This case demonstrates lengths to which taxing authorities might go to pursue hospital tax-exempt status.
Nearly 3,000 not-for-profit general hospitals in the U.S. are exempt from federal income taxation and, typically, from state ad valorem property taxes as well. The exemptions are based on a long-held assumption that care of the sick and injured is a benevolent purpose that qualifies the institution as a charity under Internal Revenue Code (IRC) Section 501(c)(3).
The tax code does not define “charity,” and the regulations merely say that “the term charitable is used in its generally accepted legal sense … within the broad outlines of ‘charity’ as developed by judicial decisions.” (Internal Revenue Service, 26 Code of Federal Regulations, Section 1.501(c)(3)-1(d)(2).) Thus, those vague terms have been a part of the law for many decades. Only in the past 30 years have they been subject to much critical analysis.
A seismic 1985 case in Utah, in which Intermountain Healthcare was stripped of its property tax exemption, started the trend toward closer examination of ad valorem taxes on hospital property (Utah County v. Intermountain Healthcare, Inc., 709 P.2d 265 [Utah 1985]).
Another tremor occurred in 2010 when the Supreme Court of Illinois upheld revocation of a Catholic hospital’s charitable and religious tax exemptions because, among other reasons, it could not prove that it “derives its funds mainly from private and public charity” and “no claim has been made that operation of a fee-based medical center is in any way essential to the practice or observance of the Catholic faith.” In fact, the court flatly stated that the hospital’s primary purpose was “providing medical care to patients for a fee (emphasis added).”
Recent Developments
Fiscal pressures on state and local governments being what they are, this trend is expected to continue. For example, as reported in an October 2017 Legal & Regulatory Forum article, the Internal Revenue Service has revoked an unnamed hospital’s federal tax exemption for failure to comply with the requirements of IRC Section 501(r) and its “community health needs assessment” provisions, among others.
As concerning as that development is, of even greater concern would be a hospital’s loss of exemption from state and local property taxes. Hospitals are often the most prominent and valuable property in their neighborhoods, and taxing authorities are understandably eager to find additional revenue.
The recent case of a hospital in Delaware County, Pennsylvania, illustrates the point (In Re: Appeal of Springfield Hospital, Folio No. 42-00-06625-01, Appeal of Prospect Crozer, LLC, No. 191C.D. 2017, Commonwealth Court of Pennsylvania, Feb. 13, 2018). Established in 1960, Springfield Hospital was a not-for-profit corporation organized and operated as a “purely public charity for hospital purposes.” In 1992, because the hospital was expanding its main campus to include medical office buildings, a sports club, and a parking garage, the county taxing board issued a notice removing the property’s exemption and fixing the assessment at $500,000. The hospital appealed, and the case was settled pursuant to a payment in lieu of taxes (PILOT).
The PILOT agreement stated that the hospital would remain tax exempt “so long as the existing hospital building is used solely for hospital purposes by … an entity which is exempt from federal tax under Section 501(c)(3).” Twenty-four years later, the hospital’s assets were sold to a for-profit company, Prospect Crozer, LLC (Prospect). The effective date of the sale was July 1, 2016, and the taxing board issued a bill for approximately $434,000 based on the change in ownership.
Prospect did not dispute that the hospital property is no longer tax exempt. But under Pennsylvania law, if property is exempt on Jan. 1—tax assessment day—it normally remains exempt for the entire year. Because the property didn’t change hands until July, Prospect argued that the change in tax status should not be instituted until Jan. 1, 2017.
In a 2-1 decision, the Commonwealth Court of Pennsylvania disagreed. It ruled that the terms of the PILOT settlement take priority. “The language of the 1994 PILOT Order … is unambiguous,” the opinion states. “The parties intended the subject property to remain tax exempt only so long as any entity that operated it as a hospital was exempt from federal taxation. That condition was no longer in effect when the property was transferred … to Prospect on July 1, 2016.”
Implications
Like all property tax cases, the outcome in the Springfield Hospital case depended on a unique set of facts and the peculiarities of state law. It has no precedential value outside the Commonwealth of Pennsylvania, but it is instructive in that it shows the lengths to which taxing authorities might go to pursue their goals. Delaware County had its eye on the hospital for nearly a quarter century.
When one reads the various judicial opinions and law review articles on this subject, one realizes the struggle legislators, judges, and taxing boards have in defining “charitable” and the standards for determining exemption. There are few easy answers. Readers are reminded to ensure that their organizations have fully complied with IRC § 501(r) and other requirements for federal and state exemptions.
J. Stuart Showalter, JD, MFS, is a contributing editor for HFMA ([email protected]).
