Case Could Cost Nonprofit NJ Hospitals Millions — and Their Tax-Exempt Status

Andrew Kitchenman | January 8, 2015 | Health Care
Municipality argues that Morristown Medical Center is actually for-profit facility and should be stripped of property-tax exemption

Morristown Medical Center
A long-running legal case in Morristown could lead to millions of dollars in additional property taxes for New Jersey hospitals, as well as more revenue and tax relief for municipalities.

The town government is seeking to remove Morristown Medical Center’s property-tax exemption, arguing that it is no longer effectively operating as a nonprofit, due to its reliance on for-profit doctors’ practices and its steep prices.

The medical center argues that its business model is the traditional approach used by all nonprofit hospitals and that it has little control over what it’s paid for its services.

If Tax Court Judge Vito Bianco rules against the hospital, it could have significant implications for nonprofit hospitals across New Jersey. They would have to consider making structural changes that would make them less likely to lose their property-tax-exempt status or pay large sums to local governments. In turn, those governments would be in a position to increase their budgets or lower the property tax rates paid by others.

The hospital has already lost one decision related to the case. In 2010, Bianco ruled that office space rented by the hospital for doctors’ offices and the cafeteria, operated by a for-profit business, couldn’t receive the tax exemption. The 2010 ruling differed from the current case because the judge found that the rented offices and cafeteria were clearly used to turn a profit. He is still considering the two sides’ arguments regarding the main hospital building.

Legal experts are urging hospitals to keep a careful eye on how they operate these off-site locations as they continue to build business ties with local practices.

The case is part of a rising number of challenges to entities that were historically exempt from property taxes, ranging from Princeton University to the Port Authority of New York and New Jersey. They point to a potential pitfall for nonprofits taking a more entrepreneurial approach to building new revenue streams, according to observers.

The case stems from a decision by Morristown’s assessor in 2008 to deny the hospital’s property-tax exemption. At the time, the case focused on whether or not the hospital’s executives’ pay was reasonable, with the town arguing that paying executives too much meant that the hospital was operating for their profit. Since then, the issues that Bianco must resolve center on how the hospital operates.

Martin Allen, an attorney for the town, said Morristown Medical Center parent Atlantic Health System Inc. had entered into agreements with for-profit doctors’ practices that effectively handed over control of much of the hospital building to the doctors.

In addition, doctors directly employed by the hospital received much of their compensation in profits, said Allen, a member of the Warren-based law firm DiFrancesco Bateman.

“It creates a profit-making motive that extinguishes the exemption,” Allen said of the payments to doctors.

Allen points to a 2010 New Jersey Supreme Court case, International Schools Services Inc. v. West Windsor, as a precedent for eliminating Morristown Medical Center’s exemption. In the earlier case, a West Windsor-based nonprofit provided space for multiple for-profit businesses, before the municipality successfully sought to remove its property-tax exemption. Allen added that Atlantic Health’s for-profit affiliates also do business with its nonprofit operations, including receiving loans from the hospital.

Allen said the town doesn’t dispute that the hospital provides “wonderful service” to the community and is a driving force for the local economy. “No one has said the hospital is a bad actor,” Allen said.

But Morristown maintains that the medical center’s profit making has dwarfed its philanthropic mission, he said.

Hospital attorney Kenneth J. Norcross rejected Allen’s argument. He said hospitals have been operating in the same way as Morristown Medical Center — relying on doctors outside of their employment — “since basically time began.” He said if this were to be the basis for removing the hospital’s property-tax exemption, then no nonprofit hospitals should ever have received the exemption.

He also noted that it’s normal for a hospital to depend on doctors who specialize in areas like emergency medicine to operate certain parts of a hospital but who aren’t employed by the hospital. In other specialties, like pediatrics, doctors may be employed by a hospital but also receive fees from patients — none of which should affect a hospital’s exemption status, said Norcross, a partner in Drinker Biddle’s Princeton office.

He described the doctors’ relationship with the hospital as being “completely different” than the facts of the International Schools case, since doctors visiting a hospital are unlike a business sharing the same space as a nonprofit. Norcross added that Atlantic Health limits the number of transactions between its for-profit affiliates and the hospital and ensures that they have an “arm’s length” relationship, with the for-profit affiliates paying appropriate interest on loans.

New Jersey State League of Municipalities Director of Government Relations Mike Cerra noted that Morristown is not alone in seeking to end property owner’s exempt status.

“There are situations … in which traditional nonprofits engage in for profit activities and it seems inconsistent with the purposes of the exemption,” Cerra said.

Cerra said some of the pressure to increase revenue might have occurred as a result of the 2007 to 2009 recession.

“It does sort of follow on the heels of the Great Recession and the challenges that all sectors — private, public, nonprofit — faced, that some nonprofits are trying to be entrepreneurial to sustain themselves, which is understandable from a business point of view,” but could harm taxpayers, he said.

David B. Wolfe, a property tax attorney with Livingston-based Skoloff & Wolfe PC, has been watching the case with keen interest.

If the town is successful “I think you will see many municipalities reexamine whether or not their hospitals should be exempt,” Wolfe said, noting that municipalities face their own pressure to identify new revenue.

He said hospitals should make sure that their bylaws are updated and reflect the hospital’s operations, and that for-profit and nonprofit assets are clearly separated.

“I would recommend hospitals examine their internal organization and structure to best optimize their chance of maintaining an exemption,” said Wolfe, chairman of the New Jersey State Bar Association’s property-tax committee.

The town also is arguing that the hospital’s charges aren’t reasonable for a tax-exempt nonprofit. Norcross noted that what the hospital is paid is based on a mix of federal programs over which it has little control and private insurers that have strong influence over charges.

Allen said that even if Bianco rules in favor of the town, it might have a limited effect on other hospitals — although that will depend on the details of the ruling. It may only affect those systems that have for-profit affiliates, but it could affect smaller hospitals, which may increase the pressure for them to merge with larger systems. It could also increase the pressure for nonprofit hospitals to convert to for-profit status.

In weighing the implications of losing the case, Norcross said there’s nothing unique about how Atlantic Health operates Morristown.

“If we lose, then all hospitals in the state lose, because we all operate in the same way,” he said, adding that the system’s surplus has been in the 2 percent to 3 percent range, while other hospitals with lower surpluses would be in a more precarious situation if they had to pay property taxes.

He said nonprofit hospitals have a pact with the state and municipalities to provide community benefits in return for their tax-exempt status. He noted that Atlantic Health’s net community-benefit spending — including charity care and uncompensated care provided to Medicaid recipients and those who don’t pay their bills, as well as professional education and local health clinics — totals more than $100 million per year.

“We do a lot of things that are not remunerative because we’re trying to fill a community need,” Norcross said, adding that having to pay property taxes would affect the services the hospital could offer. He noted that Atlantic Health operates Goryeb Children’s Hospital in Morristown at a loss.

“The motivation for Atlantic Health is not to make money, to maximize profits,” he said.

New Jersey Hospital Association spokeswoman Kerry McKean Kelly also emphasized that hospitals across the state provide public benefits and are economic engines. The association calculates that they provide $2.6 billion in charity and other community benefits and more than $20 billion in economic benefits. In addition, many hospitals make voluntary cash contributions to their host municipalities, or make in-kind contributions like donating ambulances.

“What a not-for-profit hospital brings to their community is almost immeasurable,” said Kelly, who declined to comment on the Morristown case.

While executive compensation is no longer at the heart of the case, Atlantic Health System’s executive pay has been significant. In 2012, system President and CEO Joseph Trunfio was paid $10.7 million, while Morristown Medical Center President David Shulkin was paid $1.24 million.

Norcross said that the hospital is required by federal law to pay executives “no more than fair compensation” and that Trunfio’s and others’ pay was reviewed annually by an outside consultant. Martin countered that the pay system is largely driven by the hospital’s own priorities and leads to ever-escalating payments to top executives.

The two sides’ legal briefs are due on January 23, with replies due in early February. Bianco’s decision will follow.

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