Tax invasion
Hospitals increasingly have to defend exempt status
By Joe Carlson, Modern Healthcare, May 3, 2010
If any CEO at a not-for-profit provider hasn't gotten the message yet, consider this a wake-up call: The days when hospitals could take their tax exemptions for granted are over.
Legislators and government bureaucrats have long hungered for the revenue that hospitals and health systems could deliver if placed on the tax rolls, and executives at healthcare providers have gotten used to periodically beating back those efforts behind closed doors and in the public arena.
But observers say revenue-collection efforts in a spate of localities across the country are evidence that this long-simmering struggle has become a pitched battle in the wake of the Great Recession, as cash-starved governments try to tap hospital finances in order to balance their own books.
The newfound thirst for revenue by local governments comes just as hospitals, as an industry, agreed to cede $155 billion in Medicare payments over 10 years to the cause of reform. And virtually no one expects federal lawmakers to ease up on the pressure to define their tax-exempt status in terms of hospitals' charity care, even though the number of uninsured people eligible to receive charity care is expected to drop precipitously.
And by the way: Starting this year, new tax forms are giving the public far deeper insight into exactly how much not-for-profit hospital CEOs take home each year for running large, complex businesses that don't pay taxes.
“Clearly hospitals in particular are having to justify their tax exemptions far more than ever before, because of what's going on at the state and federal level,” said Nicholas Mirkay, an associate professor of law at Widener University in Wilmington, Del.
Boston officials want to jack up voluntary payments from hospitals, Rhode Island lawmakers have floated the idea of a sales tax on hospitals and Baltimore leaders are considering a per-bed tax on hospitals. From Cleveland to Palo Alto, Calif., to Oneonta, N.Y., city governments are publicly talking about how much hospitals could help city coffers. The city of Minneapolis, for example, has even proposed a streetlight tax to help the city recoup the cost of light bulbs.
The situation has become serious enough that lawyers are advising hospitals not to ignore requests for voluntary payments from governments until all the impacts and circumstances of the individual situations are considered.
On one hand, these payments in lieu of taxes—commonly called PILOTs—may seem tough to swallow given slim hospital margins and the services that communities receive from their local hospitals.
However, fighting in court or at the statehouse to prevent the imposition of a new tax or PILOT program may also prove damaging, because defeat would mean that hospitals lose the chance to negotiate lower voluntary payments and keep them out of official tax code.
Consider the recent experiences in Rhode Island and Illinois.
In a victory for hospitals in Rhode Island, advocates for tax-exempt organizations protested and eventually defeated a long-running legislative proposal that would have imposed a sales tax on not-for-profit hospitals, which would have apparently been a first-of-its-kind in the country.
But in a nationally watched case in Illinois, officials with 202-bed ProvenaCovenantMedicalCenter in Urbana became liable for a full property tax bill when the Catholic-sponsored hospital's exemption was revoked after a four-year legal battle with the state revenue department over whether the hospital was providing adequate charity care (March 22, p. 12).
Illinois is not one of the dozen or so states that require hospitals to provide and document a specific level of charity care in order to qualify for exemption from state and local taxes. Many of those states took action in the 1990s, after the collapse of efforts at the federal level to impose charity-care requirements, which at the time were incorporated in President Bill Clinton's formulation of healthcare reform.
These days Iowa Republican Sen. Chuck Grassley, ranking member of the Finance Committee, rarely skips an opportunity to tout the finding in a 2005 General Accounting Office report that said not-for-profit hospitals on average devoted “only slightly more” of their operating expenses to charity care than their tax-paying, investor-owned competitors.
The Joint Committee on Taxation estimated that in 2002, the most recent year for which a national study is available, the nation's 2,900 nonfederal acute-care not-for-profit hospitals received benefits totaling $12.6 billion, including all types of tax exemptions and the benefits of municipal borrowing. Those benefits included $3.1 billion in local property tax exemptions, and $3.2 billion in state sales and corporate income tax exemptions, the federal commission reported.
“Legislators who may or may not be versed in why tax-exempt status exists are looking for money. Our impression is they're not targeting us because they don't like us. They're doing it because they see a pot of money that could be tapped,” said David Thompson, vice president of public policy at the National Council of Nonprofits in Washington.
That's why lawyers are urging hospital officials to do everything they can to document, in as specific of terms as possible, exactly how they benefit their communities. Those statistics can go a long way toward arguing that tax-exempt hospitals, like other charitable organizations, are giving out services that local governments would otherwise have to provide if citizens weren't getting them from healthcare providers.
This means documenting things such as the actual cost of charity care; community-benefit programs such as domestic violence outreach and mental health counseling in schools; the amount of care given under sliding-scale financial assistance pricing; volunteer hours given through the hospital; and anything that shows the hospital is providing benefits to the community beyond its core missions and its payroll.
Those are the tools that hospitals will need to argue their case when government officials come knocking. “All those things that we just assumed that we would get without a fight, we have to be prepared to fight for them and document why we're entitled to them,” said John Durso, a healthcare lawyer who is a partner with Ungaretti & Harris in Chicago.
Many of those things also happen to be required under the new Patient Protection and Affordable Care Act, which specifies that all hospitals qualifying for tax-exempt status must complete regular community-needs assessments showing that their programs meet actual needs documented in the surrounding communities. The reform act also says hospitals must post their financial-assistance policies, and that not-for-profit hospitals can charge uninsured patients no more than the lowest contracted rate for any given service.
But a local tax assessor or mayor isn't likely to walk in the door focused on all the things a hospital may be providing to a community in exchange for tax-exemption, experts say. Rather, the government officials will see that the hospital readily uses city resources, such as roads, fire departments, police and water service, at a time when revenue from other sources are declining.
“I would expect that we are seeing more and more pressure” for hospitals to offer payments to government in some form, said T.J. Sullivan, a partner in the healthcare practice at Drinker Biddle & Reath. “But at the same time, if it becomes too burdensome they are going to have to convince the legislators or the local taxing authorities that they are already doing enough to justify their tax exemptions.”
Experts differ on the best way for hospitals to respond when a local government comes calling. In Pennsylvania, where state law encourages PILOT payments, the Hospital & Healthsystem Association of Pennsylvania does not discourage such dealmaking, although it's always a local decision, said Jim Redmond, senior vice president of legislative services for the association.
Redmond said more than a third of the association's members have PILOT agreements with their local municipalities. Typically, hospitals agree to pay between 25% and 45% of what the taxes would be if they weren't exempt, but Redmond said more systems are moving toward structured agreements based on the value of services rendered.
In Boston, the local hospitals have had PILOTs since the 1980s, because more than half of the city's land is tax-exempt and yet the city has no sales tax or payroll tax.
“We recognize that the city needs help, and when hospitals feel that they can contribute, they will help, because they want to have good police and school systems” and other city services, said John Erwin, executive director of the Conference of Boston Teaching Hospitals.
Boston Mayor Thomas Menino has convened a task force for more than a year to study ways to equitably increase the amounts paid to the city through PILOT agreements with not-for-profits, eventually settling on a proposed formula under which tax-exempt organizations will be asked to make annual payments of up to 25% of the tax bill they would face based on their assessed values.
Erwin noted that hospitals successfully fought for a partial reprieve in the formula by getting the city to agree that their community benefit programs could be counted as cash equivalents for up to half of what they would owe under the program.
Thomas Glynn—who is chief operating officer for Partners HealthCare System, which has four hospitals in Boston—said one big advantage of the deliberation process with the mayor's office was that it brought a new level of understanding to the system through the public release of statistics on the PILOT payers.
“It's a voluntary program,” Glynn said. “I think (the mayor) felt that having people feel that this is fair and transparent was important.”
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