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By Lisa Bittle Tancredi
Lisa Bittle Tancredi is a bankruptcy and creditors’ rights partner practicing in Gebhardt & Smith LLP’s Baltimore and Wilmington, Delaware offices. During her more than twenty years of private practice, Lisa has represented lenders to healthcare institutions, debtors such as hospitals and nursing homes, and nearly every other type of constituency that may be involved in a financially-stressed commercial relationship.
By Lisa Bittle Tancredi
Since January 1, 2015, taxing authorities in at least sixteen states have disputed the tax exempt status of a variety of healthcare institutions, from dialysis clinics to assisted living facilities, on the grounds that they are not truly charitable organizations.
In many cases, taxing authorities have successfully reduced or eliminated the property tax exemptions that were previously enjoyed by the non-profits. The campaign to reduce or eliminate property tax exemptions is not limited to healthcare; educational institutions and other non-profits have been impacted as well. Importantly, non-profits cannot rely on their 501(c)(3) status to protect themselves from a finding that they are not charities for property tax purposes. Matter of Greater Jamaica Dev. Corp. v. N.Y.C. Tax Commn. , 2015 BL 210300, 25 N.Y.3d 614, 627 (2015).
Such a change of tax status can deal a devastating blow to a non-profit, as elimination or reduction of exemptions can result in significant tax liability. While some non-profits may have healthy margins, many non-profits barely meet their expenses. This additional tax liability may well strain their budgets beyond the breaking point, resulting in loan defaults, insolvencies and bankruptcies.
Not only may additional tax liability force some non-profits into bankruptcy, but the reasoning of these tax decisions may carry over and have significance in their subsequent bankruptcy cases, as well as in the bankruptcy cases of other non-profits. The Bankruptcy Code contains several provisions applicable only to bankrupt non-profits. These special provisions can have a major effect on the bankruptcy proceedings of a debtor. For example, creditors cannot force a non-profit into bankruptcy by filing an involuntary bankruptcy petition against it. 11 U.S.C. § 303(a). A non-profit’s chapter 11 case may be converted to a liquidation case under chapter 7 only if the non-profit requests conversion. 11 U.S.C. § 1112(c). The sale of a non-profit’s assets is subject to non-bankruptcy law, which in some states may mean that the assets must be sold to another non-profit organization with a similar purpose. See 11 U.S.C. § 363(d)(1). Non-profit status may affect the resolution of tort claims against the bankruptcy estate in states where immunity statutes cap or eliminate such claims. Thus, depending on which side of the courtroom one is on, there can be both significant advantages and disadvantages to the application of these special bankruptcy provisions.
The Bankruptcy Code does not use the terms “for-profit” or “non-profit.” Instead, the Bankruptcy Code uses the terms “moneyed” and “not” moneyed to refer to for-profit and non-profit debtors. And, “moneyed” is not defined in the Bankruptcy Code, leaving it up to the courts to determine whether debtors are “moneyed” or not. Debtors that are chartered as non-profits can be “moneyed” in bankruptcy court. As is the case in the property tax context, 501(c)(3) status is not determinative, making the recent tax cases a rich source of arguments and authority for bankruptcy purposes. See In re Caucus Distributors, Inc., 106 B.R. 890, 910 (Bankr. E.D. Va. 1989) (basing analysis on 501(c)(3) status only in part).
Many of the nation’s largest healthcare systems are structured as non-profits, notwithstanding that they may enjoy substantial revenues in excess of expenses. Non-profit healthcare systems also rely heavily on infrastructure (roads, utilities, and the like) that is funded by taxpayer dollars. Taxing authorities of cash- strapped municipalities and counties have targeted the tax exempt status of non-profit healthcare institutions, arguing that they no longer function or operate as charities but rather as profit-generating enterprises.
In order to best understand the analysis being applied by the taxing authorities, it is necessary to delve into history. The history of charitable healthcare was extensively reviewed by the Tax Court of New Jersey in the case of AHS Hosp. Corp. v. Town of Morristown, 2015 BL 206190, 28 N.J. Tax. 456 (2015). As observed by AHS, hospitals were originally established in this country in the eighteenth and nineteenth centuries as charities for the injured and diseased poor. Hospitals were staffed by unpaid volunteers and funded by donations from the wealthy and, at times, with government funds. Hospitals were not the preferred sources of health care and were stigmatized, perhaps with good reason. Surgical mortality rates were higher within the hospital walls than without. Those who could afford to do so were treated in their homes or in their physician’s private office. In the late nineteenth and early twentieth centuries, an understanding of the benefits of hygiene and sanitation was developed and hospital practices improved. Hospitals became models of sanitation and treatment, and private pay patients became more common. However, hospitals still operated as charities whose capital expenditures were funded primarily by private donations. In 1913, federal income tax law took effect that afforded exemptions from income tax to hospitals that were non-profit. At that time, hospitals were still closely associated with charities and religion, and it naturally followed that they were classified as charitable institutions.
Fast forward to the present, where most modern non-profit healthcare systems bear little to no resemblance to their charitable forbears. Indeed, the business operations of today’s non-profit hospitals and their for-profit peers can look very much the same. So, how have courts tackled the applicability of charitable tax exemptions to these modern enterprises?
Morristown Memorial Hospital, the subject of the AHS case, is a good example of the analyses being undertaken. The Tax Court examined the hospital’s patient population, finances, relationships with for-profit physicians, affiliated for-profit entities, executive salaries, employed physicians’ contracts and third party agreements. The analysis was fact-intensive and extended to the gift shop, day care facilities, fitness center and cafeteria. At Morristown Memorial Hospital, unpaid charity care accounted for approximately 8% of the hospital’s patients. Approximately 83% of admitted patients were admitted by for-profit, self-employed physicians with privileges at the hospital, and for-profit physicians practiced throughout the premises. There was no way to delineate, physically, where non-profit and for-profit activity occurred, with the limited exceptions of the visitor’s parking area, the auditorium and the fitness center. The Tax Court found that the hospital failed to prove the reasonableness of the compensation paid to its executives and that the standard applicable to the reasonableness of compensation by the IRS for federal income tax purposes was not the standard for purposes of local property tax exemptions. Contracts featuring profit-sharing arrangements or incentives based on cost-savings were determined to be for profit-making purposes. Concluding that “for purposes of the property tax exemption, modern non-profit hospitals are essentially legal fictions,” the Tax Court denied the hospital’s property tax exemption, with the exception of the hospital’s auditorium, fitness center and visitor’s parking garage. AHS, 28 N.J.Tax. at 536 (emphasis in original).
The recent tax decisions concerning charitable status have varied results, and there are cases that can support both sides of the argument. For example, in West Virginia a non-profit lessor could not claim a charitable exemption when its for-profit lessee used the property for profit-generating purposes – even though the lease proceeds were used by the non-profit lessor for charitable purposes. Matkovich v. Univ. Healthcare Found., 2016 BL 338497, 795 S.E.2d 67, 74-75 (W.Va. 2016). On the other hand, non-profit lessor in Ohio that enjoyed revenue from a lease was still permitted to claim a charitable exemption, as the lessor provided services to the community without charge. Rural Health Collaborative of S. Ohio v. Testa, 2016 BL 42272, 145 Ohio St. 3d 430, 438 (2016).
While the cases are not consistent, healthcare and residential facilities seem to be particularly vulnerable to challenges by taxing authorities. Shortly after AHS was decided, a group home for the mentally disabled in Pennsylvania was denied a charitable exemption because it was funded mostly by the residents’ social security payments, and the home failed to show that the home donated a substantial portion of its services for no cost. ARC Human Servs., Inc. v. Clearfield Cty. Assessment Office and Tax Bureau, 2015 BL 222429, 120 A.3d 465, 472 (Pa. Commw. Ct. 2015). A New York independent living facility was found not to be charitable because it did not rent its living facilities to indigent senior citizens. Gerry Homes v. Town of Elliott, 2016 BL 430125, 145 A.D.3d 1652, 1654 (N.Y. App. Div. 2016). In Wyoming, an unsubsidized independent living facility that offered services only to its residents was deemed not a charity. Mountain Vista Ret. Residence v. Freemont Cty. Assessor, 2015 BL 283940, 356 P.3d 269, 274-76 (Wyo. 2015).
The pressure to tax non-profit healthcare institutions shows no signs of abating. In Illinois, The Carle Foundation Hospital has locked horns with township, county, city and state taxing authorities over its charitable tax exemptions. The Carle Found., et al. v. Cunningham Twp., et al., ___ N.E.3d___, 2017 BL 91412 (Mar. 23, 2017). Another hospital in Illinois is in the throes of administrative proceedings with a school district and the State of Illinois over its property tax exemptions. See NorthShore Univ. Healthsystem v. Illinois Dep’t of Revenue, et al., ____ N.E.3d ____, 2017 BL 99909 (Mar. 28, 2017). Given the dollars involved and the critical nature of healthcare, legislative activity on the issue of the proper taxation of non-profits is also inevitable.
The healthcare industry faces financial pressure on a number of fronts; the taxation of non-profits being just one of many. The same reasoning being applied to determine of what is, and what is not, a charity for tax purposes can be applied to determine whether or not a debtor is “moneyed” for purposes of the Bankruptcy Code. As non-profits head towards the bankruptcy arena, this wave of property tax cases may impact and shape bankruptcy cases in new and heretofore unexpected ways.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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