Nonprofit hospitals: state and local tax authorities are again questioning tax-exemptions

Here's a great article from Kaiser Health News (July 11) on recent controversies over tax exemptions for hospitals. 

Tax-exempt status is not a "right"; it has to be earned. That means -- among other things -- that executive pay can't be excessive (or else the tax authorities will conclude the hospital is being run for private and not public benefit) and there has to be a convincing showing of tangible public benefit (uncompensated charity care, educational programs, research, etc.). 

The Kaiser piece starts with an example of the stakes involved in a typical case:

The public school system [in Pottstown, PA] had to scramble in 2018 when the local hospital, newly purchased, was converted to a tax-exempt nonprofit entity.

The takeover by Tower Health meant the 219-bed Pottstown Hospital no longer had to pay federal and state taxes. It also no longer had to pay local property taxes, taking away more than $900,000 a year from the already underfunded Pottstown School District, school officials said.

The district, about an hour’s drive from Philadelphia, had no choice but to trim expenses. It cut teacher aide positions and eliminated middle school foreign language classes.

“We have less curriculum, less [sic] coaches, less transportation,” said Superintendent Stephen Rodriguez. 

The school system appealed Pottstown Hospital’s new nonprofit status, and earlier this year a state court struck down the facility’s property tax break. It cited the “eye-popping” compensation for multiple Tower Health executives as contrary to how Pennsylvania law defines a charity.  

The court decision, which Tower Health is appealing, stunned the nonprofit hospital industry, which includes roughly 3,000 nongovernment tax-exempt hospitals nationwide.

The nonprofit hospital industry should not have been stunned. A wave of official scepticism over claims of tax-exempt status was ushered in at least 38 years ago with the case of Utah County v. Intermountain Healthcare, Inc., 709 P.2d 265 (Utah 1985). And jurisdiction after jurisdiction has viewed tax-exempt hospitals through a critical lens, often concluding that the hospitals in question were virtually indistinguishable from their for-profit competitors and that the public benefits from the nonprofits were too scant to justify the foregone tax receipts. 

This might be less of a problem if the IRS still required some level of charity care for a hospital to qualify for federal tax exemption, as it did from 1956 to 1969. (Compare Rev. Ruling 56-185 (exempt hospital must be operated "to the extent of its financial ability for those not able to pay for the services rendered") with Rev. Ruling 69-545 ("Revenue Ruling 56-185 is hereby modified to remove therefrom the requirements relating to caring for patients without charge or at rates below cost").) See GAO, Tax Administration: IRS Oversight of Hospitals' Tax-Exempt Status (April 26, 2023).

Obamacare added § 501(r) to the Internal Revenue Code to address certain aspects of the problem created by Rev. Rul 69-545, but it did not change the fundamental rule that a hospital may obtain tax-exempt status without offering a drop of unreimbursed charity care.

For its part, Texas (for once) far exceeds the federal standard by requiring minimum amounts of community benefit -- specifically including unreimbursed charity care and government-sponsored indigent health care -- in order for a hospital to qualify as a nonprofit entity under § 311.045 of the Health & Safety Code and for tax-exempt status as a charity under § 11.1801 of the Tax Code.