The Chairman's Task Force on Tax-Exempt Status of Institutional Healthcare Providers
Nonprofit institutional healthcare providers increasingly face challenges to their tax-exempt status from local, state, and Federal authorities. As part of its overall policy development on this issue, HFMA formed a Chairman's Task Force on Tax-Exempt Status of Institutional Healthcare Providers to explore the background of these challenges and to identify the specific requirements institutional healthcare providers must meet to be tax-exempt. The task force first met on January 31, 1988. Since then, a number of important challenges to hospitals' tax-exempt status have occurred. The task force has taken those challenges into account in its work.
"The tax-exempt status issue is significant and far reaching. Tax-exempt hospitals are constantly challenged to protect and preserve that which makes them unique." says task force Chairman Richard D. Telkamp, FHFMA, CPA. Telkamp is senior vice president of finance in the Greenville Hospital System in South Carolina. He adds, "The work of the task force should help in achieving that goal."
The rest of the task force consisted of:
- Thomas L.Camp, FHFMA, CMPA, CPA, Hayward, California
- Wayne Henry, Esq., partner in the law firm Kutak Rock & Campbell, Omaha, Nebraska
- William H. Nelson, CPA, Senior Vice President, Intermountain Health Care, Salt Lake City, Utah
- David Schroeder, Sr., FHFMA, CMPA, CPA, Senior Vice President and Treasurer, Riverside Medical Center, Karikakee, Illinois
- Ronald Waetzman, FHFMA, CPA, Pittsburgh, Pennsylvania
- Stephen N. Wesby, Senior Vice President - Finance, Roanoke Memorial Hospital, Roanoke, Virginia
The assistance of Judi A. Lindsey, Executive Vice President, Providence Health Foundation, Washington, D.C., in the early phases of the task force's work is greatly appreciated.
The following healthcare industry association representatives also participated in the task force deliberations:
- Linda Miller, Executive Director, Volunteer Trustees of Not-for-Profit Hospitals, Washington, D.C.
- William C. McGinly, Ph.D., President, National Association for Hospital Development, Falls Church, Virginia
Support to the task force was provided by HFMA staff Ronald R. Kovener, FHFMA, Vice President, and Wendy W. Herr, Director, Regulatory Issues in HFMA's Washington office.
BRIEF SUMMARY OF ATTRIBUTES OF INSTITUTIONAL HEALTHCARE PROVIDERS THAT WARRANT TAX-EXEMPTION
An HFMA chairman's task force selected these attributes as being most relevant to explaining the reasons a provider warrants tax-exempt status. An organization might cite one or several but probably not all of these attributes to explain why tax-exempt status is warranted.
- MISSION-The organization has a mission statement clearly articulating its charitable purpose and regularly demonstrates that its mission is fulfilled.
- USE OF FINANCIAL SURPLUSES-No individual receives any portion of the financial surpluses of the organization as a result of ownership or any other "insider" relationship, except as fair compensation, and all financial surpluses are used exclusively to further the charitable purposes of the organization.
- ACCOUNTABILITY-The organization is accountable to the public, not to stockholders, through a board which is committed to and represents the healthcare needs of the community or service area.
- CHARITY SERVICE-There is no denial of essential services (such as emergency services) to residents of the service area based on the inability of a person to pay for those services.
- REDUCES GOVERNMENT BURDEN-Provides services that are needed and which would otherwise have to be provided by government.
- ESSENTIAL HEALTHCARE SERVICES-Provides healthcare and related services so essential to the community that they warrant a special status for the organization and would require government expenditures if the organization did not provide the service.
- UNPROFITABLE SERVICES-Provides services that are inherently unprofitable due to their unusually high cost combined with low or inadequate payment. The lack of profit is not the result of inefficiency.
- EDUCATION*-Education is provided which enhances the health of individuals or the provision of health service.
- CONTRIBUTION TO HEALTH CARE*-The organization has a history of significant contributions to the health care of the community.
- MEETS UNMET NEEDS*-The organization provides needed services that no other organization is willing or able to provide within the community.
* Attributes marked with an asterisk (*) are relevant to tax-exempt status, but any one of these attributes alone are probably not sufficient to warrant tax-exemption.
DISCUSSION OF ATTRIBUTES OF A TAX-EXEMPT INSTITUTIONAL HEALTHCARE PROVIDER
The tax-exempt status of many institutional healthcare providers is under increasing scrutiny by local, state, and Federal governments. HFMA's Chairman's Task Force on Tax-Exempt Status1 explored the issue, and identified ten attributes that assist in explaining the need for tax-exempt status. This part of the task force report contains a specific listing of goals and attributes associated with tax-exempt institutional healthcare providers, along with definitions of what those attributes entail. An organization might cite one or several of these attributes, but probably not all, to justify its tax-exempt status. The last three of the attributes listed below (Education, Heritage, and Meeting unmet needs) are relevant to tax-exempt status, but any one of these three alone would probably not be sufficient to warrant tax-exemption.
The task force urges all healthcare providers to identify, measure, and disclose the attributes of their organizations that warrant tax-exempt status. It is important that government officials, the media, community leaders, and the public understand why each organization qualifies for tax-exemption. Many critics of tax-exemption focus on only one attribute, ignoring the combination and cumulative effect of activities that make tax- exemption appropriate. Each tax-exempt organization is well advised to aggressively disclose information about attributes and activities that warrant tax-exemption in its annual report, press releases, speeches, briefings, informational materials, and other outlets. The following discussion of general attributes that may justify an organization's tax-exemption will help in tailoring information for use by individual organizations.
This attribute is a cornerstone of granting tax-exemption. According to Federal law,2 the tax-exempt provider must have a clearly defined mission statement committing the institution to charitable endeavors. This mission refers to the philosophical tenets underlying the organization's service to the community. The mission will then be used by the provider in determining its strategic plan for the future.
Both the institution's historical background and the community's needs are important in determining the mission statement. A mission that bears no relevance to the community's needs makes the organization irrelevant. The mission statement should undergo relatively frequent (every five years) examination by the organization's Board of Trustees to ensure that it is still relevant to the community. The organization must constantly ensure that activities are consistent with the mission and should publicize the range of activities that fulfill the mission.
Use of financial surpluses
No individual may receive any portion of a tax-exempt institution's financial surpluses as a result of ownership. All financial surpluses, or profits, must go towards furthering the organization's charitable purpose.
Both Federal and state laws require this of all tax-exempt institutions. Federally, Section 501(c)(3) of the Internal Revenue Code prohibits private inurement, and calls for an institution's assets to be dedicated to an approved exempt purpose (a list of which is in the Code). State requirements usually impose a condition that nonprofit entities serve public interests or that property be used exclusively for charitable purposes. These requirements also generally prohibit the assets from going to private individuals upon the organization's dissolution.
These rules concerning private inurement are critical in evaluating the appropriateness of compensation arrangements and other business dealings, such as providing benefits to physicians. Incentive compensation and bonus arrangements are permissible, but must be carefully constructed. Those who benefit cannot set the amount of their personal compensation and rewards must relate to performance, not ownership.
Demonstrating that this attribute is fulfilled can be achieved best by judicious financial relationships. Also, the lifestyles of persons connected with the organization should conform with the community's. The perception of an individual reaping a financial windfall at the expense of the organization and its programs should be avoided.
The organization's Board of Trustees must hold itself answerable to the community the organization serves. It is the board's responsibility to maximize the contribution the entity makes to the community. Through policymaking and direction, the board must set priorities based upon the community's service needs, taking into account the organization's financial limitations.
Generally, this community representation is achieved through a board that is comprised of community members who fairly represent the segments, needs, and desires of every element of the community. All boards, even those that are not representative of the community served, are well advised to maintain a high level of communication with the community since all elements of any community will not agree with all of the board's decisions. Communication will help ensure that the board is well informed about the community's needs and desires as it makes program decisions.
Current tax laws generally require that exempt hospitals provide a vague category of care known as "charity care," which is usually translated as emergency care to individuals regardless of their ability to pay. This requirement has led to a great deal of controversy regarding the type and amount of charity care a hospital or other tax-exempt healthcare provider must provide. It is also unclear as to the relevance of charity care in an institution that does not provide emergency services or provides uncompensated care unrelated to emergency services. The court cases described in the second part of this report focussed largely on the requirement to provide emergency care.
Charity care, which is more generally recognized to include all services provided without expectation of payment, is only part of a hospital's total load of uncompensated care. Bad debts, those bills left unpaid by payers who had been expected to pay, makes up the rest. Bad debts are an expense and may be recovered in the price paid by some payers. Additionally, some government programs provide funds for services to people who cannot pay, thereby reducing the charity care burden somewhat.
Currently, the value of charity care is usually measured based on charges. Thus, a provider with high charges would appear to provide more charity care than a provider with lower charges that provides the same level of services.
Each organization must establish clear criteria for determining whether a patient is eligible for charity services. The organization can then identify the extent of resources devoted to such services and, at the same time, exercise good stewardship in managing expenditures. HFMA's Principles and Practice Board Statement No. 2 provides guidelines that allow each organization to exercise appropriate latitude in establishing eligibility for charity care.
Provision of charity care is an important attribute of tax-exemption, but is only one of several attributes for many organizations. It is helpful if the organization can avoid disproportionate attention on the provision of charity care and can achieve recognition of other attributes. Failure to achieve a recognition of the broad basis of tax-exemption could lead to a specific trade-off between the amount of charity care provided and the amount of tax-exemption allowed -- a dollar of charity care offset by a dollar reduction in taxes, with the organization subject to all income, property, and other taxes in excess of the amount of charity care provided.
Reduces government burden
Tax-exempt organizations provide services the community wants which government would have to provide if the tax-exempt organizations did not fill the need. Without the tax-exempt organization, the service burden would fall back upon government. Although many government-owned organizations provide healthcare services, there are too few and they do not have a comprehensive array of services that fully meets the community demand. Government provision of healthcare services would increase dramatically if tax-exempt institutional healthcare providers did not assume much of the burden.
Industry data provides valuable evidence of the fulfillment of this attribute. Services especially demanded from tax-exempt healthcare providers include high tech, high intensity services; chronic care; long-term care; and non-profitable services. Community demand not met by other organizations require the tax- exempt organizations to step in. For relieving the government's burden, these organizations deserve their tax-exemption. This is probably the attribute that is most often overlooked by providers as they describe their contribution to the community, yet it is central to the concept of tax-exemption. Each institution should look carefully at its mission and services to identify ways in which it relieves government of a burden that would increase the community's taxes. Tax-exempt organizations may find it necessary to call attention to favorable comparisons of the cost of operations, quality, or satisfaction with other organizations in the community. They should call special attention to services that would be denied the community if the tax-exempt organization were not present.
Essential healthcare services
Provision of essential healthcare services is very similar to the above attribute of relieving government burden. Tax-exempt healthcare providers are usually the sole providers of many healthcare and related services that are so essential to the community that tax-exempt status is definitely warranted. These services are of such a nature that they must be provided by someone, and neither government organizations nor for-profit healthcare providers are willing or able to provide them.
Essential services can include an outpatient clinic serving low-income patients, an emergency room, or a home health agency, to name just a few. In most areas, government is not geared towards providing these services at the level they are needed within the community. Others may shy away from these services due to financial or malpractice concerns. A tax-exempt healthcare provider would demonstrate the provision of essential services in the same manner as for the previous attribute of relieving government burden.
A tax-exempt healthcare provider that offers unprofitable services needed by the community does not practice bad business but, rather, reaffirms its commitment to the community. Unprofitability of a specific service is a direct result of high costs combined with low volume and/or inadequate payment. Inefficiency of operations should not be the cause of a financial loss in providing services identified as a justification for tax-exemption.
Unprofitable services often include burn, neonatal, and trauma center services; ambulance, home health, and educational operations; indigent clinics; community mental health centers; and meals on wheels programs. Due to the unfavorable financial results inherent in these services, many organizations must shy away from them. In contrast, tax-exempt organizations provide healthcare or health-related services based on community need as opposed to bottom line considerations, as resources permit. Provision of unprofitable services is the provider's charitable response to a community need.
Each provider must regularly evaluate the financial implications of each line of service or activity. Good management requires careful attention to any service with a financial loss and aggressive action to assure operational efficiency and appropriate payment. If this analysis concludes that a service is unprofitable due to community need, the organization should inform those with an interest. Information about these services should be featured in the organization's annual report or other informational releases. Case reports about individual incidents of service on an ongoing basis may be worthwhile. Tax-exempt healthcare providers would do better to display the provision of unprofitable services as a badge of honor, rather than as a focus of shame.
Any of the above listed attributes are sufficient justification for an organization's tax-exempt status and most healthcare providers qualify in several of these ways. There are other attributes identified by the task force that are insufficient to warrant tax-exemption on their own, but which complement the above-listed attributes and are worthy of note by tax-exempt entities.
Education to enhance either the health of individuals or the provision of health care is a valuable service often provided by tax-exempt entities. This includes public health education, wellness programs, and the training of health professional, such as nurses, technicians, or physicians. The tax-exempt organization further proves its commitment to improving the health status of people within its community through the sponsorship of education activities. This voluntary commitment of a community provider also appears to be consistent with the desires of the Federal government, as expressed by various policy statements by the Health Care Financing Administration.
Critics charge that community education programs are simply self-serving marketing programs of specific products and services. If sales are the intended result of an education effort, the effort is properly classified as marketing. However, true education objectives go beyond the singular motivation of a sale. For example, programs oriented to wellness, weight management, and stopping smoking serve to promote health in the community, not the sale of cardiac, respiratory, or oncology services. Education of health professionals is also necessary to ensure a supply of properly trained staff to meet the primary mission of providing health services.
Healthcare organizations must assist schools in meeting the education needs of their community. The community must recognize that this activity helps satisfy the criteria of tax-exempt status.
Contribution to health care
Many tax-exempt organizations have fulfilled their mission of providing care and meeting their community responsibility over a long period of time. They have been regarded as community institutions and, as such, have enjoyed reputations and community support that set them apart from tax-paying institutions. Their reputations have been significant in obtaining donations and voluntary support that enhance their operations. Such an organization usually has a very stable ownership and leadership, regularly receives philanthropic support, or a large number of people provide significant volunteer service to further the organization's mission.
If such organizations were to lose their tax-exempt status and be subjected to the same taxation as other businesses, there would be an immediate adverse effect in their communities. They would quickly lose their goodwill image and would suffer a financial loss. More importantly, the goodwill image in the minds of the community would be reflected in a withdrawal of support and a loss of the benefits previously mentioned. The very stability of the organization's reputation in the community attests to its role in serving that community.
Meets unmet needs
The organization provides needed services that no other person or organization is willing or able to provide in the community or service area. Often, in a community, civic groups or social service agencies identify human needs that are not being addressed by any organization, yet are agreed to be needed by the residents of the area. Examples of the activities that relate to the unmet needs can include senior citizen education and outreach programs, services to unwed mothers or "boarder" babies, or an operation of a soup kitchen or "meals on wheels" program.
Often, the healthcare organization is the logical choice in the community to perform such services. Operations that require dietary services or other ancillary services that an organization must have for patient care can benefit from the efficiencies of administration of operations that already exist. In the long run, the community saves by not having to duplicate facilities or staffing capabilities. Also, the healthcare organization is usually in a position to be flexible as the quantity of service needs changes.
It is important that this attribute be recognized by the community for its important contribution. While some of the activities may be performed by the organization at no charge to the public, a careful accounting of the in-kind value must be maintained. In instances where tangible expenses are incurred by the organization, records detailing these expenses should be kept and augmented by a proper valuation of the in-kind services. This accounting to the community assists in keeping the benefit to the community in proper perspective, and keeps the community from taking f or granted the effort involved in meeting the community's unmet needs.
TAX-EXEMPT CHALLENGES WARRANT INSTITUTIONAL HEALTHCARE PROVIDERS' ATTENTION3
By Wayne Henry
Task force member Wayne Henry, Esq., a partner in the law firm of Kutak, Rock & Campbell, explains, in this part of the report, the legal basis of tax-exemptions and summarizes today's challenges and recent developments.
Qualification as a tax-exempt institution-the Federal standard
To be exempt from Federal income tax, an organization must meet specific statutory and regulatory requirements. The organization must establish through its articles of incorporation and bylaws that it is exclusively organized for charitable purposes. In addition, those documents should not permit the organization to engage substantially in activities unrelated to its exempt purposes.
The organization must serve a public interest and must prove that it is not organized to benefit private individuals. Profits from the institution may not inure to the benefit of any insider in any amount; this is called the "private inurement" prohibition. The institution may benefit private individuals who are not insiders, but only incidentally in both a qualitative and quantitative sense.4 This rule does not, however, prohibit reasonable payments in arm's-length transactions.
Because private inurement is prohibited, and because the Internal Revenue Service (IRS) has indicated that physicians, officers, administrators, directors, and even employees can be considered insiders, healthcare institutions wishing to remain exempt must be careful to avoid arrangements that could be viewed as resulting in payment of excessive compensation and must be cautious in entering into joint ventures with commercial entities, rental arrangements with or sales of property to staff or affiliates, agreements providing benefits in connection with physician recruitment, and loans or loan guarantees to individuals. Even special arrangements with health maintenance organizations or preferred provider organizations may cause inurement problems unless the price can be shown to be fair.
A tax-exempt organization may participate in a limited amount of activity not related to its exempt purpose, provided that this activity is only an "insubstantial part" of its total activities. However, revenue from unrelated activities are taxed as unrelated business income.
It is still very unclear how much unrelated business activity will jeopardize a healthcare institution's tax-exempt status. Generally, when an organization's unrelated activities are challenged as excessive, exempt status is retained if one or more of the following facts is true:
- Some relationship exists between institution's exempt purpose.
- Unrelated activity is small compared to the organization's overall activity.
- A questioned activity does not compete with taxable businesses.
Cases denying or revoking exempt status for excessive unrelated activity usually involve at least some of these facts:
- The unrelated activity is in competition with commercial ventures.
- Large revenues are derived, as compared with the organization's overall revenue.
- Large-scale operations are not connected to the organization's exempt purpose.
- Some evidence of private inurement exists.
It is unlikely that an institution will lose its Federal tax-exempt status because of excessive unrelated activity. However, the consequences of such a loss (whether for unrelated activities or any other reason) are serious. They include taxation of the institution's net income, nondeductibility to donors of future donations to the institution, and, in many cases, loss of the institution's exemption from state and local taxes, such as property and sales taxes. Additional consequences include loss of access to tax-exempt bond financing, loss of grants from private foundations and the Federal government, return of Hill-Burton grants for construction or modernization of facilities, loss of Securities and Exchange Commission registration exemption, and loss of bulk-rate mailing privileges.
Unrelated business income tax
Unrelated business income tax (UBIT) is defined for Federal income tax purposes as a tax on income derived from (1) a trade or business which (2) is regularly carried on and (3) is not substantially related to the performance of the institution's tax- exempt purpose. However, a number of exceptions apply. To determine whether an activity is regularly carried on, it is compared to similar activities of commercial enterprises. For example, if commercial businesses typically conduct an activity year-round while a provider conducts it only once a year, the provider's activity is not regularly carried on.
An activity is also scrutinized for its relatedness to the institution's exempt purpose. Use of the resulting income to further the exempt purpose is irrelevant. Unrelated income is exempt only if it fits within certain defined exceptions (including, in general, most passive income such as interest and rent).
Engaging in an activity beyond what is needed to further the exempt purpose may make the activity an unrelated trade or business. If so, the revenues from the activity may be taxable as unrelated business income to the extent of the excess over costs. For example, a hospital cafeteria Is revenue from serving patients and on-call staff is exempt because that activity furthers the hospital's exempt purpose. However, revenue derived from organized cafeteria sales to the general public would be unrelated income. Similarly, where an asset is used for both an exempt function and a commercial purpose, the commercial use may be treated as an unrelated trade or business. For example, a hospital using its computers at night to operate a for-profit billing service may generate unrelated income from that service.
The IRS distinguishes between hospital activities that benefit patients and those that benefit nonpatients in determining whether UBIT applies. It is therefore important to know whether a person receiving services from a nonprofit hospital is considered, for tax purposes, to be that hospital's patient. The IRS defines a patient as a person:
- admitted to the hospital as an inpatient;
- receiving general or emergency diagnostic, therapeutic, or preventive health services from outpatient facilities of a hospital;
- directly referred to the hospital's outpatient faculties by a private physician for specific diagnostic or treatment procedures;
- refilling a prescription written during the course of treatment as a patient of the hospital;
- receiving medical services as part of a hospital-administered home healthcare program; or
- receiving medical care and services in a hospital-affiliated extended care facility.
The IRS looks closely at income earned through partnerships and joint ventures between tax-exempt healthcare organizations and taxable parties, including physicians. The IRS scrutinizes such arrangements using the following analysis: Is the exempt organization serving a charitable purpose through the partnership or join venture? If so, does participation in the partnership or join venture inhibit the organization's charitable purpose? If private parties are receiving an undue economic benefit from the partnership or joint venture, the arrangement may threaten the organization's tax-exempt status.
Other areas of IRS concern include investment earnings on temporarily unspent tax-exempt bond proceeds, income from leasing debt-financed medical office buildings, guaranties backing debts of taxable entities, and retirement centers with lavish facilities or where charitable service cannot be demonstrated. Running a foul of the IRS in any of these areas is likely to result in the income earned through the venture being taxed and could result in loss of tax-exempt status.
Analysts say an IRS audit may be prompted by a local business, complaint of unfair competition. The more a particular activities competes with local business, the more aggressively the IRS may be expected to assert that the activity generates unrelated income. Such activities as operating dietary clinics and fitness facilities and using excess capacity for purposes other than patient care are considered to be the most vulnerable to such a challenge.
To help gather data concerning unrelated income and to help identify the organizations most likely to be breaking its rules, the IRS established the Taxpayer Compliance Measurement Program (TCMP). Under the TCMP, approximately 3,000 IRS Form 990s, the form that nonprofit organizations use to report income, were randomly selected for audit. The IRS has also revised Form 990 in an attempt to improve its data-gathering ability.
Congress is showing considerable interest in certain types of income earned by exempt institutional healthcare providers (prompting the IRS to step up the TCMP reviews). Competition continues to overshadow much of the controversy over what kinds of activities should be treated as producing unrelated income. Congressional hearings have focused on claims of unfair competition asserted by taxable businesses.
The Federal laws on taxation of the unrelated businesses of tax-exempt organizations have been substantially revised only once since they were enacted in 1950. The House Ways and Means Committee's oversight subcommittee held five hearings in 1987, intending to determine the need for new legislation to extend the reach of UBIT. During the hearings, it became clear that healthcare providers were a major focus of scrutiny and will almost certainly be affected by any new legislation passed on UBIT. Additional hearings have been held since then. The hearings have covered a variety of tax-exempt organizations' activities and the extent to which those activities may be competing with local businesses. The hearings have also covered how tax-exemption relates to Federal budget control, current compliance with UBIT rules, and other considerations. The issue of whether an expanded list of healthcare provider activities should be considered unrelated business income activities for tax purposes has yet to be resolved by Congress.
Other bills have been introduced, aimed at various issues relating to tax-exempt healthcare providers. Rep. Brian J. Donnelly's (D- Mass.) proposed bill would restrict access to tax-exempt financing where a hospital has an insufficient "disproportionate patient percentage" (a component of the prospective price setting system, this formula is based on a provider's Medicare and Medicaid patient load). A second bill currently pending before Congress would restrict the use of tax-exempt bonds to healthcare facilities with Medicaid participation agreements.
On June 28, 1990, the House Select Committee on Aging held a hearing concerning the extent of charity care tax-exempt hospitals provide. At the hearing, Rep. Edward R. Roybal (D-Calif.) released a General Accounting Office report critical of some nonprofit hospitals, as well as a draft of proposed legislation. Roybal's proposal would base qualification for tax-exemption on service to a reasonable number of Medicaid patients and, unless the hospital can demonstrate financial inability, provision of charity care at least equal in value (measured at hospital charges) to the Federal and state revenues foregone due to tax-exemption. As an alternative to loss of exempt status, an excise tax would be applied in some cases where this provision is not met.
State and local governments' approach
In general, state and local government questioning nonprofit providers' exemption from property or sales and use taxes or demanding that exempt healthcare providers make some sort of alternative payment for municipal services have attempted to justify their positions by asserting that modern hospitals do not perform traditional charitable functions. Developments in this area include:
Pennsylvania: The City of Pittsburgh attempted to administratively assess property and sales taxes against hospitals, citing a lack of "charitable" care in general. As a result, two Pittsburgh hospitals agreed to pay approximately $16 million in lieu of taxes. In Erie, the exemptions of two hospitals were challenged by the city, county, and school district. One hospital entered into a settlement agreement with all three bodies; the other was subsequently determined not entitled to exemption in the Court of Common Pleas. The case is currently on appeal. In addition, three Allentown hospitals have agreed to provide free care for prisoners and discounted care for city employees in order to avoid imposition of taxes. Similar agreements have been entered into between the City of Johnstown and local hospitals.
Utah: Two hospitals operated by a nonprofit corporation were declared by the Utah Supreme Court not to be charitable institutions because they did not meet the court's newly articulated test for exemption. That test purports to define whether use is "exclusively for ... charitable purposes." The court stated that an important element of charity is a "gift to the community" identifiable by either "a substantial imbalance in the exchange between the charity and the recipient of its services" or a lessening of governmental burden. As a result of this decision, the hospitals in question had to pay property taxes. However, the principles in this case are vague and have not been followed by the supreme courts of other states.
Vermont: The City of Burlington attempted to impose property tax on a hospital, asserting insufficient charity care. Although the hospital won in Medical Center Hospital of Vermont, Inc. v. City of Burlington, the case warns other tax-exempt hospitals that cities seeking revenues may attack the exempt status of hospitals perceived as insufficiently devoted to charity care. The Vermont Supreme Court upheld a lower court decision rejecting the City's assertion that the hospital should lose its exemption because it had failed to show that a majority of its income came from charitable sources, such as donations. However, the outcome of the case was based on principles of Vermont law that do not apply in all jurisdictions.
Identification of tax-exempt dualities
Clearly, future fights over tax-exemption cannot be avoided. Tax-exempt hospitals must make doubly sure they meet the requirements Federal, state, and local governments are scrutinizing. This task is made especially difficult as these requirements are often unclear, and can change with each new court decision around the country.
1. As part of HFMA's overall policy development on the tax-exempt issue, the task force was formed to explore the historical background of the scrutiny and to identify the specific requirements an institutional healthcare provider must meet to be considered tax-exempt in today's environment.
2. See part 2 of this report for a discussion of the legislative basis of tax-exemption.
3. A version of this section of the report appeared under the same title in the January, 1991, edition of Healthcare Financial Management on page 30.
4. Private benefit is qualitatively incidental if it is necessary to achieve the exempt purpose. It is quantitatively incidental if the amount of private benefit is insubstantial compared to the resulting public benefit.
Publication Date: Tuesday, December 31, 1991