Tax exemptions and nonprofit hospitals: An uncertain future

Of the 4,926 community hospitals in the United States, the majority, about 58 percent (2,870) are not-for-profit. About 21 percent (1,053) are for-profit, and the remainder are owned by state and local governments. Hospitals serve communities by caring for the sick, but they’re also often billion dollar enterprises and tension between the mission and business model of nonprofit hospitals is growing.

Nonprofit hospitals are expected to benefit their community in exchange for their tax-exempt status. Hospitals have most commonly fulfilled this obligation by providing uncompensated care, or charity care. However, this has historically been poorly regulated. A 2013 study found that on average nonprofit hospitals spent 7.5 percent of their operating expenses on community benefit activities, and 85 percent of that was charity care. However, there was major variation in the amount allocated to community benefit, ranging from 1 percent to 20 percent.

The Affordable Care Act introduced new community benefit reporting requirements for nonprofit hospitals in an effort to bring more clarity and accountability to the amount and quality of “community benefits” delivered in exchange for 501(c)3 tax exemption. The value of the nonprofit tax exemptions for hospitals is significant: it was estimated at almost $25 billion in 2011. For states and municipalities in particular, the foregone tax revenue is nontrivial, especially as their taxes bases were squeezed by the burst of the housing bubble in 2008. It should be little surprise, then, that municipalities have started to scrutinize the tax exemptions for nonprofit hospitals.

Last year, in a closely watched case, Morristown Medical Center’s parent company, Atlantic Health System sued the municipality of Morristown, New Jersey after the town repeatedly denied their applications for property tax exemption. The tax court sided with the municipality, citing operational practices indistinguishable from a business, including the Medical Center’s inability to separate the operations of their for-profit and nonprofit ventures (particularly relevant for the purposes of taxation), and executive compensation on par with the private sector. In the ruling, the judge noted that in his review of the existing statutes and case law, he couldn’t find a viable argument for how modern nonprofit hospitals would meet the criteria for tax exemption, describing them as “legal fictions”. The judge advised that if nonprofit hospitals were to continue having tax-exempt status, the state legislature would need to promulgate new regulations to define the terms of such an arrangement. Atlantic Health Systems and the municipality of Morristown agreed to payments in lieu of taxes as a resolution to the lawsuit, but the state law issues raised by the suit have not been addressed and the broader policy questions regarding the social and financial obligations nonprofit hospitals remained uncertain.

The New Jersey Hospital Association moved swiftly to work with the state legislature on a bill that would establish a formula for payment in lieu of taxes. NJHA recognized that without an intermediate compromise, its members could wind up with open-ended tax liabilities, either through ad hoc legal action or a change in tax-exemption status via statute. Opponents to the bill were divided: some worried that any compromise could threaten hospitals’ viability and open the door for eventual taxation; others thought hospitals should be conventionally taxed. Ultimately, the bill (S3299) garnered a large majority of legislative support, and in January of 2016, went to Governor Chris Christie’s desk to be signed. Christie, however, pocket vetoed the bill.  Last week, he called for a two-year freeze on municipal attempts to collect taxes from hospitals, and proposed a commission to conduct a comprehensive review of the issue and current statute, and to make recommendations to the legislature and executive. One thing is clear: this process and its ultimate resolution will be closely watched by hospitals and policymakers around the country.

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