On March 22, 2010, the day after the historic passage by the House of Representatives of H.R. 3590, the Patient Protection and Affordable Care Act, the headline of a New York Times article announced "In Health Reform, Boons for Hospitals and Drug Makers." The New York Times article predicted that 32 million additional paying customers in the next few years will be "better able to pay for hospital stays, doctor visits, prescription drugs, and medical devices." President Obama signed H.R. 3590 into law on March 23, 2010.

Five days prior, the Illinois Supreme Court denied a Catholic hospital a property tax exemption in Provena Covenant Medical Center v. Department of Revenue,¹ The Court denied the exemption, in part, because the amount of charity care provided by the hospital was insufficient. The chilling national repercussions some portend for the Provena Covenant decision, with its inquiry into how much charity is enough to justify a property tax exemption, may ultimately be dwarfed by the repercussions of the new federal health care legislation.

After all, under the new federal health care legislation, in 2014 Medicaid coverage will be extended to households with income up to 133 percent of the federal poverty level. In addition, the new federal health care legislation will subsidize the purchase of insurance from state insurance exchanges for those below 400 percent of the federal poverty level. At that point, the extended coverage offered under Medicaid and the insurance exchanges will displace much of the charitable patient care that hospitals have traditionally dispensed. As hospital charitable patient care ebbs, so too may ebb the state and local grants of exemption for hospital properties.

State Exemption Statutes

Most state property tax laws do not generally exempt hospital property. However, the majority of state property tax laws include an exemption for property owned by a not-for-profit entity that is used exclusively for a charitable purpose. In many states, this general charitable exemption has come to be applied to property of non-profits used to provide medical care to those unable to pay for their care. The standards applied by the states to determine qualification for charitable property tax exemption generally predate those used to grant federal income tax exemption under Internal Revenue Code Section 501(c)(3). Although the Court in Provena Covenant focused more on the activities of the organization that owned the hospital, and less on the actual use of the hospital property, it found that the organization's history of spending only 0.7 percent of revenue to provide charitable care to 302 people was not substantial enough to demonstrate a charitable use of the property.

There were other deficiencies in Provena Covenant's case which alone would have supported denial of the exemption under Illinois law. For example, Provena Covenant billed indigent patients for services and then wrote off the uncollectible portion of those bills as bad debts, rather than simply not billing indigent patients. In addition, even the discounted fees charged by Provena Covenant under its charitable care policy resulted in a surplus above costs. These deficiencies might have suggested to Provena Covenant that it step back to fix the easy stuff and then reapply for its property tax exemption, rather than press on to an Illinois Supreme Court decision. However, it was perhaps unavoidable that the Illinois Supreme Court would ultimately address the question of how much charitable care is enough to qualify for the charitable property tax exemption. That being said, hospitals are now saddled with a decision rejecting a charitable property tax exemption based primarily on the insufficiency of the amount of charitable care being provided by the property owner. Although the Provena Covenant decision specifically applies the charitable exemption in the Illinois property tax context, the Illinois charitable property tax exemption is substantially similar to those found in several other states. As a consequence, the Provena Covenant decision could have far reaching consequences, at least until the federal health care legislation takes full effect.

Federal Exemption Statute

How much free care is "enough care" for a hospital to qualify for a charitable income tax exemption has long been a focus of the Internal Revenue Service (IRS), as documented in the Interim Report of the Hospital Compliance Project issued by the IRS in 2007. The Hospital Compliance Project was initiated by the IRS Tax Exempt and Government Entities Division to study nonprofit hospitals and the community benefit these hospitals provide. Like the majority of state tax property tax laws, the Internal Revenue Code does not include a specific exemption for hospitals and does not define an exempt purpose to include the promotion of health.

In Revenue Ruling 56-185, the IRS held that in order to qualify as a charitable organization exempt from federal income tax, a hospital must operate to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay, and that a hospital qualifying as a charitable organization must not ordinarily refuse to accept patients in need of care who are not able to pay for such care.²

Since the advent of Medicare and Medicaid, the IRS has used a "community benefit" standard to determine whether a nonprofit hospital is exempt, as set forth in the Revenue Ruling 69-545.³ And while that standard was relaxed somewhat by Revenue Ruling 83-157, and Revenue Ruling 98-15, providing free or below cost services to the poor is still a factor that may demonstrate a hospital promotes health for the benefit of the community.⁴

Many states operate with statutes and case law that do not take note of Medicare and Medicaid, and, therefore, do not use a "community benefit" standard. Even if such states were to adopt a "community benefit" standard for property tax exemptions, it is possible that the states would still require a showing that a specific parcel furthered the "community benefit" before extending the property tax exemption to that specific parcel. One can conceive of circumstances where the federal "community benefit" standard would be met by the organization owning the hospital property, but the exempt use requirement would not be satisfied with respect to a specific parcel.

Possible Outcomes

Beginning in 2014, as the pool of patients not able to pay for hospital services significantly dries up or disappears, the facts will tilt more heavily in favor of state and local governments seeking to deny charitable exempt status to hospital property. In the time leading up to the elimination of the pool of potential charitable care patients, hospitals must take action to understand, mitigate or eliminate the real estate tax bills that will inevitably arrive. Doing nothing will not be a good option.

In a state that does not provide a specific property tax exemption for hospitals, but rather considers hospital property eligible for the general charitable exemption, a standard similar to the federal "community benefit" standard could be adopted by legislation (although the standard would likely need to be modified to require a reasonable connection between the documented community benefit and the specific parcel to be exempted from tax). However, in states where the State Constitution imposes limits on the types of property tax exemptions that can be granted, adopting a "community benefit" standard by legislation may not be a workable solution.

Another legislative option would be to mandate a reduced assessment level for hospitals, instead of creating a new hospital exemption or expanding a charitable exemption. This would allow maximum flexibility for the legislature to consider factors other than charity that warrant state support of hospital operations through reduced property tax assessment levels.

Barring a proactive legislative solution, the property tax bills will be coming, and hospitals should not wait until 2014 to prepare their case for a reasonable and fair valuation of their property, with supportable data, qualified knowledgeable experts, and experienced counsel.

1. Illinois Supreme Court Docket No. 107328, March 18, 2010.
2. 1956-1 C.B. 202 (Jan. 1, 1956).
3. 1969-2 C.B. 117 (Jan. 1, 1969).
4. 1983-2 C.B. 94 (Jan. 1, 1983) and 1998-1 C.B. 718 (March 4, 1998).