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Nonprofit Hospitals Denied Real Estate Tax Exemption

Nonprofit Hospitals Denied Real Estate Tax Exemption

Court says they were not operated free from private profit motive and did not provide sufficient free or subsidized care

A Pennsylvania appellate court has denied charitable real estate tax exemption for four hospitals in a reginal nonprofit hospital system on the ground that they did not qualify under the state’s definition of “charitable.”  It affirmed three decisions from one county and reversed a decision from another.

The state Commonwealth Court has found that four hospitals in the Tower Health system in suburban Philadelphia did not operate free from private profit motive and did not provide a sufficient amount of below cost care to its patients.

Tower Health, a 501(c)(3) hospital limited liability company, acquired the hospitals from Community Health Systems, a for-profit entity, in 2017.  It acquired each of the hospitals through a separate single member limited liability company of which Tower Health is the single member.  It financed the acquisition with bonds covering the entire obligated group.  While the acquisition was under agreement of sale but not concluded it applied for real estate tax exemption for 2018 and beyond.

Three of the hospitals are in Chester County and one is in Montgomery County.  The county Board of Assessment in Chester County denied the exemption claim and the county court affirmed on appeal.  The Montgomery County Board of Assessment granted the application for exemption and the county court affirmed that decision on appeal, based on a prior decision from the Commonwealth Court.  The Commonwealth Court affirmed the three denials in Chester County and reversed the approval in Montgomery County.

The Pennsylvania Supreme Court had set out five criteria for charitable exemption in a major case in 1987.  To be recognized as a charity, an organization must (1) advance a charitable purpose, (2) donate or render gratuitously a substantial portion of its services, (3) benefit a substantial and indefinite class of persons who are legitimate subjects of charity, (4) relieve the government of some of its burden, and (5) operate entirely from private profit motive.  The taxing authorities argued primarily that Tower Health did not donate or render gratuitously a substantial portion of its services and did not operate entirely free from private profit motive.

In analyzing the private profit motive issue, the Chester County court said the record did not support the reasonableness of the management fees charged by Tower Health’s parent company for administering the local hospitals or the reasonableness of bond interest charges. 

In the trial court’s view, Tower Health drew money from the hospitals without sufficient explanation and “at an alarming rate.”  It charged the Jennersville hospital $1.8 million for management services in 2018 and increased it to $3 million in 2019 and to $6.1 million in 2020.  The trial court said there was no evidence presented to support the reasonableness of those fees.  It also found that use of bond funds to acquire properties other than the hospitals in question was “improper” and that “not one penny” was used to support and increase the efficiency of each local hospital.

The trial court was particularly upset by the compensation plan for Tower Health executives where it said incentives were weighted 70% on financial performance and 30% on patient care and satisfaction.  The hospital admitted that 40% of the bonus was based on financial performance goals.  The trial court found that the system “was set up to be profitable and to reward executives at all levels when it was.” 

The trial court rejected the hospital’s argument that its compensation incentives were necessary to attract and retain qualified executives in what the Commonwealth Court said was “scathing terms.”  The trial court called the executives “corporate health care raiders” who were paid $2.5 million per year.  It said the goal of the program was “evident” from the testimony, “drain the juice out of the hospitals until there was nothing left but a dried-out husk and then leave, close the doors, or sell what was left.”  One hospital was closed, one was for sale, and “while this harvesting strategy may not have killed [the Montgomery County hospital] it is left with little more than a skeleton.”

The trial court in Montgomery County had been concerned about an earlier Commonwealth Court case involving Phoebe Services prohibiting the imposition of a business privilege tax on management fees on healthcare and social service systems in 2021.  (See companion case in Nonprofit Issues® Vol. XXXI No. 1 dealing with Good Shepherd Rehabilitation Network.) Here the Commonwealth Court said “there is no bright-line test of what constitutes a substantial percentage of compensation based on financial performance.  In the circumstances of this case, however, we cannot say that basing 40% of the total incentive bonus on financial performance was not substantial.  Therefore, we conclude that the trial court did not err in finding [the hospital] failed to prove it operated free from a profit motive.”

In the Montgomery County case, the Commonwealth Court said the reasoning of an earlier case denying a real estate exemption for a bonus plan for executives was “more persuasive” than the analysis in the business privilege tax case (which was based on a different standard).  It used the real estate standard to reverse the trial court decision in the Montgomery County case.

The trial court in Chester County also rejected the hospital’s claim that it renders gratuitously a substantial portion of its services.  In the Jennersville hospital case, it said only 82 of 107,340 patients received free services (.076%) and only 5.3% received fee reductions of at least 10% of the cost of services.  The trial court rejected the hospital’s argument that it provided assistance because of shortfalls in reimbursement received for care provided to patients insured through Medicare and Medicaid.  While such arguments had been accepted in prior cases, the trial court said the hospital’s arguments were “unreliable” and based on numbers “not properly audited.”

It also rejected an expert’s testimony that was based generally on “GAAP-like numbers,” referring to Generally Accepted Accounting Principles.  “There is no such thing,” the trial court said. “This is a binary selection.  Figures relied upon either were or were not prepared in accordance with GAAP.  These were not.”

The trial court also rejected comparisons between payments received and “charges” listed on a master charge sheet, which it said were “meaningless.”  It also complained that the hospital was unable to say what its actual costs were for providing its services.

The Commonwealth Court again agreed that the trial court’s decision was based on substantial information in the record and that the hospital failed to prove that it rendered gratuitously a substantial portion of its services.

The trial court in the Chester County cases also ruled that the hospitals failed to comply with the state legislation setting forth standards for charitable exemption.  The state Supreme Court had previously held that the statute was an additional set of criteria for determining exemption but that the primary criteria were the five that it had set out as the constitutional standard in its 1987 opinion.

The one victory the hospitals had in the cases, which might help other charities in the future, was that the hospitals had standing to claim the tax exemption while the properties were under agreement of sale but not yet finally acquired.

(Jennersville Hospital v. County of Chester Board of Assessment Appeals, Commonwealth Ct. PA, No 1282 C.D. 2021, 2/10/23Pottstown School District v. Montgomery County Board of Assessment Appeals, Commonwealth Ct. PA, No 1217 C.D. 2021, 2/10/23. Phoenixville Hospital v. County of Chester Board of Assessment Appeals, Commonwealth Ct. PA, No 1281 C.D. 2021, 2/10/23. Brandywine Hospital v. County of Chester Board of Assessment Appeals, Commonwealth Ct. PA, No 1279 C.D. 2021, 2/10/23.


This case shows the necessity for reconsideration of the Pennsylvania standard for charitable exemption, particularly in connection with charitable hospitals.  Hospitals that are not “run like a business” are likely to have serious financial difficulties, and even those that are criticized for running like a business are often unable to make it.  These hospitals drew fire from having compensation based so heavily on financial performance (which is permitted by the IRS so long as it is based on revenue and not on profit) when such bonuses have been questioned in prior tax cases.  But the trial court was unrealistic in saying the hospitals were paying a tax on “excess” benefits because they were paying the tax on salaries in excess of $1 million imposed by Congress, even where the compensation is reasonable and not an “excess benefit” under the tax meaning of the term.

A subsidization based on a percentage of the hospital’s total budget is generally unreasonable to expect today when, at least in Pennsylvania, most of the patients have either private insurance or Medicaid or Medicare.  With the size of the budgets, it would be almost impossible to cover 5-10% of their costs with charitable contributions.  The old charitable community hospitals of the 1980s don’t exist today.

Part of the ultimate questions is who should subsidize the hospitals that have been losing money and going out of business throughout the nation.  We saw a wave of for-profit hospital acquisitions of charitable hospitals in the 1990s and early 2000s.  We have recently seen a wave of for-profits closing their recently purchased hospitals or selling them back to large nonprofit hospital systems because the for-profits found that they couldn’t make the money they thought they would make by operating them, particularly in states that did not expand Medicaid eligibility under the Affordable Care Act. 

In Pennsylvania, the state supreme court long ago decided, in a case involving federally subsidized housing where the feds picked up the entire deficit between costs and the subsidized rentals received, that it was not a “charitable” activity exempt from real estate when the housing provider was fully paid for its services.  It based the decision on the providers compensation, without regard to how those services were received by the residents as a form of charitable services.  In essence the state said, if the feds are going to pay, there is no reason for the local government to provide a subsidy from the loss of real estate tax revenue.  We may be at that point with hospitals today, although the feds have so far not been so willing to pick up all of the costs.  But it is disingenuous to try to reach that conclusion by applying a legal standard enunciated in a very different time.

Commonwealth Court of Pennsylvania

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