Ruling Could Put Nonprofit Hospitals on Hook for Millions in Property Taxes

Andrew Kitchenman | June 29, 2015 | Health Care
But leading Democratic legislator says state could restore tax exemption if judge’s opinion stands

Morristown Medical Center
Nonprofit hospitals across New Jersey could be liable for millions of dollars in annual property taxes, under a ruling by a tax-court judge that highlighted the difficulty in separating the charitable and for-profit activities of hospitals and other organizations.

The judge found that Morristown Medical Center had so intermingled its nonprofit and for-profit services and finances that it could no longer qualify for a tax exemption under state law. Morristown’s municipal government had tried to eliminate the exemption in 2006, prompting a case that’s been in court ever since.

Hospital officials had argued that the organization follows long-established and universal practices by hosting services offered by both doctors employed by the hospital and self-employed physicians who operate for-profit businesses. But Judge of the Tax Court Vito Bianco, in examining the history of hospitals, found that they had strayed from the strictly charitable function they served when they were originally granted exemptions.

It’s not clear how much the hospital will have to pay the town — the next stage of the legal process will focus on that issue — but attorneys for the Medical Center have put the annual figure at $2.5 million to $3 million. Considering that there are more than 50 nonprofit hospitals in the state, it’s clear that there are large ramifications.

There could be an extensive appeals process before the case is resolved in Morristown, or before any other nonprofit hospital pays its local town a cent. And a leading lawmaker on health issues is already raising the possibility that the Legislature could act to ensure that hospitals keep their property-tax exemptions.

In the 88-page opinion, Bianco ruled that, based on the evidence presented at trial, it was impossible to disentangle the nonprofit and for-profit services and finances at Morristown Medical Center. In addition, the hospital failed to prove that its executives’ compensation wasn’t excessive. Former CEO Joseph Trunfio received $12.5 million over the three years reviewed in the case.

The only sections of the hospital that would still qualify for tax-exempt status were the hospital auditorium, fitness center, and visitors’ garage, since the hospital received little to no payment for these areas, Bianco ruled.

“[I]f the property-tax exemption for modern nonprofit hospitals is to exist at all in New Jersey going forward, then it is a function of the Legislature and not the courts to promulgate what the terms and conditions will be,” Bianco wrote. “Clearly, the operation and function of modern nonprofit hospitals do not meet the current criteria.”

After the ruling, New Jersey is in a similar situation to Illinois in 2010, when its state Supreme Court upheld a ruling that an Urbana hospital no longer qualified for its property-tax exemption. This prompted its legislature to take action, passing a law signed by former Illinois Gov. Patrick Quinn in 2012 that essentially made nonprofit hospitals permanently tax-exempt by establishing minimal financial standards for providing community benefits to qualify for exemptions.

Assemblyman Herb Conaway Jr. (D-Burlington) said the New Jersey Legislature might have to take up the issue depending on the outcome of any appeals.

“This ruling, if it holds up on appeal, could have some very significant and perhaps even devastating impacts on hospitals across the state,” said Conaway, a doctor based at St. Francis Medical Center in Trenton. He is the chairman of the Assembly Health and Senior Services Committee.

“It’s certainly possible that Illinois may provide the basis for legislative action here in New Jersey,” Conaway said.

Mike Cerra, government affairs director for the New Jersey State League of Municipalities, said the decisions “may be a significant victory down the road for other municipalities who face the same issues” with nonprofit hospitals. It could even have implications for other nonprofits, although Cerra noted that Bianco focused on the details of the Morristown situation.

And Cerra said it “clearly would be a concern” if legislators were to base a new law on Illinois, adding that any redefinition of nonprofit tax-exempt status would have to be “very objective.”

Cerra added that “it’s a fairness issue” to treat nonprofit and for-profit hospitals the same when the way they operate is so similar.

“If you are going to be entrepreneurial and you’re essentially going to dabble in the for-profit realm, you’re essentially going to have to be on a level playing field with the hospitals that don’t have nonprofit status,” Cerra said.

Morristown Mayor Timothy Daugherty released a statement through an attorney saying that Bianco’s opinion was “well-reasoned and thorough.”

“While I am pleased with the decision, we still look forward to supporting Morristown Medical Center in whichever way we can to assure that the hospital continues to offer its wide spectrum of quality medical and healthcare services,” he said.

Executives at Atlantic Health System, the Morristown hospital parent company, said in a statement that they were disappointed with Bianco’s decision. They said they would “evaluate our options” regarding any appeals. They also emphasized that the decision was only focused on property-tax exemptions and didn’t call into question the hospital’s charitable or nonprofit status.

The New Jersey Hospital Association also responded swiftly. President and CEO Betsy Ryan said in a statement that the implications of the ruling might require a change to state law.

The association “and its 72 member hospitals are most concerned with anything that creates additional obstacles to our mission of providing high-quality medical care to our communities in a cost-effective manner. The tax court decision that denied Morristown Medical Center’s property tax exemption will have repercussions beyond one hospital.”

David B. Wolfe, a property-tax attorney with Livingston-based firm Skoloff & Wolff PC, is not involved with the case but has been closely tracking it. He said Bianco’s ruling was as “broad and sweeping a decision” and as far reaching as he could have written, putting all nonprofit hospitals at risk of losing their property-tax exemptions.

“Obviously, it is a fundamental shift in New Jersey law should this decision be upheld,” he said, adding that it’s “likely the first chapter in the saga,” and that a hospital appeal to the Appellate Division and if necessary the New Jersey State Supreme Court is virtually certain.

In commenting on the case in January, Wolfe said that nonprofit hospital boards should ensure that their nonprofit and for-profit activities are clearly separated. But after reading the ruling, he said Bianco’s sweeping language left little room for nonprofit hospitals to keep their exempt status. He added that Bianco did limit his ruling to the specifics of the case, so a hospital in a different situation might achieve a different result.

But he didn’t minimize the importance of the ruling to both hospitals and more broadly.

“As not-for-profits become more and more sophisticated entities, they need to be aware of … the risk if they’re not careful, of losing their property tax exemption status,” he said.

Bianco did recognize the large amount of community benefits in the form of charity care and other services that the hospital provides, the attorney added.

“I think the judge would be the first one to say (hospitals) provide a tremendous benefit to the NJ community,” said Wolfe, cochairman of the New Jersey State Bar Association’s property tax committee.

Wolfe also noted that the case was just focused on property taxes, and will have no effect on hospitals’ federal and state corporate income tax exemptions.

Bianco seemed to acknowledge the importance of his decision in a footnote on the last page. He noted that the hospital had asked earlier on the day of the ruling for an extension to attempt to reach a settlement with the town.

Any settlement agreement, “at this point, that may provide the hospital with a greater property tax exemption than this court determined it was entitled to by virtue of the evidence, would be improper and must be rejected by this court,” Bianco wrote in denying the request for an extension.

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