The facts are relatively straightforward. Tower, then the Reading Health System, acquired several “for-profit” hospitals formerly owned by Community Health Systems in 2017. The acquisition was funded by a $590 million bond. Tower, a 501(c)(3) entity, created new limited liability companies to hold the acquired properties. Tower was the sole member of each limited liability company. The new limited liability companies each filed a tax exemption application for tax year 2018, each seeking to qualify as a “purely public charity.” The exemption applications were denied at the administrative level and then at the Trial Court.
On appeal, the Court focused most intensely on whether Tower (as opposed to each separate LLC) met the prong of the HUP Test that requires a purely public charity “[o]perates entirely free from private motive.” The Court found three of Tower’s practices to be grounds to uphold the trial court’s decision that Tower “failed to sustain its burden of demonstrating the absence of a profit motive,” namely, (1) Tower’s “improperly exorbitant management fees;” (2) Tower’s investment of interest payments on the bonds for the acquisition of hospital properties in areas other than the efficiency and facilities of each hospital; and (3) Tower’s executive compensation.
Concerning Tower’s “improperly exorbitant management fees,” the Court found that the diversion of monies in management fees to profit-driven entities is evidence of “profit motive.” The Court upheld the use of management fees charges by Tower to each hospital as evidence of “profit motive.” The Court noted the Trial Court’s holding that the hospitals “did not scrutinize whether the management fees were reasonable for the services provided by Tower[]” and noted the fees increased significantly over a three-year period.
Concerning Tower’s use of the bond issuance, the Court agreed with the Trial Court’s expressed rationale that the bond interest payments were used for acquisitions of properties other than the hospitals. The Court also noted findings that no monies from the bond issuance went directly to the hospitals and that the hospitals’ assets were pledged as collateral.
Concerning Tower’s executive compensation and bonuses, the Court agreed that the rates of executive compensation were profit-driven and “went far beyond self-support.” The Court highlighted ties between executive compensation and the financial performance of the institution to support its finding that Tower did not operate free from profit motive. In doing so, the court dispensed with Tower’s argument that its executive compensation rates were necessary to attract and retain qualified executives. While the Court did not prohibit the consideration of financial performance in assessing executive compensation, the court upheld the trial court’s finding that Tower’s practice of basing 40% of the total incentive bonus for executive compensation on the financial performance of the company was evidence of a profit motive supporting the denial of nonprofit tax exemptions. The Court also reinforced the concept that the HUP Test “may preclude a tax exemption even though less [than] the majority of an employee’s compensation is not based on the institution’s financial performance.”
These cases suggest a shift in focus for nonprofit tax exemption analysis under the HUP Test from property operations to institutional management. While the Court does set forth the specific corporate structure of Tower, the holdings do not suggest that the corporate structure is determinative, or that courts will look separately at the HUP criteria as to each distinct entity in that structure. This shift, if continued, suggests that courts will scrutinize the overall entity, including executives and management, to assess whether the institution is “operating entirely free from private profit motive.”
In Allegheny County, the City of Pittsburgh has specifically created a task force to explore the HUP status of “purely public charities,” particularly the larger, significant property owners. These cases may provide a road map for the City to apply this application of the HUP Test to any significant “purely public charity.”
Client Alert 2023-062
- Brandywine Hosp., LLC v. Cnty. of Chester Bd. of Assessment Appeals, 2023 Pa. Commw. LEXIS 14, *17-18 (Pa. Commw. Feb. 10, 2023); Jennersville Hosp., LLC v. Cnty of Chester Bd., 2023 Pa. Commw. Unpub. LEXIS 75 (Pa. Commw. Feb. 10, 2023); Phoenixville Hosp., LLC v. Cnty. of Chester Bd. of Assessment Appeals, 2023 Pa. Commw. Unpub. LEXIS 73 (Pa. Commw. Feb. 10, 2023).
