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A tale of one state: Hospital tax status in Pennsylvania
While the 39 federal class action lawsuits filed this year are based primarily on nonprofit hospital billing and collection practices, especially as applied to the uninsured and underinsured, there also are questions raised about the tax-exempt status of nonprofit hospitals. Those questions have been litigated in local and state courts in recent years.
One state that was a hotbed for such litigation a few years ago but now is relatively quiet is Pennsylvania. The reason tensions have eased there is a 1997 law that redefined what it is necessary for an organization to be an "institution of purely public charity," the type of organization the state constitution says is necessary for tax exemption.
Philadelphia attorney Philip Korb, in a paper written for The Pennsylvania Bar Association, contended that for many years, Pennsylvania nonprofit institutions met relatively little resistance in applications for exemption from real estate and sales taxes. But by the 1980s, many once small nonprofits had become major institutions with great economic power at the same time that taxing authorities had become financially pressed, often facing greater responsibilities but shrinking tax bases.
Taxing authorities began to challenge historical tax exemptions more often, and in 1987, the Pennsylvania Supreme Court decided the landmark HUP (Hospital Utilization Project) case that established five specific tests for qualification for tax exemption based on the state constitution’s limiting of exemptions to institutions of purely public charity.
The number of challenges grew exponentially following that decision, and at one point, there was a cottage industry of consultants offering to teach local governments how to challenge the tax status of major nonprofits, especially hospitals and other health care institutions.
Because county and state courts often reached differing results in applying the tests from the HUP decision, there were calls for legislation to provide a consistency in standards for exemption and encouragement for nonprofits to make payments to local governments in lieu of taxes.
Act 55’s five prongs
Pennsylvania Act 55 of 1997, the Institutions of Purely Public Charities Act, follows the five-prong HUP test set forth by the Supreme Court in 1987, but attempts to precisely quantify the standards for meeting each of the prongs. The law says institutions must do the following:
1. advance a charitable purpose;
2. donate or render gratuitously a substantial portion of its services;
3. benefit a substantial and indefinite class of people who are legitimate subjects of charity;
4. relieve the government of some burden;
5. operate entirely free from private profit motive.
One of the reasons for challenges to tax-exempt status of nonprofits, especially hospitals, was that some of them were operating businesses that seemed far removed from their charitable purpose. For instance, questions were raised about an Erie health system that owned and operated a Lake Erie marina, and about hospitals that used their laundry facilities to compete with private laundries.
Act 55 legislated a counterweight to the protection given charities by prohibiting them from competing with small businesses. Under the law, a charity may not fund or subsidize a commercial business that is unrelated to its charitable purpose. During the debate over Act 55, Pennsylvania’s Catholic bishops issued a white paper making a strong care for tax exemption as the "key to charitable service."
After reciting the wide-ranging services provided by Catholic Charities agencies, the bishops noted the many activities of other nonprofit tax-exempt organizations that, among other endeavors, furnish human services, help the physically and mentally challenged, and treat drug and alcohol abuse. "All of these organizations, whether under Catholic or other auspices, differ in many ways, but share one common thread: Through charity, they improve the lives of Pennsylvanians — in many cases the most needy and impoverished — in urban and rural communities where they are located," the bishops said.
"They enhance the spiritual and material well-being, the health, and the educational and cultural life of all the commonwealth’s citizens. . . . Loss of tax-exempt status may well force charitable organizations to cut back their services or close their doors.
"One of the great ironies of the current situation is that many charitable organization serving those in need are located in educationally distressed areas. These organizations shouldering the greatest burden by serving the poor are also being attacked most severely by their local municipalities.
"If the charities were forced to curtail services or go out of existence altogether, government would have to assume the crushing burden of providing these services, at an even greater cost. These additional and substantial costs would have to be passed on to the taxpayer, increasing the tax burden, which already is perceived as unduly heavy," they wrote
Law still in force
Since the law’s passage in 1997, it has weathered several challenges to its constitutionality and has greatly reduced the number of local government challenges. Because it doesn’t address the issues of billing and collections, however, it remains to be seen whether it will be useful to hospitals that are named in the latest federal lawsuits.
Jim Redmond, senior vice president of The Hospital and Healthsystem Association of Pennsylvania, who was one of the key figures in the negotiations that led to passage of Act 55, tells State Health Watch that he expects hospitals named in the federal suits will cite their compliance with the law as a defense in terms of how much charity care they provide. But he says the law’s silence on the question of the amount hospitals should be charging the uninsured could be a problem.
"The new suits are dealing with slightly different issues," Mr. Redmond adds.