Talking about property tax exemptions for nonprofits is problematic once the discussion goes beyond state borders. Property taxation is idiosyncratic, with each state having its own quirky set of rules. Despite that problem, the final decision handed down by the Illinois Department of Revenue in Department of Revenue of the State of Illinois v. Provena Covenant Medical Center last week has important implications for nonprofits throughout the country. The Department of Revenue ruled that Provena was...
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not entitled to a property tax exemption for its facility because it did not provide sufficient amounts of charity care.
There are a number of problems with the Provena decision. First, the exemption in question is rooted in the Illinois Constitution of 1970, which limits the legislature’s authority to create property tax exemptions for charitable organizations to property that is “exclusively” used for charitable purposes. Guess what? Exclusively has been interpreted to mean something less than exclusive. That interpretation can only lead to perplexing interpretative problems.
In interpreting the terms “exclusive” and “charitable purpose,” the Illinois courts have developed a five-part test. This test poses significant opportunities for abuse because it is rooted in ever shifting court opinions rather than clearly articulated legislative standards.
There are two political realities coloring the application of the law. First, the State of Illinois tax system provides insufficient revenue to run state and local governments--this has been referred to as a structural deficit. The top individual income tax rate in Illinois is 3%. Although sales tax rates are relatively high, property taxes are not as high as many Illinoisans would like to believe. As consequence, state officials are looking for sources of revenue. Further restricting property tax exemptions is one way to increase revenue.
Second, like many Americans, many Illinoisans are dissatisfied with health care financing and the number of uninsured individuals. They see the property tax exemption as a bargaining chip, telling hospitals that unless they provide more charity care, they will lose their property tax exemptions. The problem with this approach is threefold. First, and most important, it places way too much emphasis on charity care. As confusing as court-made law may be, the standard for exemption focuses on charitable activity rather than charity care. Second, if these dissatisfied Illinoisans succeed, they are like to reduce available charity care in Illinois by driving many nonprofit hospitals out of business. Third, the law should be based on clear standards arrived at through a legislative process rather than the opinions of administrators.
Against that background, let’s consider the Department of Revenue’s opinion point by point. This is not easy to do because the Department of Revenue's opinion is poorly constructed and organized, and reflects a clear bias.
Five-Part Test. The Illinois courts use the following facts or tests to determine whether a property tax exemption is available: (1) the benefits derived are for an indefinite number of people, persuading them to an educational or religious conviction, for their general welfare or in some way reducing the burdens of government; (2) the organization has no capital, capital stock or shareholders, earns no profits or dividends, but rather derives its funds mainly from public and private charity and holds them in trust for the objects and purposes expressed in its charter; (3) the organization dispenses charity to all who need and apply for it; (4) it does not provide gain or profit in a private sense to any person connected with it; and (5) it does not appear to place obstacles of any character in the way of those who need and would avail themselves of the charitable benefits it dispenses. There are two fundamental problems with the resulting analysis. First, and as previously noted, there is no statutory or constitional language that supports this elaborate framework. Second, the analysis does not indicate the relative importance of each factor, as the Department of Revenue's opinion in Provena aptly demonstrates. Is each factor given equal weight? Is there a balancing test? Is the absence of one factor fatal to the exemption?
Factor 4: Private Inurement. The Department of Revenue’s opinion does not address these factors in any logical order—it chooses to jump around. Early in the opinion, it addresses the fourth factor, recharacterizing this factor as a prohibition against private inurement. The Department of Revenue presumes that there has been inurement, stating:
The fact that Provena’s parent owns the laboratory, and that Provena has an exclusive arrangement for laboratory services with this business, raises the distinct possibility that there is a private inurement flowing back to Provena Health. It is not clear whether Provena Health in fact profited from this arrangement, but if it did then that single fact might disqualify this applicant from receiving the exemption.
The bias is quite evident in this statement. If the nonprofit doesn’t affirmatively prove that there isn’t inurement, the Department of Revenue presumes it by referring to “the distinct possibility.” That may be convenient for purposes of reaching a pre-determined result, but it should scare every nonprofit in Illinois that is part of an affiliated group of entities. Unless each entity has appraisals showing fair value is being exchanged, it is vulnerable to the Department of Revenue’s presumption. Whatever happened to reviewing evidence?
Factor 2: Charitable Contributions. The Department of Revenue viewed the absence of private charitable contributions as a negative. This ignores Medicaid reimbursements that the hospital receives, which we view as public contributions. Many Illinois social service agencies receive the bulk of their funds from federal and state grants. Under the Department’s logic, the property tax exemptions of these entities are vulnerable if grants are not treated as some form of contribution. More important, it is not even clear that this is a separate standard under the original formulation of what it means to be a charity. See Congregational Sunday School and Publishing Society v. Board of Review, 290 Ill. 108 (1919), which focuses on the question of private or public gain rather than the source of revenue when it summarizes Factor 2.
Factor 3. Dispense Care to All Who Need It. There do not seem to be specific facts in the record that indicate that Provena turned away anyone who needed care, but who could not pay for it. Yet, the Department of Revenue concludes that the percentage of charitable care is simply to small relative to overall revenues to warrant tax exemption. The problem is that the very early precedent makes it quite clear that the charity need not provide all of its service free of charge and only to those who cannot afford them. In 1907, the Illinois Supreme Court wrote:
It is then argued that this hospital should not be held to be an institution of public charity by reason of the great disparity between the number of charity patients and those who pay for the care and attention they receive at this institution. This objection seems to us without merit, so long as charity was dispensed to all those who needed it and who applied therefore, and so long as no private gain or profit came to any person connected with the institution, and so long as it does not appear that any obstacle, of any character, was by the corporation placed in the way of those who might need charity of the kind dispensed by this institution,calculated to prevent such person making application or obtaining admission to the hospital. The institution could not extend its benefactions to those who did not need them, or to those who did not seek admission.
Sisters of Third Order of St Francis v. Board of Review of Peoria County, 231 Ill. 317 (1907).
The issue is not the relation between charity care to overall service; it is whether all who ask for charity care receive it. To the extent that the Department of Revenue believes that there is opportunity for abuse, it can look to Factor 1, which focuses on lessening the burdens of government. There is little question that in providing medical services, every hospital lessens the burdens of government. In essence that is what the debate about health care is all about: who is responsible for providing health care. If hospitals close, people will look to the government for medical services, something that cash-strapped governments truly fear.
Factor 3. Charity. Factor 3 does not refer to charity care. It
refers to charity. In assessing whether a hospital is providing
charity, the Department of Revenue should not limit the qualifying activity to medical
services that are provided to indigent individuals. The Department of Revenue should give hospitals credit for community-based education, screening, and other programs that
hospitals provide. Moreover, the Medicare reimbursement rules require
hospitals to accept reimbursements below cost for services. In
2002, Provena provided $10 million in unreimbursed Medicare and
Medicaid services. The Department of Revenue cites two cases for the
proposition that this subsidy isn’t charitable. Riverside Medical Center v. Dept. of Revenue, 342 Ill.App. 3d 603, 795 N.E.2d 361
(3rd Dist. 2003); and Alivio Medical Ctr. v. Dept. of Revenue, 299
Ill.App.
3d 647, 702 N.E.2d 189 (1st Dist. 1998) Neither opinion, however, was issued by Illinois Supreme Court. We would argue that this view of the law
is incorrect. We simply don’t understand how providing
subsidized services doesn’t constitute an act of charity. Some policymakers may want all health care to be provided without charge to the recipient, but that just is not how healthcare is financed in this country. The current healthcare system does provide for an element of charity entitlement program reimbursements.
Factor 3. Bad Debts. The Department of Revenue doesn’t recognize bad debts as charitable care either. We can actually understand the logic behind that position; this position ignores reality. Like it or not, running a hospital entails many costs and hospitals must recover the costs somehow. What better way to approach the problem then by billing all but the obvious candidates for charitable care, seeing what you can collect, and then writing off debts that patients simply cannot afford to pay. We agree, it is not the optimum or preferable way to do business, but it is a resource allocation methodology that forces people to prove they need a subsidy. Until this country adopts an comprehensive health care system, hospitals must deal with the world that actually exists rather than the one politicians wished existed.
If the Department of Revenue and the Illinois Attorney General persist in revoking longstanding property tax exemptions for political gain, they are only going to prove that the nonprofit hospitals do lessen the burdens of government when these hospitals are forced to close and the patients look to the government for medical care.
Ad hoc Change in the Law. Were we writing on a clean slate, we might impose a different set of standards on nonprofit hospitals. However, we are not. The existing system of exemptions is longstanding and we suspect that the underlying facts have not significantly changed in recent years. That is what troubles us about what appears to be the beginning of widespread challenges to hospital property tax exemptions. What has changed in the last decade or two to justify this now sudden change in the interpretation of the exemption standards? We suspect there has not been a change in the financing of healthcare. Instead, what we are seeing is an attempt to force public policy objectives on an industry without legislative authorization. This is only possible because the Illinois courts have truly fallen down on the job when it comes to articulating the standards underlying property tax exemption. That has occurred largely because the courts decided that they would define the standards judicially rather than looking to the legislature to define the standards within constitutional limits. At this point, Illinois needs a revision to its constitution so that ad hoc court decisionmaking can be eliminated in favor of a legislative forumulation of the rules.
Lessons for Other Nonprofits. We have recently heard about a challenge to a social service agency's property tax exemption by another state department of revenue. The department of revenue is arguing that the agency is not entitled to exemption because it receives its provides services for fees rather than giving them away. Nobody seems to dispute that the agency's clientele is comprise exclusively of low-income people.
We believe that any charity that operates through a structure involving affiliated entities, charges for services, or that receives significant government grants is potentially vulnerable under the Department of Revenue's approach in Provena.
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