Around the country, states are more closely scrutinizing whether hospitals and other health care providers should be granted property tax exemptions. Federally granted 501(c)(3) tax exempt status does not automatically entitle an organization to state and local tax exemptions, such as property tax exemptions. Rather, such exemptions are granted at the state level, typically based on an organization’s use of its property for charitable purposes, but requirements vary from state to state.1

In a case monitored by many tax-exempt hospitals nationwide, the Supreme Court of Illinois recently issued a decision upholding the Illinois Department of Revenue’s denial of a property tax exemption for Provena Hospitals (“Provena”), a not-for-profit § 501(c)(3) corporation. The Provena case, discussed below, reflects an emerging trend linked to and fueled by states’ increasing revenue needs and by the continuing scrutiny of for-profit versus not-for-profit hospital characteristics with respect to their eligibility for property and other tax exemptions governed by state law.

At the same time, actions affecting exempt health care providers are taking place at the federal level. Certain of these actions are the result of the early attention received by the Provena 2 case. Most recently, new requirements for hospitals holding 501(c)(3) exempt status were included in the health care legislation passed by Congress and signed into law by President Obama.3

Although many hospitals, including those aligned with the Catholic Health Association of the United States, undertook measures to respond to the focus on charitable care issues in the middle of the past decade, there are many that either retain outdated charity care policies or apply their policies in a manner which may be inconsistent with both the federal and state standards for tax exemption.

This update provides an overview of both the Provena case and its implications as well as the newly-enacted federal measures.4

THE PROVENA CASE

Provena is a not-for-profit Illinois corporation holding 501(c)(3) status under the Internal Revenue Code. Provena is exempt from Illinois’ sales and use tax, is an approved recipient of charitable donations in accordance with the State Attorney General’s determinations, and is a religious organization exempt from the State’s annual financial reporting requirements. Provena owns and operates six hospitals, including Provena Covenant Medical Center (“PCMC”) in Urbana, Illinois, which occupies the property in question. PCMC is a fullservice hospital serving a 13-county area in east central Illinois.

Illinois provides property tax exemptions for land (1) owned by public charitable institutions that is (2) actually and exclusively used for charitable purposes and not otherwise used for profit. The statute’s key concepts are “charitable institution” and “exclusively used for charitable purposes.”5 The Court identified the following five characteristics of a charitable institution: (1) it has no capital, capital stock, or shareholders; (2) it earns no profits or dividends but rather derives its funds mainly from private and public charity; (3) it dispenses charity to all who need it and apply for it; (4) there is no private gain or profit for any person connected with it; and (5) it does not appear to place any obstacles in the way of those who need and would avail themselves of the charitable benefits it dispenses.

The Court defined charity as “a gift to be applied for the benefit of an indefinite number of persons, persuading them to an educational or religious conviction, for their general welfare, or in some way reducing the burdens of government.”

In analyzing whether Provena was a charity, the Court determined that Provena failed to meet the second, third and fifth factors for the tax year in question. The Court found that virtually all of Provena’s revenues came from non-charitable sources, that its provision of charity care did not reach all who needed it, and that its charity care policies were by no means obstacle-free.

The Court also analyzed the second requirement of the property tax exemption, that the land at issue be actually and exclusively used for charitable purposes, and not used with a view to profit. The exemption requires charitable use as a primary purpose and is not satisfied by incidental charitable use or a mere aspiration to provide charity.

In evaluating charitable use, the Court looked to whether the use alleviated burdens which otherwise would be borne by the governmental entity losing revenue as a result of the granted exemption. The Court found the amount of free and discounted care offered to uninsured patients by PCMC very minimal, both in terms of the number of patients served and the dollar value of those services. The charity care provided amounted to only 0.723% of PCMC’s revenues for that year and equaled approximately 75% of the property tax relief Provena sought.6 “With very limited exception, the property was devoted to the care and treatment of patients in exchange for compensation through private insurance, Medicare and Medicaid, or direct payment from the patient or the patient’s family.”

Although PCMC did not condition its services on patients’ ability to pay, it also did not advertise charitable care. In addition, balances left unpaid were automatically forwarded to collection agencies and were waived only if a patient could prove that no other source of payment was available and that he or she was otherwise eligible for participation in the charitable program. The Court drew a parallel between Provena’s approach to charitable care and a for-profit institution’s write-off of bad debt, while also observing the substantial incongruence between the amount of charitable care provided by the organization and the number of low income and underinsured residents of the counties that it served.

Provena unsuccessfully argued that PCMC’s provision of care to Medicare and Medicaid patients should be taken into account in determining its eligibility for the property tax exemption, because the organization was unable to recover the full cost of care. The Court countered that accepting such patients furthered the financial interests of the organization by allowing income generation by otherwise underutilized hospital resources and qualifying the organization for beneficial treatment under federal tax law.

It is important to understand that the Provena decision relates to only one tax year (2002) and the specific facts before the Court. Furthermore, the Illinois statute, as it has been interpreted by Illinois courts over many years, is very strict in its requirements. As a result, one could conclude that the decision is limited and of no meaning to hospitals and other health care providers in other states.

That view, however, fails to take into account the years of fallout from these proceedings, which have spread far beyond Illinois. It also ignores the longstanding issue of what constitutes a charity and charitable use for state, rather than federal, law purposes. While Provena may have garnered the greatest amount of attention, tax-exempt entities need to be cognizant of the specific issues raised by their state statutes which, in the current economic climate, are subject to further restriction either at the legislative or judicial levels. Tax-exempt providers should take the recent Provena decision as at least a reminder to check charitable policies and property use.

NEW FEDERAL LAW PROVISIONS

The health care reform legislation includes a number of provisions which affect a hospital’s ability to maintain 501(c)(3) status and, for the first time, creates statutory standards for such status. The law provides that hospitals: (1) must complete a community needs assessment once every three years; (2) must adopt and publicize a financial assistance policy; (3) may not bill patients who qualify for financial assistance at its highest rates; and (4) unless the hospital has undertaken reasonable efforts to notify patients of its financial assistance, may not undertake extraordinary collection actions against the patients. The new law also: (1) requires the Internal Revenue Service to review the tax-exempt status of each hospital every three years; (2) requires an annual report to Congress on levels of charity care and bad debt and certain other data relating to unreimbursed costs from the Treasury and Health and Human Services Departments; and (3) requires a report from those Departments in five years analyzing the trends shown by the annual reports.

While there are many details that will need to be flushed out from the new legislation, it is clear that tax-exempt hospitals must now begin taking steps to comply with the new standards to justify their special status. In the words of Senator Grassley:

ENDNOTES

1. The Provena case has been the subject of national attention with respect to real estate property tax exemptions. Although the decision relates only to the specific Illinois statute governing such exemptions, because of the national attention the case has received, its implications reach far beyond the Illinois statute involved.
2. The case, decided on March 18. 2010 by the Illinois Supreme Court, first gained attention in 2004 when the local board denied Provena’s request for a tax exemption for the 2002 tax year.
3. The force behind these changes has been Sen. Chuck Grassley of Iowa, who first became interested in this as a result of the widespread publicity surrounding the Provena proceedings in 2004.
4. This client alert will not present a comprehensive discussion of the new federal measures, but rather provide a summary of the actions tax-exempt hospitals will be required to take under the new law to maintain 501(c)(3) status. For futher explanation of the new requirements, please see Health Care Reform: Charitable Hospitals Face New Requirements To Maintain Their Tax-Exempt Status.
5. These two concepts, or substantially similar ones (e.g., New Hampshire law refers to “owned, used and occupied … directly” for charitable purposes), are typical predicates to state real property tax exemption. Certain states have a statutory definition of what constitutes a “charity” for these purposes.
6. Certain of the judges referred to Provena’s charity care as “often illusory.” The discounts given to uninsured patients (50% and 25% in certain cases) frequently resulted in the patient being billed at an amount in excess of PCMC’s actual costs of care, which were less than 50% of its established charges on which uninsured patients were billed.