New Jersey hospital’s loss of tax exemption sends a warning

Many not-for-profit hospitals across the country could lose their tax exemption if the same analysis of for-profit activities is applied to them as a New Jersey Tax Court judge recently used in revoking a Morristown hospital’s property-tax exemption, experts say.

Tax Court Judge Vito Bianco decided last month that because Morristown Medical Center operates in many ways like a for-profit business, it should not be exempt from property taxes. The hospital and its parent, Atlantic Health System, brought the lawsuit against the city of Morristown after the municipality had denied the hospital’s claims for property-tax exemptions for several years.

The ruling comes at a time when the tax-exempt status of not-for-profit hospitals faces increased scrutiny amid concerns that some are acting more like for-profit entities, especially when it comes to limited community benefit activities and aggressive debt collection. Though the judge’s ruling affected only the Morristown hospital, experts say it could have implications for hospitals elsewhere.

“The facts they have here are not unique at all to Morristown,” said Michael Meissner, a tax partner at Squire Patton Boggs. “If this standard were applied across the board or across the country, you would have a lot of hospitals that would have some serious concerns.”

The judge in the Morristown case suggested as much. “If it is true that all nonprofit hospitals operate like the Hospital in this case, as was the testimony here, then for purposes of the property-tax exemption, modern nonprofit hospitals are essentially legal fictions,” Bianco wrote.

The judge noted that the hospital has relationships with for-profit subsidiaries and owns a number of forprofit physician practices. The court was “unable to discern between nonprofit activities carried out by the Hospital on the Subject Property, and the for-profit activities carried out by private physicians,” he wrote. “By entan- gling and co-mingling its activities with for-profit entities, the Hospital allowed its property to be used for forbidden for-profit activities.”

In addition, the hospital paid its executives unreasonably high salaries, including $5 million to its CEO in 2005, the judge said.

In a joint statement, Atlantic Health and the municipality of Morristown said the judge last week granted a request by the parties for more time to settle the matter.

Hospitals in Illinois, Ohio and Pennsylvania also have faced tax challenges.

Jim Flynn, who heads the healthcare practice group at Bricker & Eckler, said more challenges to hospitals’ property tax-exempt status are likely as state and local governments hunt for increased property revenue to ease budget crunches. “It’s not the first one of these, and it’s not going to be the last,” he said. “This decision is obviously a bad sign for the way that trend is flowing.”

Many of the practices cited by the judge, such as transactions between Morristown Medical Center and forprofit physicians, are relatively com- mon to not-for-profit hospitals, he said.

The hospital’s executive compensation also is not particularly unique, Meissner said. “Certainly, they are not the only hospital system in the country where the CEO is making multiple millions of dollars to run the hospital system,” he said.

Not-for-profit hospitals in the U.S. received a collective $24.6 billion tax break in 2011, about twice as much as a decade earlier, according to a recent study in Health Affairs. That includes federal and state taxes and the ability to raise money through tax-exempt donations and municipal bonds.

It can be difficult for hospitals to meet the goals of the reformed U.S. healthcare system, including improving care while lowering costs, without entering into many of the types of business arrangements criticized by the judge in the Morristown case, said Don Stuart, a partner at Waller Lansden Dortch & Davis who also leads the American Health Lawyers Association’s tax and finance practice group. “Hospitals are being pushed out there to become creative and collaborate and do more with what they have,” Stuart said.

The Morristown case was somewhat unusual, Stuart said, in that the court focused on the hospital’s operations and structure rather than the benefit it provides to the community. The case may prompt hospitals to work with state lawmakers to more clearly define what they must do to preserve their tax exemption, Stuart added.

For example, Illinois passed a law that requires not-for-profit hospitals to provide certain services whose value is equal to the amount of tax savings they receive from their property tax exemption. Stuart said New Jersey hospitals may push for similar clarity.

Bianco said in his opinion the issue of how to handle hospitals’ tax exemptions is more appropriate for the Legislature than the courts. “If the propertytax exemption for modern nonprofit hospitals is to exist at all in New Jersey going forward, then it is a function of the Legislature and not the courts to promulgate what the terms and conditions will be,” he wrote.

“The facts they have here are not unique at all to Morristown. If this standard were applied across the board or across the country, you would have a lot of hospitals that would have some serious concerns.”

Michael Meissner Tax partner Squire Patton Boggs