Healthcare reform and recent legal cases can affect hospitals' property tax exemption.
At a Glance
- Healthcare reform includes specific requirements for hospitals and health systems related to property tax exemption.
- Some states impose their own requirements for hospitals to qualify as a charity.
- Hospitals should proactively address property tax exemption status.
In these tight economic times, not-for-profit hospitals and health systems are finding their property tax-exempt status questioned and sometimes eliminated by state and local government agencies. Property tax is one of the largest tax revenue generators for states, generating $168 billion collectively in the fourth quarter of 2009, according to the U.S. Census Bureau (U.S. Census Bureau, Quarterly Summary of State & Local Government Tax Revenue, December 2009). The new healthcare reform legislation is fueling the debate about whether not-for-profit hospitals are legitimate candidates for property tax exemption.
States have historically interpreted and designed their respective laws regarding not-for-profit hospital property tax exemption. However, a growing wave of federal litigation is occurring due to the growing number of not-for-profit hospitals, intrinsically high property values, significant revenue generation, vague laws defining a not-for-profit hospital, and existing local property tax exemption laws that predate federal income tax exemption. The result is greater scrutiny of community benefits generated by not-for-profit hospitals versus the associated cost of those same benefits via tax exemptions.
Not-for-profit hospitals represent a loss of potential property tax revenue of more than $2 billion for local government due to the property tax exemption status of many not-for-profit hospitals (American Hospital Association, AHA Hospital Statistics, 2010 edition). As a result, not-for-profit hospitals represent a logical target for local governments to obtain revenue.
Consider the following:
- Not-for-profit hospitals account for 58 percent of the 5,010 hospitals in the United States (Joint Committee on Taxation, Congressional Budget Office, Nonprofit Hospitals and Tax Arbitrage, December 2006).
- The definition of a not-for-profit hospital is vague and open to interpretation.
- Most hospitals' property values are estimated in the millions of dollars.
- Most not-for-profit hospitals today don't pay property taxes.
The Healthcare Reform Connection
Historically, if a hospital was deemed not-for-profit under federal standards, property tax exemption was typically granted at the local level. Although the majority of municipalities continue to use federal exemption status to determine property tax exemption, this trend is reversing.
The Patient Protection and Affordable Care Act (Pub. L. No. 111-148), part of the major healthcare reform bill, was signed into law on March 23, 2010. The act includes four primary adjustments to the federal income tax exemption requirements for not-for-profit hospitals. Under the act, tax-exempt hospitals must:
- Conduct a community health needs analysis at least once every three years, soliciting input from the communities that they serve
- Make their financial assistance policies, which must specify eligibility criteria for discounted care and how the organization determines amounts that are billed to patients,widely available
- Notify patients of financial assistance policies through "reasonable efforts" before initiating various collection actions or reporting accounts to a credit rating agency
- Restrict charges of uninsured, indigent patients to those amounts generally charged to insured patients
The act imposes penalties on hospitals that fail to conduct their community health needs assessments in a timely manner. Under the act, the IRS must review the exempt status of hospitals every three years. In addition, the act requires the U.S. Department of the Treasury, in consultation with the U.S. Department of Health and Human Services (HHS), to prepare an annual report for the U.S. Congress on charity care, bad debt expenses, certain unreimbursed costs, and costs incurred for community benefit activities. In five years, the Treasury and HHS must also provide to Congress a report on community benefit-related trends.
The vision of healthcare reform is to provide affordable health care to all U.S. citizens. Beginning in 2014, the major provisions of the healthcare reform law will take effect. As the number of patients able to pay for hospital services dramatically increases, state and local governments could deny charitable exempt status altogether. The not-for-profit status could disappear as a result.
Property Tax Exemption Requirements
Some aggressive states are already requiring not-for-profit hospitals to abide by new metrics and calculation methods for what qualifies a hospital as a charity-independent of whether a hospital is deemed not-for-profit by federal standards. Not meeting the standards is another reason not-for-profit hospitals could lose their property tax exemptions.
This loss of tax-exempt status occurred to the Provena Covenant Medical Center in Urbana, Ill., in March 2010. The Illinois Supreme Court ruled that Provena Hospitals' Provena Covenant Medical Center in Urbana, Ill., was not entitled to religious or charitable property tax exemptions. "With very limited exception, the property was devoted to the care and treatment of patients in exchange for compensation through private insurance, Medicare and Medicaid, or direct payment from the patient or the patient's family," the ruling stated (www.state.il.us/court/Opinions/SupremeCourt/2010/March/107328.pdf). Based on the ruling, Provena will have to pay $1.1 million in property tax and possibly as much as $10 million for past years ("Provena Health Strong Enough to Make Tax Payments for Urbana Hospital," Chicago Tribune, March 24, 2010).
Three states-Pennsylvania, Texas, and Utah-have some degree of quantified charity care in their statutes to define the standards for property tax exemptions.
In Pennsylvania, the prevention and treatment of disease or injury qualifies as a charitable activity, but the Pennsylvania statute in 10 P.S. §375 sets forth various quantified criteria that institutions of purely public charity must meet to obtain charitable status. The institution must donate or render gratuitously a substantial portion of its services. One of the ways in which the institution can qualify is to provide wholly gratuitous goods or service to at least 5 percent of those receiving similar goods or services.
The Texas Tax Code, §11.1801 provides specific criteria for not-for-profit hospitals to qualify for exemption, in addition to the traditional requirements set forth in Texas Tax Code, §11.18, in the following terms.
Level of Care. Charity care and government-sponsored indigent health care must be provided at a level that is reasonable in relation to the community needs, as determined through the community needs assessment, the available resources of the hospital or health system, and the tax-exempt benefits received by the hospital or health system.
Amount of Care. Charity care and government-sponsored indigent health care must be provided in an amount equal to at least 4 percent of the hospital's or health system's net patient revenue. It also must be provided in an amount equal to at least 100 percent of the hospital's or health system's tax-exempt benefits, excluding federal income tax. In addition, charity care and community benefits must be provided in a combined amount equal to at least 5 percent of the hospital's or health system's net patient revenue, provided that charity care and government-sponsored indigent health care are provided in an amount equal to at least 4 percent of net patient revenue.
In Utah, according to Standard 2 Property Tax Exemptions Standards of Practice (Appendix 2D), hospitals must meet numerous requirements to qualify for property-tax exemption. For example, the total gift provided by a hospital to the community must equal or exceed the hospital's property tax liability. For this purpose, a gift includes indigent care, community education and service, medical discounts, and donations of time and money.
According to a September 2008 U.S. Government Accountability Office (GAO) study, Nonprofit Hospitals: Variation in Standards and Guidance Limits Comparison of How Hospitals Meet Community Benefits Requirements (GAO-08-880, September 2008), 15 states require that hospitals provide community benefits to receive tax exemption or achieve not-for-profit status and, therefore, property tax-exempt status. Yet even in these states, the requirements vary in nature and scope. Thus, determining whether a given not-for-profit hospital tax exemption is safe may be impossible because the methods tend to be unclear and the criteria for providing adequate charity care are often ill defined. Case law precedence, varying metrics compliance, reporting and remittance requirements for multiple states, and federal mandates are making property tax compliance increasingly difficult to effectively manage.
Cases Where State Law Superseded Federal Law
The following four legal cases illustrate how state law can superseded federal law.
St. Joseph's Living Center, Inc., v. Town of Windham. According to The Charity Care Requirements for Hospital Property Tax Exemptions (American Bar Association, Section of Taxation, May 5, 2009), the Connecticut Supreme Court decided St. Joseph's Living Center, Inc. v. Town of Windham, 290 Conn. 295 (March 24, 2009). Although the conclusion that the medical facility was not entitled to exemption paralleled the Illinois decision in Provena, the analysis of the charity care requirement in the two decisions is quite different. In St. Joseph's, the town assessor denied a charitable exemption to St. Joseph's Living Center, Inc., a skilled nursing facility, because the facility did not provide free care to any of its patients. The center was a not-for-profit organization exempt from federal income taxes under IRC §501(c)(3).
Utah County v. Intermountain Health Care, Inc. In 1985, the Supreme Court of Utah rendered a decision that has been influential. Utah County v. Intermountain Health Care, Inc. 709 P.2d 265 (Utah 1985). At issue was property tax exemption for Utah Valley Hospital, which was owned and operated by Intermountain Health Care (IHC), and American Fork Hospital, which was leased and operated by IHC. The Utah Supreme Court rejected the granting of exemption under the provisions of the Utah constitution.
City of Richmond v. Richmond Memorial Hospital. In City of Richmond v. Richmond Memorial Hospital, 202 Va. 86, 116 S.E. 2d 79 (1960), the issue was whether the right to exemption "depends solely upon the extent to which free service is rendered." The court rejected that standard and concluded that the exemption depends not upon the number of patients who are treated free of charge, but upon the nature of the institutions and the purpose of the operations. The constitution of Virginia did not require that services be rendered for free as the basis for exemption.
Wexford Medical Group v. City of Cadillac. In 2006, the Michigan Supreme Court rejected a focus solely on the value of free care to qualify for property tax exemption for a medical facility. Instead, the court examined the overall purpose of the healthcare provider. Wexford Medical Group v. City of Cadillac, 474 Mich. 192, 713 N.W. 2d 734 (2006). The decision of the Supreme Court reversed both the Michigan Tax Tribunal and the Michigan Court of Appeals.
Proactively Addressing Property Tax Exemption Issues
It is only a matter of time before changing litigation could affect property tax exemption status. The financial implications of a hospital losing its not-for-profit status are substantial.
A hospital or health system faced with a multimillion dollar property tax bill must divert funds away from providing healthcare services. Because most not-for-profit hospitals have not needed to establish best practices to streamline property tax compliance, documenting accounting procedures to prove not-for-profit status is now needed. In addition, such documentation will provide consistency in filings preventing "red flags," which could trigger a property tax audit. The following are key steps in creating property tax best practices.
Community benefits and charity care actions. The best strategy for any not-for-profit healthcare organization is to demonstrate through its actions that it is truly a charitable organization. Com-munity benefit is generally thought of as an annual reporting activity when, in fact, community benefit should be a well-organized, systemic program that links the mission of the organization to its operations. The amount of charity care provided by a hospital should be responsive to the needs of the community.
Assign ownership. Appoint a specific property tax point of contact, as well as a "property tax committee" to manage compliance with property tax responsibilities. In addition, management should clearly understand the importance of property tax compliance matters. There should be organizational commitment to include community benefit roles and responsibilities, performance assessments that include community benefits, adequate staffing (internally or externally), and a budget for community benefits. The organization should identify the needs of the community and develop a plan to meet those needs that is integrated into the strategic and operating plan of the organization. The organization should evaluate its community benefit programming on an ongoing basis to communicate its story based on credible quantitative and qualitative information and consistent accounting principles.
Review collection policies. Organizations should conduct a complete review of their records, which is critical to accurately reporting and proving not-for-profit status. Hospitals should review their pricing, billing, and other business practices that may raise issues with respect to not-for-profit status. Practices and policies would consist of communicating and advertising financial assistance policies to provide increased access to the uninsured of limited means and educating patients and their families; assisting patients to qualify for financial assistance; and ensuring fair and transparent billing practices.
Research state and federal requirements. Property tax exemption laws vary from state to state. Various metrics used to qualify for not-for-profit status should be researched and implemented. For states that use federal not-for-profit exempt status to determine property tax exemption, federal mandates should be consistently applied and monitored.
Healthcare reform and recent court cases make it clear that new standards and a more rigid approach are being implemented to determine property tax exemption status. Hospitals should take action to understand, mitigate, and prepare for potential real estate tax and the flurry of property tax-exempt changes on the horizon.
Tom Mason is MAI director, ONESOURCE Property Tax, Thomson Reuters, Dallas (email@example.com).
Publication Date: Wednesday, September 01, 2010