DISCUSSION WEEK 4

CHAPTER

459

TAXATION OF HEALTHCARE INSTITUTIONS

Introduction

To be exempt from taxation, an organization must meet the criteria of the tax law in question. Not-for-profit status is a prerequisite to tax-exempt status, but the two concepts are not the same. The former is based on state corporation law, while the latter depends on the federal or state tax law from which the organization wishes to be excused. The various tax law criteria must be exam- ined carefully because an organization can be exempt under one statute (e.g., federal income, excise tax) but taxable under another (e.g., state property tax).

Nature of a Charitable Corporation

Among the organizations exempt from federal income taxation are those described in Internal Revenue Code (IRC) section 501(c)(3):

Section 501(c)(3)

Corporations, and any community chest, fund, or foundation, [that is] organized

and operated exclusively for religious, charitable, scientific, testing for public

12 After reading this chapter, you will

• know the difference between tax-exempt and not-for-profit status,

• recognize the differences between standards for exemption from federal income taxation and standards for exemption from state ad valorem (property) taxation,

• be familiar with an important state supreme court decision denying property tax exemption to a church-affiliated health system,

• appreciate the federal rules regarding lobbying and political campaign activity and how they apply to 501(c)(3) organizations,

• understand the meaning of “used for charitable purposes,” and

• know how the Affordable Care Act may affect the tax status of not- for-profit healthcare organizations.

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C o p y r i g h t 2 0 2 0 . H e a l t h A d m i n i s t r a t i o n P r e s s .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

EBSCO Publishing : eBook Collection (EBSCOhost) - printed on 5/31/2022 1:51 PM via UNIVERSITY OF MARYLAND GLOBAL CAMPUS AN: 2361947 ; Stuart Showalter.; The Law of Healthcare Administration, Ninth Edition Account: s4264928.main.eds

T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n460

safety, literary, or educational purposes . . . no part of the net earnings of which

inures to the benefit of any private shareholder or individual, no substantial part

of the activities of which is carrying on propaganda, or otherwise attempting, to

influence legislation [with one exception], and which does not participate in, or

intervene in . . . any political campaign on behalf of (or in opposition to) any can-

didate for public office.1 [Emphasis added.]

Most healthcare institutions that claim tax-exempt status rely on section 501(c)(3). In particular, they claim to be organized for “charitable pur- poses.” This raises two important questions: What is a charity? What is a charitable purpose?

What Is a Charity?

Somewhat surprisingly, the IRC does not define either charity or charitable purpose. Even though the terms have lain encysted in the tax code for many decades and are used in various state constitutions and statutes, only since the mid-1980s have they been subjected to any critical analysis. A passage from the famous Dartmouth College case of 1819 is one example of language in which the meaning of these terms is assumed to be self-evident. In the opinion, while quoting from Blackstone’s Commentaries, Chief Justice John Marshall wrote:

[Dartmouth College] is an eleemosynary corporation. It is a private charity, origi-

nally founded and endowed by an individual, with a charter obtained for it at his

[the King’s] request, for the better administration of his charity. “The eleemosynary

sort of corporations are such as are constituted for the perpetual distributions of

the free-alms or bounty of the founder of them, to such persons as he has directed.

Of this are all hospitals for the maintenance of the poor, sick and impotent; and all

colleges both in our universities and out of them.” 1 Bl. Com. 471.2

The chief justice then proceeded to discuss eleemosynary (philanthropic) corporations and their legal history as they were viewed about 200 years ago:

Eleemosynary corporations are for the management of private property, accord-

ing to the will of the donors; they are private corporations. A college is as much

a private corporation as [a] hospital; especially, a college founded as this was,

by private bounty. A college is a charity. “The establishment of learning,” says

Lord HARDWICKE, “is a charity, and so considered in the statute of Elizabeth. A

devise [a testamentary gift] to a college, for their benefit, is a laudable charity, and

deserves encouragement.” 1 Ves. 537. The legal signification of a charity is derived

chiefly from the statute 43 Eliz., c. 4. “Those purposes,” says Sir. W. GRANT, “are

charity An organization that exists to help those in need or to provide religious, educational, scientific, or similar aid to the public.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 461

considered charitable, which that statute enumerates.” 9 Ves. 405. Colleges are

enumerated as charities in that statute. The government, in these cases, lends its

aid to perpetuate the beneficient [sic] intention of the donor, by granting a charter,

under which his private charity shall continue to be dispensed, after his death.

This is done, either by incorporating the objects of the charity, as, for instance, the

scholars in a college, or the poor in a hospital; or by incorporating those who are

to be governors or trustees of the charity.3 [Emphasis added.]

These passages have some notable aspects. The first concerns the use of the word hospital itself. According to the Oxford English Dictionary, it comes from the Latin hospitalis—the root of our English words hospitality and hospitable—and originally referred to an institution for welcoming and housing travelers and persons who were needy, infirm, or aged. For example, London’s Foundling Hospital was established in 1739 for the “education and maintenance of exposed and deserted young children,” not for the purpose of providing medical care.4 Today we might call such an institution a “home” or an “orphanage” rather than a “hospital.” The sense of hospital as an estab- lishment providing medical or surgical treatment developed only gradually with the advancement of modern medicine (see chapter 1, part 2).

The second salient point in Marshall’s opinion is to note the authorities he cites: “Bl. Com.”—short for Sir William Blackstone’s eighteenth-century treatise, Commentaries on the Laws of England—and various statutes dating back to the reign of Queen Elizabeth I including the Statute of Elizabeth, also known as the Charitable Uses Act, which was enacted in 1601. Thus, the Dartmouth College case is both a good example of how English common law carried over to the United States and evidence that courts and legislatures have struggled with the concept of charity for more than four centuries.

Third, Chief Justice Marshall equated hospitals and colleges, assumed without discussion that they are charities, and cited them as examples of organizations “constituted for the perpetual distributions of . . . free-alms or bounty.” Is this description characteristic of today’s healthcare institutions— or today’s colleges, for that matter?

Fourth, the chief justice assumed that the beneficiaries of hospitals were poor in addition to being “sick and impotent” (by which he meant “infirm”). His concept of a hospital echoes the description in chapter 1 of the almshouses in the Middle Ages—pits of misery and horror—and is consistent with the meaning of the word in Marshall’s time.

Fifth, research reveals that hospitals per se were not among the enu- merated charities in the Statute of Elizabeth; the sole reference to healthcare in that law was “maintenance of sick and maimed soldiers and mariners.”5

The final notable point, which confirms the premise of our current discussion, is Chief Justice Marshall’s failure to provide a clear definition of

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n462

the very term that is at the heart of the case. Apparently, charity could only be described, not defined, in 1819.

Two centuries later, a clear definition of the word remains elusive. For example, in Provena Covenant Medical Center v. Department of Revenue,6 the Supreme Court of Illinois quoted with approval an 1893 case that had quoted an 1867 case from Massachusetts:

A charity, in a legal sense, may be more fully defined as a gift, to be applied consis-

tently with existing laws, for the benefit of an indefinite number of persons, either

by bringing their hearts under the influence of education or religion, by relieving

their bodies from disease, suffering or constraint, by assisting them to establish

themselves for life, or by erecting or maintaining public buildings or works, or

otherwise lessening the burthens of government.7

This ancient description has been repeated, rephrased, reinterpreted, and regurgitated many times, but as venerable as it is, its clarity has not improved and it is little help in deciding real-life cases. As demonstrated later in this chapter, antediluvian language can be problematic when applied to twenty- first-century circumstances.

At the least, it seems that a charity must benefit a large segment of the public (“an indefinite number of persons”) and not restrict its offerings to a privileged few. Thus, charities are distinguished from the broader category of not-for-profit organizations; that is, charitable corporations are not-for- profit, but not all not-for-profit organizations are charities. Countless not-for- profits—for example, social clubs, fraternal organizations, and labor unions— may extend a significant degree of social service and community benefit without operating for purposes that would exempt them from taxation.

A charity’s benefits can be restricted to a particular type of beneficiary. In healthcare, prominent examples are children’s hospitals and women’s hospitals. In other words, organizations do not jeopardize their charitable status by confining their activities to a particular purpose and restricting benefits to a particular category of people (as long as the restriction does not discriminate against a suspect class of people) or by restricting their activities because they lack particular types of staff and facilities. Whether the benefits of a charity may be restricted to the members of a particular church, lodge, or labor union or to the employees of a particular company depends on the issue involved in the particular case.

If state law requires tax-exempt organizations to be “purely public charities,” their beneficiaries usually may not be restricted to the members of a specific church denomination, fraternal order, or similar group. An old but still respected case is City of Philadelphia v. Masonic Home of Pennsylvania (1894), which denied real estate tax exemption to a home for aged Masons because it served only them, not the general public, and therefore was not

suspect class A group of people often subjected to discrimination because of stereotyping; criteria for suspect classification and thus careful judicial review include race, religion, national origin, gender, and so on.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 463

“purely public.”8 Nine decades later, the court in the 1982 case West Allegheny Hospital v. Board of Property Assessment, Appeals and Review relied on Masonic Home when it decided that a community hospital was tax exempt because it was open to all without regard to “race, color, creed, national origin or sex” and was not restricted to members of a particular social organization.9

By way of comparison, Kansas does not require a charity to be “pub- lic” in the same sense that Pennsylvania does. Therefore, in Kansas, a hospi- tal may be considered tax exempt even if it serves only specific groups—for example, Masons, Methodist clergy, or members of Roman Catholic religious orders.10 The definition of and limitations on the class of persons to be served by a “charity” thus depend on local law and are open questions in many jurisdictions. The point comes into focus with respect to specialized institu- tions, such as hospitals that care only for patients with a particular disease or disability. Discrimination on the basis of indigence or suspect classification is still prohibited, but an institution does not forfeit its charitable status by restricting benefits on the basis of its purpose, facilities, staff, or ability to serve particular conditions.

As discussed in chapter 10, a hospital may not restrict its provision of emergency care to those able to pay. A related question concerns whether the organization must render some amount of free care to maintain its charity status. This issue has become contentious in recent years, particularly in the context of whether the hospital must pay ad valorem taxes on the property it owns. This question will be revisited later in this chapter.

Pretermitting property tax issues for the moment, the question becomes: Is the provision of medical care in itself a charitable purpose? For many years, the answer was beyond peradventure, as reflected in the follow- ing language from a 1944 New York decision:

Hospitals which are devoted to the care of the sick and injured, which aid in main-

taining public health and which make valuable contributions to the advancement

of medical science are rightly regarded as benevolent and charitable. A hospital . . .

which devotes all of its funds exclusively to the maintenance of the institution is

a public charity and this is so irrespective of whether patients are required to pay

for the services rendered.11

That case was decided during World War II, however, and a lot has changed in three-quarters of a century. The assumption that a hospital is a charity has come into question lately, as litigants and policymakers challenge whether not-for-profit hospitals are in any significant way different from their for-profit counterparts. This question is a serious public policy issue given the fiscal pressures facing state and local governments and the potential property tax revenues that could be generated by placing hospital property on the tax assessor’s rolls.

peradventure Chance or uncertainty; doubt; question.

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n464

Federal Tax Issues

Healthcare organizations’ exemption from federal income tax is based on IRC section 501(c)(3). The following explores some significant questions regarding exemption from federal income tax.

Basic Requirements for Federal Exemption Charitable Purpose Is the provision of healthcare a charitable purpose? Section 501(c)(3) does not define the term charitable. The regulations contain the following relevant but less-than-enlightening language:

Charitable defined. The term charitable is used . . . in its generally accepted

legal sense and is, therefore, not to be construed as limited by the separate

enumeration in section 501(c)(3) of other tax-exempt purposes which may fall

within the broad outlines of charity as developed by judicial decisions. Such

term includes: Relief of the poor and distressed or of the underprivileged;

advancement of religion; advancement of education or science; erection or

maintenance of public buildings, monuments, or works; lessening of the bur-

dens of Government; and promotion of social welfare by organizations designed

to accomplish any of the above purposes, or (i) to lessen neighborhood ten-

sions; (ii) to eliminate prejudice and discrimination; (iii) to defend human

and civil rights secured by law; or (iv) to combat community deterioration and

juvenile delinquency.12

One thing is clear: healthcare per se is not listed among these activities. So where does it fit? Does it lessen the burdens of the government? Would the government necessarily need to provide healthcare as a social service if community hospitals did not exist? Does providing care amount to relief of the poor? Are “the poor” only the indigent, or does the term include those poor in health or spirit? Should it be interpreted that way?

We sense that charity involves benevolence—assisting the less fortu- nate, doing good works, and promoting the general welfare—but an instinc- tive response does little to resolve the legal issues, and the answers remain unclear. Apparently, charity—like pornography, famously—is hard to define, but you know it when you see it.

No Private Inurement In addition to being organized and operated for charitable purposes (what- ever that means), a tax-exempt organization’s net earnings may not inure to the benefit of any private individual or corporation. The statute and regula- tions do not define inure for these purposes, and the dictionary definition— “to make accustomed”—is ill fitting. Nevertheless, the regulations’ intent is

inure A term used but not defined in IRC section 501(c)(3); in context, it means a charity’s income or assets may not benefit, accrue to, or be distributed to private interests.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 465

relatively clear: A charity’s net earnings must be permanently dedicated to exempt purposes and may not be distributed to private interests.

This requirement goes hand in hand with the concept of public benefit, and it raises many questions. Each case must be decided on its own merits, and no single factor or set of factors is conclusive in determining whether a corporation claiming tax-exempt status is truly providing a community benefit or is merely a shield for conferring a financial gain on proprietary interests. The courts consider several factors, most of which flow from or relate directly to corporate control.

When control of a corporation rests exclusively with a small group of individuals, the parties’ motives should be subject to close scrutiny. Private gain is indicated by such factors as (1) division of income among trustees, members, or officers of the corporation; (2) private use of corporate funds or facilities; (3) in the case of a hospital, exclusive privileges to admit or treat patients; and (4) failure to provide services to those unable to pay.13 Even if tax-exempt status is granted without requiring the hospital to provide free care, its charity record is evidence of a willingness to serve the public. In other words, the absence or rarity of charity work may be evidence of private gain.

Because of changes in healthcare financing in the last quarter of the twentieth century, hospitals developed various economic incentive plans to attract physicians to the medical staff, encourage the economical use of hospital facilities, and (one hopes) reduce overall costs. The theory is that if physicians share in net revenues, they will have a financial incentive to be efficient and all parties will benefit. As long as the doctors’ compensation is reasonable and furthers the charitable purpose of the institution, its tax-exempt status is not jeopardized.14 Of course, the institution must receive and should document services of value in return for the incentives it grants the doctors. (Note that such arrangements implicate state or federal antikickback and self-referral laws, as discussed in chapter 15.)

In addition, federal law imposes sizable financial penalties on persons who receive “excess benefits” and on the orga- nizational managers who approve the transactions.15 Tax-exempt organizations are advised to develop compensation and conflict-of-interest policies to ensure the pro- priety of transactions with corporate insiders, including physicians. Failure to abide by such policies puts the insiders and corporate managers at substantial monetary risk.

The Johnson Amendment

The provision that prevents 501(c)(3) organiza- tions from engaging in political activities (at the risk of losing their tax-exempt status) is the so- called “Johnson Amendment.” It is named for Senator (and later President) Lyndon B. Johnson, who offered it as an amendment to the IRC in 1954. There have been numerous efforts to repeal this provision, all of which have failed for a variety of reasons.

One concern is that political contributions funneled through 501(c)(3) organizations would be tax-deductible for donors. Another is that repeal would damage the organizations’ image and turn them into partisan “super-PACs.”

Those who support repeal (including Presi- dent Trump) claim that the prohibition violates First Amendment rights.

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Lobbying and Political Activity Not only does section 501(c)(3) bar private inurement; it also prohibits exempt organizations from campaigning and electioneering on behalf of or in opposition to candidates for political office (see The Johnson Amend- ment). However, they may engage in lobbying as long as that activity does not amount to a “substantial part” of their overall operations. What amounts to a “substantial part” is a matter of some dispute, so public chari- ties (except certain religious organizations) are permitted to file an election with the Internal Revenue Service (IRS) indicating their intent to engage in lobbying. If they do so, they are subject to defined limitations on their lobbying expenditures. The following, however, are not considered lobby- ing expenses:

• Publishing nonpartisan research data • Providing testimony to a legislative body • Sending communications to a governmental official outside the

legislative branch

Health Reform Adds New Requirements The Affordable Care Act (ACA) adds a number of new requirements to the tax code and imposes additional standards regarding care of the poor.16 To qualify for the federal exemption, charitable hospitals now must

• conduct a community health needs assessment (CHNA) at least once every three years,

• adopt an implementation strategy to meet the health needs identified in the assessment,

• publicize and implement a written financial assistance policy (essentially a charity care policy) for services to indigent patients,

• adopt a written policy on nondiscrimination in emergency services, • limit the amounts charged for care to indigent patients, and • not attempt “extraordinary collection actions” without first

determining whether the patient meets financial assistance criteria.

The CHNA must include “input from persons who represent the broad interests of the community served by the hospital facility, including those with special knowledge of or expertise in public health” and must be made “widely available to the public.”17 Failure to comply subjects hospitals to a penalty tax.

The ACA also adds new review and reporting requirements. IRC sec- tion 501(r) requires hospitals to be audited at least once every three years for compliance with the CHNA requirement, and organizations will need to file

lobbying Activity intended to influence the outcome of pending legislation.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 467

their audited financial statements and report annually to the IRS how they are meeting community needs. Finally, the ACA requires the secretaries of the departments of Treasury and Health and Human Services to report annu- ally to Congress the levels of charity care hospitals are providing, hospitals’ bad debt expenses, unreimbursed services, and similar items.

In a nutshell, a healthcare organization seeking to maintain federal tax exemption needs to meet these new charity care and community benefit requirements in addition to meeting the traditional charitable purpose and private inurement standards. Notably, these new provisions of the ACA con- tain a built-in irony: If more people gain insurance coverage as health reform takes hold, fewer people will qualify for charity and hospitals will have more difficulty meeting their charity care obligations. Furthermore, if the United States were to achieve universal health insurance, would hospitals no longer qualify as “charitable” institutions? Whether federal tax exemption will con- tinue to be a viable concept for healthcare organizations remains to be seen.

Taxation of Unrelated Business Income Even if an organization meets the requirements for tax exemption, not all its income is tax exempt (see Legal Brief). When a 501(c)(3) charity earns rev- enue from a line of business that does not further its charitable purpose, that income is subject to unrelated business income taxation (UBIT) as though it were earned by a for-profit organization. Without UBIT, the charity would have an unfair competitive advantage over commercial entities that provide the same types of products or services.

So long as the unrelated activities do not constitute a substantial part of the charity’s work, unrelated income does not threaten the organization’s underlying tax-exempt status. What constitutes a “substantial part” has not been clearly defined, but a rule of thumb is that the IRS might challenge the tax-exempt status of a charity if its gross income from unrelated activities exceeds 50 percent of its total revenue. In addition, sales of goods or services to private parties below cost may also constitute private inurement and may jeopardize the tax-exempt status of the seller.18

Investment income—for example, income from dividends, inter- est, annuities, and research—is not tax- able, but such operations as hospital gift shops; restaurants; parking lots; pharma- cies; physicians’ offices; and residences for interns, nurses, and other staff may generate taxable income. The fact that the income is used for hospital or chari- table purposes does not exempt it from taxation. The test is whether the activity

Legal Brief

The taxation of exempt organizations’ unrelated business income is governed by IRC §§ 511 to 515 and regulations found at 26 C.F.R. §§ 1.511-1 to 1.514(g)-1.

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itself is substantially related to the charitable purpose of the tax-exempt institution. In other words, does it further the mission of the exempt organization, or is it simply an extra source of revenue? All the nuances of that question cannot be addressed here, but a hospital generally can avoid UBIT if it can show that it is conducting the business activity primarily for the convenience of patients. Whether sales to persons other than patients generate taxable income is a complex question that should be addressed with qualified tax counsel.

State and Local Property Taxes

Some of the most interesting and financially consequential tax cases concern whether healthcare organizations’ property should be assessed for ad valorem tax. A hospital, for example, typically sits on prime real estate, and given its structures and other improvements, the campus is often the most promi- nent and valuable property in the neighborhood. State and local authorities are understandably eager to generate tax revenue from those assets, but (as shown in this section) charities and governmental organizations—which are not taxed—do not offer a solution to communities’ fiscal woes.

Governmental Property Federal property is exempt from state and local taxes, and so is most property owned by state and local entities, depending on the relevant state constitu- tion or statute. In some states, governmental ownership and control are suf- ficient to establish exemption, but other states require also that the property be used exclusively for a public purpose to justify exemption.19

In a 1986 Minnesota case, a medical clinic owned and operated by a municipal hospital was not exempt from taxation when it was staffed by physicians engaged in private practice on a fee-for-service basis. The board of the hospital and the physicians annually reviewed and agreed on the service fees charged to patients. Each doctor then received 60 percent of his gross accounts receivable. Noting that the issue hinged on whether the primary use of the facility was for public purposes or for private gain, the Minnesota Supreme Court denied the exemption; the facility was not being used exclu- sively for a public purpose.20 (Today, this arrangement would raise fraud and abuse issues as well.)

Private Property The exemption of private healthcare institutions’ real estate and personal property from taxation depends on two main factors: (1) qualification as a charity and (2) use for a charitable purpose.

ad valorem tax Tax imposed in proportion to the value of the property being assessed.

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Qualification as a Charity Like the property of any other business, the property of a for-profit health- care organization is fully taxable. If the owner claims to be a charity, state constitutional or statutory provisions determine exempt status.

In many states, a constitutional provision mandates tax exemption for property owned by charities. The legislature and courts cannot alter this requirement, although the courts have the power to interpret its meaning. Other state constitutions contain permissive exemptions, and a few state constitutions are silent on the matter. In either of these latter situations, the standards for tax-exempt status are for the legislature to determine.

The distinction between a mandatory constitutional provision and a permissive one (or none at all) is significant when, in the search for addi- tional revenue, there is political pressure to restrict or reduce the number of ad valorem tax exemptions. This distinction was a factor in the iconoclastic decision of Utah County v. Intermountain Health Care, Inc.21

The Utah constitution had exempted from taxation all property owned by nonprofit entities and used exclusively for either religious worship or charitable purposes. In an attempt to “clarify” the constitutional language, the Utah legislature defined charitable purposes to mean “religious, hospital, educational, employee representation, or welfare purposes.”22 At issue in the case was whether the statutory definition impermissibly expanded the consti- tutional provision. The Supreme Court of Utah held that it did, saying that

in ruling upon the validity of a statute which purports to define the meaning of a

constitutional provision, we are obligated to scrutinize the language of the Consti-

tution with considerable care. It is true . . . that a significant degree of deference

is due to a legislative construction of the meaning of a constitutional term. But . . .

[the Constitution] grants a charitable exemption and our statutes cannot expand or

limit the scope of the exemption or defeat it. To the extent the statutes have that

effect, they are not valid.23

After an exhaustive review of the meaning of charity and reaffirming a strict constructionist view that “taxation has been the rule and exemption has been the exception,” the Supreme Court of Utah held that the 21-hospital Intermountain Health Care system had not proven its entitlement to relief from property taxes. The court found significant the fact that even though “no person in need of medical attention is denied care solely on the basis of a lack of funds,” Intermountain Health Care’s policy was to collect hospital charges from patients whenever possible. This ruling shook up comfortable assumptions and was a wake-up call for the healthcare sector. The shock waves that Intermountain created can still be felt today, as evidenced by Provena (presented later in The Court Decides; see Legal Brief).

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Prior to Intermountain, provision of free care was not deemed a prerequisite for tax exemption, and few (if any) courts bothered to question that premise—at least not with any intellectual rigor. It was simply a given that caring for people is a charitable act, whether they have to pay for the care or not. As Justice Oliver Wendell Holmes Jr. wrote more than a hundred years ago, “It is one of the misfortunes of the law that ideas become encysted in phrases and thereafter for a long time cease to provoke further analysis.”24 Such was the case with the con- cepts of charity and charitable purpose.

For example, in the 1967 Nebraska case Evangelical Lutheran Good Samari- tan Society v. County of Gage,25 a home for the aged was organized as a not-for-profit corporation and required all residents to pay if they were able. Its rates were nearly

the same as those charged by proprietary homes, and it operated at a profit in some years and at a deficit in others. The court held the real estate to be exempt, ruling in effect that charity should be defined in broader terms than merely almsgiving and relief of poverty.

Likewise, in Central Board on Care of Jewish Aged, Inc. v. Henson, the court of appeals of Georgia ruled in 1969 that a home for the elderly was exempt.26 The home provided medical and nursing services to elderly persons of the Jewish faith. The residents’ average age was nearly 83, and each resi- dent paid a monthly charge based on financial ability—the maximum being $450. No applicant was refused admission because of inability to pay, and at all times a few residents were permitted to remain without paying. Deficits in annual operating expenses were covered by contributions from the Jewish Welfare Fund or individuals. The court wrote as follows: “The concept of charity is not confined to the relief of the needy and destitute, for aged peo- ple require care and attention apart from financial assistance, and the supply of this care and attention is as much a charitable and benevolent purpose as the relief of their financial wants.”27

In 1981, the Massachusetts Supreme Judicial Court wrote,

We recognize . . . that major changes in the area of health care, especially in

modes of operation and financing, have necessitated changes as well in defini-

tional predicates. The term “charitable,” as applied to health care facilities, has

been broadened since earlier times when it was limited mainly to almshouses for

Legal Brief

After the Intermountain case, the tax-exemption issue percolated in Utah for a few years and in 1990 the state’s Tax Commission released new administrative standards for determining property tax exemption. Based on those standards, the health system reapplied and the exemption was granted for all but one of the Intermountain hos- pitals. When county assessors challenged those determinations, the Utah Supreme Court held that the exemptions were proper because the hospi- tals’ total benefit to the community exceeded what their annual property tax would be (See Howell v. County Bd. ex rel. IHC Hosps., 881 P.2d 880 [1994]).

—Howell v. County Bd. ex rel. IHC Hosps., 881 P.2d 880 (1994)

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 471

the poor. As a result, the promotion of health, whether through the provision of

health care or through medical education and research, is today generally seen

as a charitable purpose. Such a purpose is separate and distinct from the relief of

poverty and no health organization need engage in “almsgiving” in order to qualify

for exemption.28

Although these types of opinions give obeisance to the underlying principles, they merely rehash old definitions and apply those definitions to new facts. As shown again in a few pages, the situation has not changed much since Justice Holmes’s day. Charity remains an encysted idea, and neither courts nor legislatures seem willing to question its continued pertinence to healthcare institutions in the twenty-first century.

Use for a Charitable Purpose In general, an entity must own each parcel of land it wants exempted from taxation, and each parcel must qualify for exemption separately. The test of “ownership” is not as simple as it might appear because real estate law recog- nizes various types of land ownership and leasehold interests. All states grant exemption if the charity holds fee simple (complete) legal title to the land, and nearly all states likewise grant exemption if the charity holds equitable title. (Equitable title is held, for example, when one purchases land under a mortgage or an installment contract.)

However, many states deny exemption to landowners who lease their land to a charitable corporation. In such cases, the charity has neither fee simple nor equitable title; it has merely obtained the right to possess and use the land by virtue of the lease. On the other hand, some states exempt such property from taxation because they believe that reducing the operating costs of charitable organizations is sound public policy.

Like Utah, most states require that tax-exempt property be used exclu- sively for charitable purposes. The meaning of this phrase has been the subject of thousands of disputes in venues from local taxing commissions to state supreme courts. For one thing, it usually means that vacant property and property owned for investment purposes do not qualify because they are not being used for charitable purposes. In other words, the use of the property determines the tax-exempt status; even charitable use of income derived from investment property does not qualify.

More contentious than use is the word exclusive. It raises issues about property owned by a charity but rented to or occupied by others, such as facilities used by medical staff members in their private practices. These situations, which are decided case by case and state by state, are usu- ally analyzed by examining (1) how closely the use of the property relates to the primary purpose of the hospital and (2) the relative benefits to the respective parties.

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n472

In general, property is subject to taxation if a hospital rents it to pri- vate physicians or others and if the rent generates a profit in excess of the hos- pital’s overhead (see The Court Decides: Greater Anchorage Area Borough v. Sisters of Charity at the end of this chapter).29 A few states grant exemption for property rented to medical staff physicians for their private offices if the rent covers only the hospital’s overhead costs, and in rare cases exemption may be permitted if the property is provided free of charge, such as when it serves as living quarters for a hospital chaplain.30 However, other courts deny exemption in these situations even if the rent does not exceed the hospital’s costs; they do so either (1) on the ground that it results in a private benefit and that therefore the exclusive-use test is not met or (2) on the ground that local statutes allow tax exemption only on land occupied by the hospital itself.31 (Note that private inurement and fraud issues may also be implicated by less-than-market-value transactions. These subjects are covered later in this chapter and in chapter 15, respectively.)

Genesee Hospital v. Wagner is a frequently cited New York case that illustrates the issues of public policy raised by the lease of hospital-owned real estate.32 The hospital built an office building next door for lease to private physicians. Rent paid by the doctors was set at market prices, but at first it did not cover operating costs. The New York statute requires that “real property owned by a corporation or association organized or conducted exclusively for . . . hospital . . . purposes . . . and used exclusively for carrying out . . . such purposes . . . shall be exempt from taxation.”33 However, the statute provides that “if any portion of such real property is not so used exclusively to carry out . . . such purposes but is leased or otherwise used for other purposes, such portion shall be subject to taxation and the remaining portion only shall be exempt.”34 At issue, then, was whether the office building was used exclusively for hospital purposes.

The trial court held that the building was exempt from taxation. Rather than give exclusively its literal meaning, the court considered whether the office building was “reasonably incident to the major purpose” of the hospital. Because the evidence clearly established that the hospital’s concern was to maintain a “first-rate” medical center for both patient care and medi- cal education rather than to benefit the private physicians personally, the trial court judge concluded that the hospital, its house staff, and patients benefited more from the use of the building than the private physicians did.35 The pub- lic policy involved was made evident when the trial court concluded that the community views a modern hospital building to be an important investment if it enables a highly trained staff of attending physicians to work together.

On appeal, the decision was reversed and the office building was held to be taxable. The appellate court recognized that a professional building was an admirable addition to the community and that it enhanced the patient care

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 473

and teaching functions of the hospital, but the facility was in direct competi- tion with privately developed professional office buildings serving an identical function. Accordingly, the leased space did not qualify for exemption under the language of the New York statute.36 (See also The Court Decides: Barnes Hospital v. Collector of Revenue at the end of this chapter.)

As in the area of unrelated business income, property tax issues are sometimes raised regarding cafeterias, gift shops, pharmacies, parking lots, and the like that a hospital owns and operates. Again, the legal issue is whether these activities are consistent with the requirement that they be used exclusively for charitable purposes. If such an activity is not conducted for commercial profit, and if it takes place in an area of the hospital building or the immediate premises not open to the general public, tax-exempt status is likely to be granted. If a cafeteria, gift shop, parking lot, or similar facil- ity is not tax exempt, the hospital must determine whether local and state statutes permit split listing of property for tax purposes if the related activity frequently takes place in some part of an institutional building. Split listing essentially means that local tax authorities will list as taxable only the space that is not exempt and then grant the remainder of the hospital building tax-exempt status. Split listing is permitted in most jurisdictions.37 In states that do not allow it, hospitals should seek competent legal advice regarding nonexempt uses of the property.

With respect to vacant or unoccupied land, a court’s decision turns on the exact language of the related state statute and judicial interpretation of that language. To confer tax exemption, some states require that the land be not only “used” for charitable purposes but also “occupied.” Even if occupancy for a charitable purpose is not a statutory requirement, the meaning of used has to be determined. Vacant land held for possible use in the indefinite future but for which no plans for development exist would normally be taxable.38 On the other hand, if plans for construction and development are well along, fund- raising is under way, and bids for construction have been received, the land— although still vacant, perhaps—is exempt in some jurisdictions.39 Other states, however, may require actual use and occupancy before granting exemption.

Finally, note that to an increasing extent, healthcare institutions are choosing to lease rather than purchase equipment and other types of personal property. Just as in states that require landowners to pay real estate taxes on property they lease to charities, leased personal property may be subject to ad valorem taxation. In an Alaska case, a hospital’s rental of beds, television sets, and X-ray equipment did not entitle the property’s owner (the lessor) to an exemption. The exemption provisions did not apply because the lessor was presumably earning a profit, and thus the property was not being used “exclusively for non-profit, religious, [and] charitable purposes” as required by the state constitution and the relevant statute.40

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n474

Coming Full Circle

As noted at the beginning of this chapter, US courts and legislatures have struggled with tax exemption issues since the earliest days of the republic. The chapter now closes with one of the oldest and one of the newest cases to have entered the fray.

In 1860, the US Supreme Court was called on to interpret an 1851 Pennsylvania statute that revoked the tax exemption of Christ Church Hos- pital in Philadelphia. The hospital claimed that its exemption—granted by the legislature in 1833—was meant to be perpetual. According to Justice John Archibald Campbell, however, “Perpetual is not synonymous to irre- vocable,”41 and using concepts almost identical to those in the twenty-first- century decision discussed in the following paragraphs, he held that the Philadelphia hospital was not entitled to the exemption. Exemptions are special privileges, Justice Campbell said; they belong “to a class of statutes in which the narrowest meaning is to be taken,” and they can be revoked at the pleasure of the state.

In 2010—more than 150 years after Christ Church Hospital was decided—came Provena Covenant Medical Center v. Department of Revenue, which was mentioned briefly at the start of this chapter. Provena Covenant Medical Center (PCMC) is a modern, full-service Catholic hospital adjacent to the campus of the University of Illinois in Urbana. The details of the case are given in The Court Decides at the end of the chapter, but assume for now that PCMC is virtually indistinguishable in its operations from any hospital of its size in the country, whether for-profit or not-for-profit. It participates in Medicare and Medicaid, accepts most private health plans, and has a char- ity care policy for indigent patients. Consistent with its charitable mission, PCMC provides free care to persons in need, but it attempts to maintain a positive bottom line through appropriate billing and collection activities. The modest amount of charity care it provides is less than the value of its tax exemption, which would be $1.1 million for the 2002 tax year.

After reviewing the definition of charity by tracing the term back to 1867, the Supreme Court of Illinois determined that PCMC was not entitled to an exemption. The court used some familiar concepts in reaching its conclusion:

• Taxation is the rule; exemption is the exception. • The burden of proof is on the one seeking the exemption. • Any doubt about the propriety of the exemption must be resolved in

favor of the tax being paid. • The way PCMC dispensed its “charity” did not differ substantially

from the way a for-profit writes off bad debt.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 475

• With few exceptions, PCMC provided services in exchange for compensation through insurance, Medicare, Medicaid, or self-payment by the patient.

The court summarized this last point as follows:

There was ample support for the Department of Revenue’s conclusion that Provena

failed to meet its burden of showing that it used the parcels [of land] in the PCMC

complex actually and exclusively for charitable purposes. As our review of the

undisputed evidence demonstrated, both the number of uninsured patients receiv-

ing free or discounted care and the dollar value of the care they received were de

minimis. 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.

Provena applies criteria that have been established Illinois law for decades. It does not plow new legal ground, but it does churn up a lot of dust. Taxing authorities in other states are certain to use the lessons learned from the PCMC decision to plan or continue their own assaults on healthcare organizations’ tax exemptions.

Summary

This chapter addresses the taxation of healthcare organizations, primarily not-for-profit corporations. All tax-exempt organizations are not-for-profit, but not all not-for-profits are tax exempt. The standards for income and property tax exemption are also discussed, as are the occasions in which some income of a tax-exempt organization may be taxable. The chapter raises the question of what it means to be a charity and what implications that designa- tion may have under federal and state law. It closes with a review of a 2010 decision that, if followed by other states, augurs rough sailing ahead for non- profit hospitals’ property tax exemptions, especially if the ACA significantly decreases the number of uninsured Americans.

Discussion Questions

1. How should the term charity be defined? What are the arguments against and in favor of counting the provision of healthcare in and of itself as charity?

2. Compare the structure and financing of today’s “medical–industrial complex” to your mental image of the nineteenth- and early

de minimis Inconsequential or of minor importance; a reference to the legal maxim de minimis non curat lex (Latin meaning “the law does not concern itself with trifles”).

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n476

twentieth-century hospital. Outline your arguments—both pro and con—for this debate topic: Resolved, that government shall eliminate all favorable tax treatment for not-for-profit healthcare organizations.

3. Consider Genesee Hospital. Do you see any parallels between that case and Charlotte Hungerford Hospital (discussed in The Court Decides in chapter 3)? Both cases concern the use of hospital property for a medical office building. In Charlotte Hungerford Hospital, the arrangement was upheld; in Genesee Hospital, it was not (in effect). Why were the cases decided differently?

4. Suppose the law requires that, for a property to be tax exempt, it must be used for exempt purposes. Suppose also that January 1 is the assessment date, and the use of the property on that date determines its exempt status for the coming year. In July 2016, a hospital buys a parcel of land near its main campus to build a facility for housing and maintaining its fleet of ambulances. Construction begins on December 1, 2016, and is completed in June 2017. The hospital starts using the building as an ambulance station on June 30, 2017. Should the land be considered exempt for 2016? What if construction had begun on January 2, 2017?

5. Discuss the future of property tax exemption in your state in the wake of decisions such as Provena.

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 477

The Cour t Decides

Greater Anchorage Area Borough v. Sisters of Charity 553 P.2d 467 (Alaska 1976)

Burke, J.

The central issue in this appeal is the tax- exempt status of a building owned by the Sisters of Charity of the House of Providence, under the provisions of Art. IX, Sec. 4, of the Constitution of Alaska and AS 29.53.020. [Footnotes omitted.]

The Sisters of Charity, a long-time health- care provider in Alaska, erected the building in question, the Providence Professional Building, adjacent to their hospital on land deeded to them in 1959 by the United States for “hospital site, school and recreational purposes only.” The construction of the Pro- fessional Building began in 1970; its first full year of operation was 1972.

The Professional Building has four floors, including a basement, and is connected by an underground tunnel to nearby Providence Hospital. Three floors are the subject of this appeal, since the parties agree that the base- ment and tunnel are used exclusively for hospital purposes and are, therefore, exempt from taxation.

The first, second and third floors are rented to doctors having hospital staff privileges at Providence Hospital, for use as their private office space. Approximately thirty-five doc- tors rent such space. These doctors, although enjoying staff privileges, are not employed by Providence Hospital, and their patients are not necessarily patients of the hospital. Thus, the

actual use made of the first, second and third floors is for office space by doctors engaged in the private practice of medicine. . . .

A taxpayer claiming a tax exemption has the burden of showing that the property is eligible for the exemption. . . . [T]herefore, the burden is on the Sisters to show that the office space is exempt. . . . They must first show . . . that the property is “used exclusively for nonprofit . . . hospital . . . purposes.” [Quot- ing from the Alaska statute.] . . . [W]e find as a matter of law, that the office space is not used exclusively for hospital purposes. . . . [W]hen the property in question is used even in part by non-exempt parties for their private busi- ness purposes, there can be no exemption. . . .

The record indicates that the Sisters have performed a service to doctors and patients alike in constructing the Professional Build- ing, and that healthcare at Providence has been benefited. In order to qualify for an exemption, however, the taxpayer must show, not benefits, but exclusive use. The use of the Professional Building for nonprofit hos- pital purposes is not exclusive. Therefore, we reverse and remand to the superior court for the entry of an order affirming the Board of Equalization’s decision denying the Sisters’ appeal.

Questions

For questions, please see the end of The Court Decides: Barnes Hospital v. Collector of Revenue (next in the chapter).

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n478

The Cour t Decides

Barnes Hospital v. Collector of Revenue 646 S.W.2d 889 (Mo. Ct. App. 1983)

Pudlowski, J.

This appeal by Barnes Hospital involves taxa- tion of Queeny Tower, a 17-story building con- nected to, used and owned by Barnes Hospital for the tax-exempt purposes of treating patients and providing them with care and services. Washington University Medical School, whose teaching facilities are located within the Barnes Hospital complex and whose faculty members comprise the medical staff of the hospital, leases Queeny Tower from Barnes. The part- time faculty subleases offices in Queeny Tower from Washington University for use in their pri- vate practice as well as for use in their teaching, research and Barnes Hospital functions. . . .

The sole question raised is whether prop- erty owned by a tax exempt hospital and leased to the medical school for use by its faculty may be taxed where its part-time fac- ulty members, also engaged in limited private practice, maintain their offices therein. . . .

[In a 1979 case] the Supreme Court [of Missouri] stated that property must meet the following provisions . . . in order to qualify for tax exemption:

(1) [the property] must be actually and regularly used exclusively for purposes purely charitable as ‘charity’ is defined in [a 1945 case]; (2) it must be owned and operated on a not-for-profit basis; and (3) the dominant use of the prop- erty must be for the benefit of an indefi- nite number of people and must directly or indirectly benefit society generally.

The first prerequisite for exemption is that the property be “used exclusively” for

charitable purposes. Nowhere in its [1979] decision did the Missouri Supreme Court define the meaning of the statutory words “used exclusively” or “purposes.” Thus, the . . . the statutory phrase “used exclusively,” must be examined. The phrase could mean “solely” or “entirely” in its narrowest sense. We do not construe it in that sense. [We conclude that] the statutory phrase “used exclusively” has reference to the primary and inherent use as against a mere secondary and incidental use. Our courts since [the 1979 decision] have continued their reliance and acceptance of this definition.

. . . We reject respondent’s contention that the use of the office space in the private practice by the part-time faculty does not meet the 1st prong of the . . . tri-partite test. We reject the rigid adherence to a literal read- ing of the statute. We further interpret the Supreme Court . . . to permit such conclusion.

The policy underlying the statute is to encourage charitable organizations. The meaning we attach to the language of the statute accords with the mandate in Barnes. Although it is the general rule that consti- tutional provisions exempting property are to be strictly construed, such provisions, though not subject to extension by construc- tion or implication, are to be given a reason- able, natural and practical interpretation in light of modern conditions in order to effec- tuate the purpose for which the exemption is granted. . . .

For the foregoing reasons, the judgment of the trial court is reversed and the cause remanded with directions that the decree

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 479

of August 24, 1978, remain in full force and effect and that appellant’s questioned prop- erty be removed from the tax rolls of St. Louis

City and the City Collector be prohibited from levying tax or compelling payment thereon.

All concur.

Discussion Questions

1. How can the Greater Anchorage (Alaska) and Barnes Hospital (Missouri) courts take two nearly identical tax laws, apply them to situations with virtually identical facts, and arrive at opposite conclusions? Are their decisions fair?

2. Which of the two interpretations do you find more persuasive? 3. Would Barnes Hospital have been decided differently if the property in question had been

owned by a for-profit company but leased to the hospital for the same purposes? 4. What if a parking garage with daily or hourly fees and used by employees, patients,

families, and visitors were located on a parcel of land owned by and adjacent to the hospital property? Would that use be exempt in Alaska or Missouri? Would it matter who accrued the revenue from the parking garage or what fees were charged? Does your answer change if the garage could also be used by patrons of local businesses that are not related to the hospital?

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The Cour t Decides

Provena Covenant Medical Center v. Department of Revenue 236 Ill.2d 368, 925 N.E.2d 1131 (2010)

[As described in this chapter, the issue in this case is whether a certain Catholic hospital system, Provena Hospitals, had proven that it qualifies for property tax exemption for its Urbana, Illinois, hospital. The director of revenue had determined that the system had not sufficiently made its case and denied the exemption. On review, the circuit court reversed the director’s decision, but an appellate court reinstated the denial. The hospital system now appeals to the state’s highest court.

The system, which is the property owner, is itself exempt from federal income tax under

IRC § 501(c)(3) and from various Illinois occupa- tion and use taxes. None of these exemptions is determinative of the property tax issue. The opinion begins with some further background.]

Provena Hospitals owns and operates six hospitals, including Provena Covenant Medical Center (PCMC), a full-service hospi- tal located in the City of Urbana. PCMC was created through the merger of Burnham City Hospital and Mercy Hospital. It is one of two general acute care hospitals in Champaign/ Urbana and serves a 13-county area in east central Illinois. The services it provides

(continued)

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n480

include a 24-hour emergency department; a birthing center; intensive care, neonatal intensive care, and pediatrics units; surgical, cardiac care, cancer treatment, rehabilitation and behavioral health services; and home health care, including hospice. It offers case management services to assist older persons to remain in their homes and runs various support groups and health-related classes. It also provides smoking cessation clinics and screening programs for high cholesterol and blood pressure as well as pastoral care.

PCMC maintains between 260 and 268 licensed beds. Each year it admits approxi- mately “10,000 inpatients and 100,000 outpatients.” Some 60% of its inpatient admissions originate through the hospital’s emergency room, which treats some 27,000 visitors annually.

PCMC provides an emergency department because it is required to do so by the [Illinois] Hospital Emergency Service Act. Where emer- gency room services are offered, a certain level of health care is required to be provided to every person who seeks treatment there. That is so as a matter of both state and federal law. [Citations omitted here and throughout.]

Staffing PCMC are approximately 1,000 employees, 400 volunteers and 200 physi- cians. The physicians are not employed or paid by the hospital. . . . Provena Hospitals’ employees do not work gratuitously. Everyone employed by the corporation, including those with religious affiliations, are paid for their services.* Compensation rates for senior exec- utives are reviewed annually and compared against national surveys. Provena Health “has targeted the 75th percentile of the market for senior executive total cash compensation.”

* This assertion by the court is not literally true. Members of Catholic religious orders who have taken a vow of pov- erty are not themselves compensated for their services; instead, their religious orders (e.g., the Sisters of Mercy, Alexian Brothers) are paid directly. The earnings are con- sidered to be the income of the religious order and are not taxable to the individual. See IRS Pub. 517.

According to the record, PCMC’s inpatient admissions encompass three broad categories of patients: those who have private health insurance, those who are on Medicare or Medicaid, and those who are “self-pay (unin- sured).” PCMC has agreements with some private third-party payers which provide for payment at rates different from “its estab- lished rates.” The payment amounts under these agreements cover the actual costs of care. The amounts PCMC receives from Medicare and Medicaid are not sufficient to cover the costs of care. Although PCMC has the right to collect a certain portion of the charges directly from Medicare and Medicaid patients and has exercised that right, there is still a gap between the amount of pay- ments received and the costs of care for such patients. For 2002, PCMC calculated the differ- ence to be $7,418,150 in the case of Medicare patients and $3,105,217 for Medicaid patients.

PCMC was not required to participate in the Medicare and Medicaid programs, but did so because it believed participation was “consistent with its mission.” Participation was also necessary in order for Provena Hospitals to qualify for tax exemption under federal law. In addition, it provided the insti- tution with a steady revenue stream.

[The court next reviews various facts relat- ing to the system’s and the hospital’s finan- cial performance, including budget items; expenses; net revenues; and policies relat- ing to billing, collections, and charity care. The opinion contains the following findings, among others.]

In 2002 [the tax year in question], PCMC budgeted $813,694 for advertising. . . . The ads taken out by PCMC in 2002 covered a variety of matters, including employee want ads. None of its ads that year mentioned free or discounted medical care.

While not mentioned in PCMC’s adver- tisements, a charity care policy was in place at the hospital, and the parties stipulated that PCMC’s staff made “outreach efforts to

(continued from previous page)

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 481

communicate the availability of charity care and other assistance to patients.” The charity care policy, which was shared with at least one other hospital under Provena Hospitals’ auspices, provided that the institution would “offer, to the extent that it is financially able, admission for care or treatment, and the use of the hospital facilities and services regard- less of race, color, creed, sex, national origin, ancestry or ability to pay for these services.”

The charity policy was not self-executing. An application was required. Whether an application would be granted was deter- mined by PCMC on a case-by-case basis using eligibility criteria based on federal pov- erty guidelines. . . .

PCMC’s policy specified that the hospi- tal would give a charity care application to anyone who requested one, but it was the patient’s responsibility to provide all the information necessary to verify income level and other requested information. To verify income, a patient was required to present documentation “such as check stubs, income tax returns, and bank statements.”

PCMC believed that its charity care pro- gram should be the payer of last resort. It encouraged patients to apply for charity care before receiving services, and if a patient failed to obtain an advance determination of eligibility under the program, normal collec- tion practices were followed. PCMC would look first to private insurance, if there was any; then pursue any possible sources of reimbursement from the government. Failing that, the hospital would seek payment from the patient directly. . . .

The fact that a patient’s account had been referred to collection did not disqualify the patient from applying to the charity care pro- gram. Applications would be considered “[a]t any time during the collection process.” . . .

During 2002, the amount of aid provided by Provena Hospitals to PCMC patients under the facility’s charity care program was modest.

The hospital waived $1,758,940 in charges, representing an actual cost to it of only $831,724. This was equivalent to only 0.723% of PCMC’s revenues for that year and was $268,276 less than the $1.1 million in tax ben- efits which Provena stood to receive if its claim for a property tax exemption were granted. The number of patients benefitting from the charitable care program was similarly small.

[The court next establishes the standard for review in cases such as this.] This stan- dard is “significantly deferential.” An admin- istrative decision will be set aside as clearly erroneous only when the reviewing court is left with the definite and firm conviction that a mistake has been committed. . . . [T]his is not such a case.

Under Illinois law, taxation is the rule. Tax exemption is the exception. All property is subject to taxation, unless exempt by statute, in conformity with the constitutional provisions relating thereto. Statutes granting tax exemp- tions must be strictly construed in favor of taxa- tion and courts have no power to create exemp- tion from taxation by judicial construction.

The burden of establishing entitlement to a tax exemption rests upon the person seek- ing it. . . . If there is any doubt as to applica- bility of an exemption, it must be resolved in favor of requiring that tax be paid.

[Citing Methodist Old Peoples Home v. Korzen, 39 Ill 2d 149, 233 N.E.2d 537 (1968), the court lists five “distinctive characteristics of a charitable organization.” They are as follows:] (1) it has no capital, capital stock, or shareholders; (2) it earns no profits or dividends but rather derives its funds mainly from private and public charity and holds them in trust for the purposes expressed in the charter; (3) it dispenses charity to all who need it and apply for it; (4) it does not pro- vide gain or profit in a private sense to any person connected with it; and (5) it does not appear to place any obstacles in the way of those who need and would avail themselves

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n482

of the charitable benefits it dispenses. For purposes of applying these criteria, we defined charity as “a gift to be applied *** for the benefit of an indefinite number of persons, persuading them to an educational or religious conviction, for their general wel- fare—or in some way reducing the burdens of government.” . . .

Provena Hospitals plainly fails to meet the second criterion: its funds are not derived mainly from private and public charity and held in trust for the purposes expressed in the charter. They are generated, overwhelmingly, by providing medical services for a fee. While the corporation’s consolidated statement of operations for 2002 ascribes $25,282,000 of Provena Hospitals’ $739,293,000 in total rev- enue to “other revenue,” that sum represents a mere 3.4% of Provena’s income, and no showing was made as to how much, if any, of it was derived from charitable contributions. The only charitable donations documented in this case were those made to PCMC, one of Provena Hospitals’ subsidiary institutions, and they were so small, a mere $6,938, that they barely warrant mention.

Provena Hospitals likewise failed to show by clear and convincing evidence that it satisfied factors three or five. . . . While the record is filled with details regarding PCMC’s operations, PCMC is but one of numerous institutions owned and operated by Provena Hospitals. It [PCMC] does not hold title to any of the property for which an exemption is sought. The actual owner is Provena Hos- pitals. As the Director of Revenue expressly concluded, however, “the record contains no information as to Provena Hospitals’ chari- table expenditures in 2002.” The Director reasoned that without such information, it is simply “not possible to conclude that the true owner of the property is a charitable institution as required by Illinois law.” We fully agree. The appellate court was therefore correct when it concluded that this aspect

of the Department’s decision was not clearly erroneous.

As detailed earlier in this opinion, eligibil- ity for a charitable exemption under [Illinois law] requires not only charitable ownership, but charitable use. Specifically, an organiza- tion seeking an exemption . . . must establish that the subject property is “actually and exclusively used for charitable or beneficent purposes, and not leased or otherwise used with a view to profit.” . . .

In rejecting Provena Hospitals’ claim for exemption, the Department determined that the corporation also failed to satisfy this charitable use requirement. As with the issue of charitable ownership, the appellate court concluded that this aspect of the Depart- ment’s decision was not clearly erroneous. Again we agree.

[The court here quotes other cases, including the 1867 Massachusetts case mentioned early in this chapter under What Is a Charity? The opinion continues as follows.]

[W]e explained [in a 1936 decision] that “[t]he reason for exemptions in favor of chari- table institutions is the benefit conferred upon the public by them, and a consequent relief, to some extent, of the burden upon the State to care for and advance the interests of its citizens.” See also [a 1927 case stating:] “The reason for exempting certain property from public taxes arises from the fact that such property, in its use for charitable pur- poses, tends to lessen the burdens of gov- ernment and to affect the general welfare of the public.”

Conditioning charitable status on whether an activity helps relieve the burdens on gov- ernment is appropriate. After all, each tax dollar lost to a charitable exemption is one less dollar affected governmental bodies will have to meet their obligations directly. If a charitable institution wishes to avail itself of funds which would otherwise flow into a public treasury, it is only fitting that

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C h a p t e r 1 2 : Ta x a t i o n o f H e a l t h c a r e I n s t i t u t i o n s 483

the institution provide some compensatory benefit in exchange. While Illinois law has never required that there be a direct, dollar- for- dollar correlation between the value of the tax exemption and the value of the goods or services provided by the charity, it is a sine qua non of charitable status that those seeking a charitable exemption be able to demonstrate that their activities will help alleviate some financial burden incurred by the affected taxing bodies in performing their governmental functions. . . .

Even if Provena Hospitals were able to [show that it somehow reduced a burden on local government] there was ample support for the Department of Revenue’s conclusion that Provena failed to [show] that it used the parcels in the PCMC complex actually and exclusively for charitable purposes. As our review of the undisputed evidence dem- onstrated, both the number of uninsured patients receiving free or discounted care and the dollar value of the care they received were de minimus. With very limited excep- tion, 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.

To be sure, Provena Hospitals did not con- dition the receipt of care on a patient’s finan- cial circumstances. Treatment was offered to all who requested it, and no one was turned away by PCMC based on their inability to demonstrate how the costs of their care would be covered. The record showed, how- ever, that during the period in question here, Provena Hospitals did not advertise the avail- ability of charitable care at PCMC. Patients were billed as a matter of course, and unpaid bills were automatically referred to collection agencies. Hospital charges were discounted or waived only after it was determined that a patient had no insurance coverage, was not eligible for Medicare or Medicaid, lacked the

resources to pay the bill directly, and could document that he or she qualified for par- ticipation in the institution’s charitable care program. As a practical matter, there was little to distinguish the way in which Provena Hospitals dispensed its “charity” from the way in which a for-profit institution would write off bad debt.

[The opinion continues for another ten pages in which it dismisses the hospital’s arguments that not a lot of charity is needed in this university town, that it provides other community benefits, and that it is entitled to a religious exemption because “it is, itself, a ministry of the Catholic Church.” The penul- timate substantive paragraph of the opinion reads:]

[T]he record clearly established that the primary purpose for which the PCMC prop- erty was used was providing medical care to patients for a fee. Although the provision of such medical services may have provided an opportunity for various individuals affiliated with the hospital to express and to share their Catholic principles and beliefs, medi- cal care, while potentially miraculous, is not intrinsically, necessarily, or even normally religious in nature. We note, moreover, that no claim has been made that operation of a fee-based medical center is in any way essential to the practice or observance of the Catholic faith.

[The majority opinion then concludes:] For the foregoing reasons, the Department of Revenue properly denied the charitable and religious property tax exemptions requested by Provena Hospitals in this case. The judg- ment of the appellate court reversing the circuit court and upholding the Department’s decision is therefore affirmed. . . .

[The majority opinion was written by an associate justice and joined by the chief justice and another member. Two justices did not participate. Two others joined in

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n484

affirming the director’s decision that Provena failed to carry its burden of proof and that it is not entitled to a religious exemption, but they dissented from the majority’s discus- sion of charitable use. The dissenting por- tion of the second opinion reads, in part, as follows:]

[T]he plurality holds that Provena Hos- pital’s use of the property in 2002 was not a “charitable use” because the charity care provided was de minimus. . . . I disagree with this rationale. By imposing a quantum of care requirement and monetary threshold, the plurality is injecting itself into matters best left to the legislature.

The legislature did not set forth a mon- etary threshold for evaluating charitable use. We may not annex new provisions or add conditions to the language of a statute. . . .

I do not believe this court can, under the plain language of section 15-65, impose a quantum of care or monetary requirement, nor should it invent legislative intent in this regard. Setting a monetary or quan- tum standard is a complex decision which should be left to our legislature, should it so choose. The plurality has set a quantum of care requirement and monetary requirement without any guidelines. This can only cause

confusion, speculation, and uncertainty for everyone: institutions, taxing bodies, and the courts. Because the plurality imposes such a standard, without any authority to do so, I cannot agree with it.

I also disagree with the plurality’s conclu- sion that Provena Hospitals was “required to demonstrate that its use of the property helped alleviate the financial burdens faced by the county or at least one of the other entities supported by the county’s taxpay- ers.” Alleviating some burden on government is the reason underlying the tax exemption on properties, not the test for determining eligibility. Despite acknowledging this, the plurality converts this rationale into a condi- tion of charitable status. I neither agree with this, nor do I believe that Provena Hospitals failed to show it alleviated some burden on government. . . .

While “lessening the burden of govern- ment” is a component of the definition of charity, it is inextricably tied to the public policy justifying the exemption itself and is not a requirement for demonstrating entitle- ment to the exemption. The plurality here errs in requiring Provena Hospitals to specifically demonstrate some burden of government it relieved. There is no such requirement.

Discussion Questions

1. As this Provena excerpt (about one-fourth of the total) shows, the case decision is long and complicated. It reflects the public policy struggles inherent in these issues. From what you have read, which of the two opinions (majority or partial dissent) do you feel is better reasoned, and why?

2. The court relies on—and quotes with approval—cases that are many decades (even more than a century) old. Why might those old cases not be relevant today?

3. Should the idea of charity be redefined to meet today’s realities? Is it still a valid concept in the context of healthcare? If not, what would you recommend be changed?

4. Given what you know about other hospitals, to what extent do you think the Illinois court’s rationale will serve as a blueprint for other states to revoke hospitals’ tax exemptions?

5. How, if at all, can hospitals position themselves better to deal with property tax issues?

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Notes

1. 26 U.S.C. § 501(c)(3). 2. Trustees of Dartmouth College v. Woodward, 17 U.S. 518 (1819). 3. Id. The same day this decision was announced (February 2, 1819),

the Supreme Court also decided Trustees of the Philadelphia Baptist Ass’n v. Hart’s Executors, 17 U.S. (4 Wheat.) 1 (1819). The definition of charity was not at issue in that case, but its juxtaposition with Dartmouth College is interesting, to some at least.

4. Ruth K. MccluRe, coRaM’s childRen: the london Foundling hospital in the eighteenth centuRy 205 (Yale University Press, 1981).

5. Duhaime’s Law Dictionary, Charity Definition, www.duhaime.org/ LegalDictionary/C/Charity.aspx (accessed March 8, 2019).

6. 236 Ill.2d 368, 925 N.E.2d 1131 (2010). 7. 925 N.E.2d at 1147. 8. City of Philadelphia v. Masonic Home of Pennsylvania, 160 Pa. 572,

28 A. 954 (1894). 9. West Allegheny Hospital v. Board of Property Assessment, Appeals and

Review, 500 Pa. 236, 455 A.2d 1170 (1982). 10. See Kansas Masonic Home v. Board of Commissioners, 81 Kan. 859, 106

P. 1082 (1910); accord Fitterer v. Crawford, 157 Mo. 51, 57 S.W. 532 (1900). In Fitterer, a home was denied tax exemption for other reasons.

11. Doctors Hospital v. Sexton, 267 A.D. 736, 48 N.Y.S.2d 201, 205 (1944), aff’d, 295 N.Y. 553, 64 N.E.2d 273 (1945). See also Bishop and Chapter of the Cathedral of St. John the Evangelist v. Treasurer of the City and County of Denver, 37 Colo. 378, 86 P. 1021 (1906) (a hospital may charge fees to all patients, and the amount received may exceed expenses).

12. 26 C.F.R. § 1.501(c)(3)-1(d)(2). 13. See, e.g., Sonora Community Hosp. v. Commissioner, 397 F.2d 814

(9th Cir. 1968). 14. Rev. Rul. 383, 1969 C.B. 113. 15. 26 U.S.C. § 4958. 16. 26 U.S.C. § 501(r). 17. 26 U.S.C. § 501(r)(3)(B). 18. 26 C.F.R. § 1.512(a)-1(f). See United States v. Am. College of

Physicians, 106 S. Ct. 1591 (1986) (income received by a medical organization from commercial advertisements in a professional journal is taxable as unrelated business income).

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T h e L a w o f H e a l t h c a r e A d m i n i s t r a t i o n486

19. For example, Ohio Rev. Code Ann. § 5709.08 (page 1985) provides that “real or personal property belonging to the state or United States used exclusively for a public purpose, and public property used exclusively for a public purpose, shall be exempt from taxation.” See Carney v. Cleveland, 173 Ohio St. 56, 108 N.E.2d 14 (1962).

20. City of Springfield v. Commissioner of Revenue, 380 N.W.2d 802 (Minn. 1986).

21. 709 P.2d 265 (Utah 1985). 22. 709 P.2d at 302, quoting from utah code ann. § 59-2031. 23. Id. at 268. 24. Hyde v. United States, 225 U.S. 347, 391 (1911) (Holmes, J.,

dissenting). 25. 181 Neb. 831, 151 N.W.2d 446 (1967). 26. 120 Ga. App. 627, 629, 171 S.E.2d 747, 749 (1969). 27. Id. at 750. 28. Harvard Community Health Plan, Inc. v. Board of Assessors, 384

Mass. 536, 427 N.E.2d 1159 (1981). 29. 553 P.2d 467 (Alaska 1976). 30. Aultman Hosp. Ass’n v. Evatt, 140 Ohio St. 114, 42 N.E.2d 646

(1942) (residence for nurses was exempt); Sisters of Saint Mary v. City of Madison, 89 Wis. 2d 372, 278 N.W.2d 814 (1979) (rent- free residence provided for full-time hospital chaplain was exempt); Oakwood Hosp. Corp. v. Michigan State Tax Comm’n, 374 Mich. 524, 132 N.W.2d 634 (1965) (housing for interns and residents was exempt).

31. See, e.g., Milton Hosp. v. Board of Tax Assessors, 360 Mass. 63, 271 N.E.2d 745 (1971); Medical Center of Vt., Inc. v. City of Burlington, 131 Vt. 196, 303 A.2d 468 (1973) (case was remanded to determine facts of whether physician’s use of offices at noncommercial rental was primarily for hospital or private purposes); White Cross Hosp. Ass’n v. Warren, 6 Ohio St. 2d 29, 215 N.E.2d 374 (1966) (offices leased to physicians were not exempt); Doctors Hosp. v. Board of Tax Appeals, 173 Ohio St. 283, 181 N.E.2d 702 (1962) (housing for married staff paid a stipend by the hospital was not exempt); City of Long Branch v. Monmouth Medical Center, 138 N.J. Super. 524, 351 A.2d 756 (1976), aff’d, 73 N.J. 179, 373 A.2d 651 (1977) (housing for resident interns and nurses was exempt; space rented to private physicians at less than commercial rates is taxable).

32. Genesee Hosp. v. Wagner, 76 Misc. 2d 281, 350 N.Y.S.2d 582 (N.Y. Sup. Ct. 1973), rev’d, 47 A.D.2d 37, 364 N.Y.S.2d 934 (1975), aff’d mem., 39 N.Y.2d 863, 352 N.E.2d 133, 386 N.Y.S.2d 216 (1976).

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33. N.Y. Real Property Tax Law § 420-a(1)(a) (McKinney 1984). 34. N.Y. Real Property Tax Law § 420-a(2). 35. 76 Misc. 2d at 285–89, 350 N.Y.S.2d at 586–90. 36. Genesee Hosp. v. Wagner, 47 A.D.2d 37, 364 N.Y.S.2d 934 (1975). 37. Sisters of Charity v. Bernalillo County, 93 N.M. 42, 596 P.2d 255

(1979) (pro rata taxation is allowed when office building and parking structure are used for both charitable and noncharitable purposes).

38. See, e.g., Oak Ridge Hosp. v. City of Oak Ridge, 57 Tenn. Ap. 487, 420 S.W.2d 583 (1967); Cleveland Memorial Medical Found. v. Perk, 10 Ohio St. 2d 72, 225 N.E.2d 233 (1967); Hillman v. Flagstaff Community Hosp., 123 Ariz. 124, 598 P.2d 102 (Ariz. 1979).

39. See, e.g., Good Samaritan Hosp. Ass’n v. Glander, 155 Ohio St. 507, 99 N.E.2d 473 (1951); Cleveland Memorial Medical Found. v. Perk, 10 Ohio St. 2d 72, 255 N.E.2d 233 (1967).

40. Sisters of Providence in Washington, Inc. v. Municipality of Anchorage, 672 P.2d 446 (Alaska 1983).

41. Christ Church Hospital v. County of Philadelphia, 65 U.S. (24 How.) 300, 302 (1860).

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