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Print articleNew Jersey Case Wakes Up the Nonprofit Hospital Industry - What the Morristown Case Means for Hospital Property Tax Exemptions
August, 2015 -
Nonprofit hospital executives and lawyers throughout the
country are taking notice of a recent tax court case out of New Jersey
involving the Morristown Medical Center, in which Judge Vito Bianco agreed with
the local town and denied the New Jersey hospital of its tax exemption for the
majority of its properties. Estimates put the annual dollar cost of this loss
of property tax exemption for the hospital at between $2.5 million to $3
million. The case has triggered national media attention from The Wall Street
Journal, Modern Healthcare and other publications.
This decision is unique due to the analysis the judge undertook by specifically looking at the operations and organizational structure of the hospital system, along with its executive compensation in deciding to revoke the hospital’s property tax exemption. This approach of “looking under the hood” is very different than what we have seen in other hospital property tax exemption cases in other states, such as Illinois, Pennsylvania and Ohio, among others.
The analysis in those cases was the amount of charity care and other community benefit provided by the hospitals to the community and whether that amount justified the hospitals’ property tax exemption. Many of the hospital’s practices cited by Judge Bianco in his decision – such as transactions between the hospital and physicians – are relatively common to nonprofit hospitals. The hospital's executive compensation, called out in the decision, was also not particularly unique.
Several weeks after the Morristown decision was released, the town and the hospital issued a public statement that they have requested a period of time to enter into negotiations to end the litigation, which the judge granted. Without such negotiations taking place, the next step would have been an appeal by the hospital. If the negotiations do end in a resolution between the parties, it may likely involve some form of payment by the hospital to the town in lieu of taxes.
Although the Morristown decision was limited to New Jersey nonprofit and property tax law, Judge Bianco’s ruling raises questions about the implications of the decision as potentially reframing the nonprofit hospital landscape beyond New Jersey’s borders in several ways.
Is this a signal of more changes to come? The issue of nonprofit hospitals being subject to taxes is one that has only increased in recent years. It was not that long ago when the scrutiny of tax-exempt hospitals at the federal level was taking place in Washington, DC with Congress and the IRS, and the 501(c)(3) exempt status for hospitals was put at risk. The ultimate compromise between Congress, the IRS and the nonprofit hospital associations was a new set of requirements to be met (known as the 501(r) regulations), along with increased public disclosure. Some believe as nonprofit hospitals have evolved over the years and operate more as businesses than charitable entities, that the state and local governments should review their property tax exemption. A hospital making a profit, some argue, even if denominated as a nonprofit, should at least pay real estate taxes. The reality is that with local municipalities seeking additional sources of revenue and looking at the potential taxpayers in the area, for many towns, the local nonprofit hospital (along with tax-exempt universities) are sitting on some of the most valuable untaxed property. The timing of the Morristown decision is right in the middle of a renewed look at nonprofit hospitals and taxation.
Does structure matter as much as what benefits are provided to the community? The Morristown case was unusual in that the judge primarily focused on the hospital's operations and organizational structure, rather than the benefit the hospital provides to the community. While prior suits focused on charitable contributions as the key indicator, the Morristown decision takes aim at the “entangled” nature of the hospital system, its subsidiaries and affiliates, and specifically the hospital’s arrangements with physicians. This reasoning is very problematic. In a post-Affordable Care Act landscape and an era of increased partnerships between hospitals, physicians and payors, hospitals are bound to get entangled with each other in trying to improve quality and control costs. The Affordable Care Act and the current administration have been very proactive in encouraging hospitals (whether nonprofit or for-profit) to form accountable care organizations (ACOs), with physicians and other providers to provide coordinated care to Medicare patients and others. If the ACO succeeds in coordinated high-quality care and cost savings, the partners share in the savings generated for Medicare. Doing so, at least as of now in New Jersey, may put a nonprofit hospital’s property tax exemption at risk with this decision via the it’s not just what you’re providing to the community, but how you are structured and affiliated analysis. It will be interesting to see whether this analysis of looking deeper into hospital partnerships and affiliations will be embraced by other states and municipalities when reviewing property tax exemption. In light of the nation’s overarching healthcare goals, it is difficult not to envision future conflicts centered on this new standard for property tax exemption.
What role will legislators play in defining property tax exemption for nonprofit hospitals? In his opinion, the judge stated that “if the property tax exemption for modern non-profit hospitals is to exist at all in New Jersey going forward, then it is a function of the Legislature and the courts to promulgate what the terms and conditions will be.” This statement may be the most important point to this entire case. Following a path seen in other states, the Morristown case will likely prompt the New Jersey Hospital Association and others to work with state lawmakers to define more clearly what must be done to preserve the tax exemption for nonprofit hospitals. For example, after several deeply contested hospital property tax cases in Illinois, the legislature passed a law that requires nonprofit hospitals to provide charity care at a value at least equal to the amount of tax savings they receive from their property tax exemption. Other states could preemptively pass laws making the tax-exempt status of nonprofit hospitals less open to interpretation. A better test could be constructed that leaves little room for subjective ambiguity, unlike the organizational structure test in Morristown. Other states such as Connecticut are beginning to look at alternatives such as taxing off-campus properties owned by the hospital and exempting only property in the same location as the emergency department. It is clear that the legislative process will indeed play a bigger role in the coming years for establishing criteria for hospital property tax exemption.
What solutions are available to create more certainty around property taxes? The rating agencies have started to take notice and looked at the Morristown case as “credit negative” for New Jersey hospitals. The uncertainty of the ultimate cost of loss of property tax exemption to a hospital will largely be dependent on the financial health and size of the health system. Those single stand-alone hospitals not part of a large system may see a significant cost that will either have to be covered by cutting other services or passed down ultimately to the patient. What options exist for nonprofit hospitals looking to avoid the uncertainty around property taxes and possible litigation? Are there ways to establish a fixed lower cost instead of full property tax liability? One option has been a payment in lieu of taxes (PILOT) program. PILOT programs exist between nonprofit entities and the municipalities where they operate to allow nonprofits to acknowledge the benefits they receive from local governments while avoiding the more fraught issue of taxation. While this is more preferable than getting into a legal fight, PILOTs are also time-intensive and take up a lot of resources to negotiate. Additionally, the widespread use of PILOTs to avoid litigation over property taxes may come with its own set of problems. What may be interesting is if there is ensuing competition over the terms of each nonprofit hospital's individual PILOT deal with the local government. If one hospital gets a PILOT deal, do its competitors get the same one? New Jersey may be facing such dilemmas if an agreement is reached in Morristown.
For additional information, please contact Don Stuart in Waller's Tax practice at 800.487.638
This decision is unique due to the analysis the judge undertook by specifically looking at the operations and organizational structure of the hospital system, along with its executive compensation in deciding to revoke the hospital’s property tax exemption. This approach of “looking under the hood” is very different than what we have seen in other hospital property tax exemption cases in other states, such as Illinois, Pennsylvania and Ohio, among others.
The analysis in those cases was the amount of charity care and other community benefit provided by the hospitals to the community and whether that amount justified the hospitals’ property tax exemption. Many of the hospital’s practices cited by Judge Bianco in his decision – such as transactions between the hospital and physicians – are relatively common to nonprofit hospitals. The hospital's executive compensation, called out in the decision, was also not particularly unique.
Several weeks after the Morristown decision was released, the town and the hospital issued a public statement that they have requested a period of time to enter into negotiations to end the litigation, which the judge granted. Without such negotiations taking place, the next step would have been an appeal by the hospital. If the negotiations do end in a resolution between the parties, it may likely involve some form of payment by the hospital to the town in lieu of taxes.
Although the Morristown decision was limited to New Jersey nonprofit and property tax law, Judge Bianco’s ruling raises questions about the implications of the decision as potentially reframing the nonprofit hospital landscape beyond New Jersey’s borders in several ways.
Is this a signal of more changes to come? The issue of nonprofit hospitals being subject to taxes is one that has only increased in recent years. It was not that long ago when the scrutiny of tax-exempt hospitals at the federal level was taking place in Washington, DC with Congress and the IRS, and the 501(c)(3) exempt status for hospitals was put at risk. The ultimate compromise between Congress, the IRS and the nonprofit hospital associations was a new set of requirements to be met (known as the 501(r) regulations), along with increased public disclosure. Some believe as nonprofit hospitals have evolved over the years and operate more as businesses than charitable entities, that the state and local governments should review their property tax exemption. A hospital making a profit, some argue, even if denominated as a nonprofit, should at least pay real estate taxes. The reality is that with local municipalities seeking additional sources of revenue and looking at the potential taxpayers in the area, for many towns, the local nonprofit hospital (along with tax-exempt universities) are sitting on some of the most valuable untaxed property. The timing of the Morristown decision is right in the middle of a renewed look at nonprofit hospitals and taxation.
Does structure matter as much as what benefits are provided to the community? The Morristown case was unusual in that the judge primarily focused on the hospital's operations and organizational structure, rather than the benefit the hospital provides to the community. While prior suits focused on charitable contributions as the key indicator, the Morristown decision takes aim at the “entangled” nature of the hospital system, its subsidiaries and affiliates, and specifically the hospital’s arrangements with physicians. This reasoning is very problematic. In a post-Affordable Care Act landscape and an era of increased partnerships between hospitals, physicians and payors, hospitals are bound to get entangled with each other in trying to improve quality and control costs. The Affordable Care Act and the current administration have been very proactive in encouraging hospitals (whether nonprofit or for-profit) to form accountable care organizations (ACOs), with physicians and other providers to provide coordinated care to Medicare patients and others. If the ACO succeeds in coordinated high-quality care and cost savings, the partners share in the savings generated for Medicare. Doing so, at least as of now in New Jersey, may put a nonprofit hospital’s property tax exemption at risk with this decision via the it’s not just what you’re providing to the community, but how you are structured and affiliated analysis. It will be interesting to see whether this analysis of looking deeper into hospital partnerships and affiliations will be embraced by other states and municipalities when reviewing property tax exemption. In light of the nation’s overarching healthcare goals, it is difficult not to envision future conflicts centered on this new standard for property tax exemption.
What role will legislators play in defining property tax exemption for nonprofit hospitals? In his opinion, the judge stated that “if the property tax exemption for modern non-profit hospitals is to exist at all in New Jersey going forward, then it is a function of the Legislature and the courts to promulgate what the terms and conditions will be.” This statement may be the most important point to this entire case. Following a path seen in other states, the Morristown case will likely prompt the New Jersey Hospital Association and others to work with state lawmakers to define more clearly what must be done to preserve the tax exemption for nonprofit hospitals. For example, after several deeply contested hospital property tax cases in Illinois, the legislature passed a law that requires nonprofit hospitals to provide charity care at a value at least equal to the amount of tax savings they receive from their property tax exemption. Other states could preemptively pass laws making the tax-exempt status of nonprofit hospitals less open to interpretation. A better test could be constructed that leaves little room for subjective ambiguity, unlike the organizational structure test in Morristown. Other states such as Connecticut are beginning to look at alternatives such as taxing off-campus properties owned by the hospital and exempting only property in the same location as the emergency department. It is clear that the legislative process will indeed play a bigger role in the coming years for establishing criteria for hospital property tax exemption.
What solutions are available to create more certainty around property taxes? The rating agencies have started to take notice and looked at the Morristown case as “credit negative” for New Jersey hospitals. The uncertainty of the ultimate cost of loss of property tax exemption to a hospital will largely be dependent on the financial health and size of the health system. Those single stand-alone hospitals not part of a large system may see a significant cost that will either have to be covered by cutting other services or passed down ultimately to the patient. What options exist for nonprofit hospitals looking to avoid the uncertainty around property taxes and possible litigation? Are there ways to establish a fixed lower cost instead of full property tax liability? One option has been a payment in lieu of taxes (PILOT) program. PILOT programs exist between nonprofit entities and the municipalities where they operate to allow nonprofits to acknowledge the benefits they receive from local governments while avoiding the more fraught issue of taxation. While this is more preferable than getting into a legal fight, PILOTs are also time-intensive and take up a lot of resources to negotiate. Additionally, the widespread use of PILOTs to avoid litigation over property taxes may come with its own set of problems. What may be interesting is if there is ensuing competition over the terms of each nonprofit hospital's individual PILOT deal with the local government. If one hospital gets a PILOT deal, do its competitors get the same one? New Jersey may be facing such dilemmas if an agreement is reached in Morristown.
For additional information, please contact Don Stuart in Waller's Tax practice at 800.487.638
Footnotes: The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance. |
