Area Nonprofit Organizations Should Prepare for Challenges to Tax-Exempt Status

Posted on March 07, 2012

The tough economic climate and the decline of taxable real estate has encouraged local government officials to review the tax-exempt status of area nonprofit organizations. As the Erie Times-News (Palattella 03/04/12) reported, in response to the new countywide reassessment figures, Erie County Executive Barry Grossman will study area nonprofit organizations and “decide whether to challenge the exemptions of some nonprofits or ask others for contributions to county government in lieu of taxes.” The issue is one that is pervasive among local governments across the United States.

In 2010, the Supreme Court of Illinois attracted the attention of the health care industry when it upheld a lower court’s decision to remove a Catholic hospital’s property tax exemption. In August of 2011, the Chicago Tribune (Bergen 08/17/11) reported that the Illinois Department of Revenue denied property tax exemption to three more Illinois hospitals (Northwestern Memorial’s Prentice Women’s Hospital in Chicago, Edward Hospital in Naperville, and Decatur Memorial Hospital in Decatur) due to each hospital’s low percentages of charity care as a percent of their overall net revenues.

Aware that the Illinois Department of Revenue was in the process of reviewing exemption requests for fifteen additional hospitals, Governor Pat Quinn of Illinois granted a moratorium on hospital real estate tax exemption rulings and provided the IL Department of Revenue, the Illinois Hospital Association, and other interested parties until March 1, 2012 to reach a legislative compromise.

As the eleventh hour approached, it became apparent that hospital and state officials would fail to produce a legislative test to assess whether a hospital qualifies for real estate tax exemption. With no agreement reached, on March 1, 2012, Governor Quinn lifted the moratorium on his State’s review of the tax exemptions of nonprofit hospitals. Illinois nonprofit hospitals, fearing that they may owe millions of dollars in unpaid property taxes, now anxiously await the findings of the IL Department of Revenue.

While not novel, deates about how to quantify a nonprofit organization’s deservedness of tax-exempt status are increasingly common as governments strain to find ways to pay for public services. Many states and the federal government have proposed new legislation on such topics. For example, Section 9007 of the Patient Protection and Affordable Care Act (PPACA) imposes additional regulations on charitable hospitals attempting to qualify for Section 501(c)(3) tax-exempt status by adding a new Section 501(r) to the Internal Revenue Code. Section 501(r) creates four new requirements for tax-exempt hospitals including: (1) a community health needs assessment, (2) written financial assistance and emergency care policies, (3) limitations on certain charges, and (4) requirements relating to billing and collection actions.

Critics of the current systems advocate for a bright line test for exemption and argue that, in exchange for tax exemption, nonprofit organizations should be required to contribute a certain percentage of their gross revenues to “charitable services.” Unlike the religious almshouses of old, however, today’s nonprofit, tax-exempt organizations are complex entities and such “charitable services” are more difficult to measure (as evidenced by the failed negotiations in Illinois).

Finally, even if a nonprofit organization meets the requirements for federal, state, and local tax exemptions, governments may still pressure the nonprofit organization to make financial contributions through voluntary arrangements. In Boston, Massachusetts, for example, a significant portion of downtown real estate is owned by nonprofit hospitals and cultural and educational institutions. Therefore, for years, these institutions have agreed to “payments in lieu of taxes” (also known as PILOT agreements) to diversify the city’s revenue stream and reduce the burden on residential and commercial taxpayers.

With the upcoming countywide reassessment, nonprofit organizations in Erie County should prepare for a possible inquiry or challenge concerning their tax-exempt status, and should take the time to review their organization’s activities which may fit the concept of “charitable services.” Leaders of nonprofit organizations should also familiarize themselves with the nuances of PILOT agreements and whether such an arrangement may be workable if their real estate tax exemption is questioned by governmental officials.

For additional information on new trends in tax exemption for nonprofit organizations or other concerns regarding nonprofit and healthcare entities, contact us at (814) 459-2800.

Joy E. Sadaly is an Associate at Knox McLaughlin Gornall & Sennett, P.C.’s Erie office.

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