,750 in taxes paid on $250,000 of taxable income, or $80,750 ÷ $250,000 = 32.3%. The federal corporate income tax system is progressive, which means that higher incomes lead to higher tax rates. However, the system is only mildly progressive, and, as we pointed out earlier, the rate structure flattens out at higher levels of income. Corporations must also pay state income taxes, which generally are flat (a single rate) and range roughly from 5 to 10 percent.

To avoid taxation at both the corporate and individual levels, small corporations that are owner managed can file as an S corporation. Alternatively, small corporate businesses, such as a five-physician primary care practice, can create zero taxable corporate income by distributing any income earned by the business to the owner-physicians in the form of salaries or bonuses. By doing so, the corporation pays no income taxes, but, of course, the physicians have to pay personal taxes on the added income. Still, a situation of double taxation is converted into single taxation. Note, however, that the IRS is wary of small corporations that pay its owners/managers salaries and bonuses far in excess of prevailing wage standards and can impose corporate taxes on the amount deemed excessive.

services from primary care to specialized procedures.” St. Jerome’s mission is to “extend the Catholic healthcare ministry by continually improving the health and quality of life of the people in the communities we serve.”

These mission statements are laudable, but do they translate to different financial goals? Probably not. Southwest does not address the issue of owners’ wealth in its mission statement, but the physician-owners are concerned with earning a return on the capital they invested in the business. To succeed, the practice must offer the services needed by the communities in which it operates at a price and quality that make its services competitive in the marketplace. St. Jerome’s must achieve the same goal. To accomplish its mission, the hospital needs to offer state-of-the-art technology and services at competitive prices.

Thus, both organizations must maintain the financial wherewithal to expand the number and types of services they provide to meet the changing needs of the populations they serve. In addition, each organization must be able to invest in new technologies to pro- vide the best patient care and to remain competitive. As one prominent Catholic healthcare administrator said, “No margin, no mission,” which simply means you have to be profitable to accomplish your mission.

In the end, Jon determined that the finance function at for-profit and not-for-profit healthcare providers must be executed in just about the same way. All businesses must maintain financial viability to be competitive in the marketplace.

Did you arrive at the same conclusion?

This chapter presents background material on business organizations and goals. Here are the key concepts:

➤ A business maintains its financial viability by selling goods or services, while a pure charity relies solely on contributions.

➤ The three legal forms of business are proprietorship and partnership, corporation, and hybrid. Although each form of organization has unique advantages and disadvantages, most large businesses, and all not-for-profit entities, are organized as corporations.

➤ Investor-owned corporations have stockholders, who are the owners of the corporation. Stockholders exercise control through the proxy process, whereby they elect the corporation’s board of directors and vote on matters of major consequence to the firm. As owners, stockholders have a claim on the residual earnings of the corporation. Investor-owned corporations are fully taxable.

➤ Healthcare organizations that meet certain criteria can be organized as not- for-profit corporations, which are governed by a board of trustees. Rather than having a well-defined set of owners, such organizations have a large number of stakeholders, who have an interest in the organization. In effect, not-for-profit corporations are “owned” by the communities they serve, although technically they have no owners.

➤ From a financial management perspective, the primary goal of investor-owned corporations is shareholder wealth maximization, which translates to stock price maximization. For not-for-profit corporations, a reasonable goal for financial management is to ensure that the organization can fulfill its mission, which translates to maintaining financial viability. Both goals lead to roughly the same managerial behavior.

➤ An agency problem is the conflict of interest that arises between the owners and managers (agents) of large for-profit corporations. The problem is mitigated by incentives created to motivate managers to act in the best interest of owners.

➤ The value of any income stream depends on the amount of usable, or after-tax, income. Thus, tax laws play an important role in financial management decisions.

➤ Individuals pay personal (individual) taxes to federal and state (in most states) authorities on proprietorship, partnership, interest, dividend, and capital gains income.

➤ For-profit corporations pay corporate income taxes to federal and state authorities. Because corporations pay taxes, and then individuals pay taxes on dividend and capital gains income, corporate income typically is subject to double taxation.

➤ Before-tax (BT ) income can be converted to after-tax ( AT ) income using this equation: AT = BT × (1 – T ),

where T is the tax rate.

➤ Small corporations can file with the Internal Revenue Service (IRS) for S corporation status, under which they are taxed as proprietorships or partnerships and hence avoid double taxation.

➤ Not-for-profit corporations generally are exempt from all levels of property, income, and sales taxes. Furthermore, not-for-profits can use tax-exempt debt financing, which means that lenders do not have to pay taxes on the interest earned. Contributions to not-for-profit corporations can be deducted from the donor’s taxable income, which encourages such contributions.

Because managers of healthcare organizations must make financial decisions within the constraints imposed by the economic environment, we draw on the concepts described here throughout the remainder of the book.

End of chapter Qu

2.1 a. From a financial perspective, briefly describe the concept of a business. b. What is the difference between a business and a pure charity?

2.2 What are the three legal forms of business organization? What are their advantages and disadvantages?

2.3 What are the primary differences between investor-owned and not-for-profit corporations?

2.4 What is the difference between a standard corporation (C corporation) and a benefit corporation (B corporation)?

2.5 a. What is the primary goal of investor-owned corporations?

b. What is the primary goal of most not-for-profit healthcare corporations?

c. Are substantial differences found between the finance goals of investor-owned and not-for-profit corporations? Explain your answer. d. What is an agency problem?

2.6 a. Why are tax laws important to healthcare finance?

b. What three major advantages do tax laws give to not-for-profit corporations?

End of chapter problem

2.1 Assume that Provident Health System, a for-profit hospital, has $1 million in taxable income for 2012, and its tax rate is 30 percent. a. Given this information, what is the firm’s net income? (Net income is what remains after taxes have been paid.) b. Suppose the hospital pays out $300,000 in dividends. A stockholder, Carl Johnson, receives $10,000. If Carl’s tax rate on dividends is 15 percent, what is his after-tax dividend?

2.2 A firm that owns the stock of another corporation does not have to pay taxes on the entire amount of dividends received. In general, only 30 percent of the dividends received by one corporation from another are taxable. The reason for this tax law feature is to mitigate the effect of triple taxation, which occurs when earnings are first taxed at the first firm, its dividends paid to the second firm are taxed again, and the dividends paid to stockholders by the second firm are taxed yet again. Assume that a firm with a 35 percent tax rate receives $100,000 in dividends from another corporation. What taxes must be paid on this dividend, and what is the after-tax amount of the dividend?

2.3 Kim Davis is in the 40 percent personal tax bracket. She is considering investing in HCA (taxable) bonds that carry a 12 percent interest rate.

a. What is her after-tax yield (interest rate) on the bonds? b. Suppose Twin Cities Memorial Hospital has issued tax-exempt bonds that have an interest rate of 6 percent. With all else the same, should Kim buy the HCA or the Twin Cities bonds? c. With all else the same, what interest rate on the tax-exempt Twin Cities bonds would make Kim indifferent between these bonds and the HCA bonds?

2.4 Jane Smith currently holds tax-exempt bonds of Good Samaritan Healthcare that pay 7 percent interest. She is in the 40 percent tax bracket. Her broker wants her to buy some Beverly Enterprises taxable bonds that will be issued next week. With all else the same, what rate must be set on the Beverly bonds to make Jane interested in making a switch?

2.5 George and Margaret Wealthy are in the 48 percent tax bracket, considering both federal and state personal taxes. Norman Briggs, the CEO of Community General Hospital, has been aggressively pursuing the couple to contribute $500,000 to the hospital’s soon-to-be-built Cancer Care Center. Without the contribution, the Wealthys’ taxable income for 2012 would be $2 million. What impact would the contribution have on the Wealthys’ 2012 tax bill?