Emerging Trends Towards the Taxation of Non-Profits

Transcription

1 Emerging Trends Towards the Taxation of Non-Profits Brian Grossman Worsek & Vihon LLP Chicago, Illinois Jeff Gordon Archer & Greiner P.C. Princeton, NJ

2 Introduction Reported at 28 N.J. Tax 456 (Tax Ct. 2015) Tax Court of New Jersey Trial Court No appellate case (settlement)

3 Failure of Proofs This determination is based substantially on a failure of the evidence. Simply put, the Hospital has failed to meet its burden of proof... Primary fact witnesses: the court found their testimony at times to be less than forthcoming, and often lacking in sufficient support or foundation. Their memory and recollection of details, facts and events, particularly on cross-examination, were somewhat selective. CPA/expert: he was neither offered nor qualified as an expert witness. The objections by Morristown s counsel were sustained.

4 Legal Standard New Jersey Supreme Court s 3-Prong Test: 1. Organizational Prong Is the entity organized for the exempt purpose? (Hospital won summary judgment) 2. Use Prong is the property used for the exempt purpose? (hospital won summary judgment) 3. Profit test whether the property and the institution using it are operated for profit? (at issue) Rejection of Kimberley School v. Montclair, 2 N.J. 28 (1949) and progeny s dominant motive test

5 Judge Bianco s Five Primary Analyses: 1. Private, for-profit doctors use of hospital (more to follow) 2. Hospital was intermingled with captive for-profit P.C. s, affiliated and non-affiliated for-profit entities, and an affiliated for-profit insurance company. 3. Executive compensation found excessive ($5MM). 4. Employee doctor s contracts showed a profit-driven commercial nature due to incentives (for professional billings, increase in revenues from new patients, qualitative improvements and other arrangements). 5. Third-party agreements had profit-driven incentive terms (increased NOI).

6 #1 is Key use by private, for-profit physicians: Doctors with privileges and exclusive licenses were forprofit doctors not employed by AHS. Received income for services rendered inside hospital Their areas of use would not be exempted. AHS testimony failed to limit those areas: Physicians actually are allowed anywhere in the hospital... they do their work everywhere, furthermore, she stated any physician in the hospital if requested could deliver services in the facility (emphasis in original).

7 Settlement before valuation trial 3 years in ruling - $10MM+ taxes, interest, penalties Interest and penalties: $550,000/year for 10 years Akin to a 10 year, unshared PILOT for municipality

8 Settlement All other years of appeal withdrawn by both parties 2016 and future Less taxed area -- leased areas and space used under exclusive professional service agreements Assessed market value of $105 PSF What about 3 rd parties?

9 Settlement Footnote 76 create third party concerns? [I]t is clear that the Hospital does not meet the criteria for property tax exemption for nearly all of the Subject Property. Therefore, any settlement 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 the court. The parties are free to negotiate a settlement on the remaining tax appeals yet to be tried. But settlement increased exempt area

10 Settlement Ease of 3 rd Party Challenge? Same Judge (Bianco) more recently ruled that a third party may challenge a tax exemption, and the burden of proof will be on the non-profit owner. Fields v. Trustees of Princeton University, 28 N.J. Tax 574 (Tax Ct. 2015) Wipes away the exemption -- owner has to re-prove in court as if not granted No presumption of correctness Grants citizens veto rights over the tax assessor Settlement: AHS must defend any 3 rd party challenges

11 What does the ruling mean for hospitals? Fact sensitive analysis, but Judge Bianco indicates that most or all hospitals lose their exemption under the decision: If it is true that all non-profit hospitals operate like the Hospital in this case, as was the testimony here, then for purposes of the property tax exemption, modern nonprofit hospitals are essentially legal fictions... Clearly, the operation and function of modern non-profit hospitals do not meet the current criteria for property tax exemption under N.J.S.A. 54:4-3.6 and the applicable case law.

12 Other Municipalities responses Some removed exemptions (hospitals appeal; refund exposure for towns) A few continued exemptions pending legislation (status quo) Most kept the exemption but town appealed to remove Some settlements - partial exemptions and/or contribution agreements (risk third-party challenges)

13 Counter-strategies with the courts? Avenues for judicial challenge Subsequent case: By hospital with better facts With a different trial judge and/or appellate courts Potential areas of challenge Appellate courts broader policy viewpoint Various parts, including 1918 hospital inconsistency Dominant motive test under Prong 3 (profit test) of Paper Mill Playhouse

14 Counter-strategies with the courts? N.J.S.A. 54:4-3.6 requires that the property or institutions using and occupying them are not conducted for profit. Kimberley School, 2 N.J. 28 (1949) dominant motive test: the test imposed by the statute is simply whether or not the [claimant] is conducted for the purposes of making a profit. To determine such purpose, the court enumerated a list of factors to consider that may bear[] upon the ascertainment of the dominant motive in the conduct of the [claimant]. The court eliminated the existing judicial gloss. A court s sole function is to determine on all the facts, present and past, whether the [claimant is] being run for the purpose of making money.

15 Counter-strategies with the courts? Next: 1960 Appellate Court re Rider University: [i]f the college does show operational surpluses from some years, the crucial inquiry is who gets the money? If we can trace it into someone s personal pocket, as the raison d etre of the school, then even though the form of operation is that of so-called non profit organization, the college is not entitled to tax exemption, despite its educational function. City of Trenton v. State of New Jersey, 65 N.J. Super. 1, 12 (App. Div. 1960).

16 Counter-strategies with the courts? Next: 1983 Supreme Court in Paper Mill Playhouse, 95 N.J. 503, 506 (1983). A crucial factor, it held, is where the profit goes. As the Appellate Division stated, [i]f the college does show operational surpluses for some years, the crucial inquiry is, Who gets the money? If we can trace it into someone s personal pocket...the college is not entitled to tax exemption. (quoting Rider case) Language hidden in the underlined ellipses: as the raison d etre of the school

17 Counter-strategies with the courts? Subsequent Tax Court decisions: Due to the Pediatricians incentive plans, a portion of surplus revenues can be traced to someone s personal pocket this diversion of part of the surplus revenues to the physicians characterized the Practice as operated for a profit-making purpose. Hunterdon Med. Center v. Readington Tp, 22 N.J. Tax 302, 319 (Tax Ct. 2005) (this portion affirmed).

18 Counter-strategies with the courts? Subsequent Tax Court decisions: In Paper Mill Playhouse, supra, the Court set forth the principal criterion by which courts have since determined whether or not a corporation is operated for profit: whether the profits can find their way into anyone s pockets. Presbyterian Home at Pennington v. Pennington, 23 N.J. Tax 473 (Tax Ct. 2007) (rev d on other grounds).

19 Counter-strategies with the courts? Subsequent Tax Court decisions: A crucial factor is where the profit goes. If [the court] can trace it into someone s personal pocket [the hospital] [will] not be entitled to a tax exemption. AHS Hospital Corp. D/B/A v. Town of Morristown, 25 N.J. Tax 374, 383 (Tax Ct. 2010).

20 Changing facts or trial presentation 1. Private, for-profit physicians use of space Facts: End private practice relationships. Limit areas where private practices/ companies perform and earn fees. ( ring-fence in agreements, plans, policies, etc.)

21 Changing facts or trial presentation 1. Private, for-profit physicians use of space Trial presentation: Present proofs that third-party fees are earned in a limited area For hospitals, show that bundled fees tie to a spatially limited area (surgeon earns $ in O.R., not post-op room visits)

22 Changing facts or trial presentation 2. Intermingling with captive P.C. s, affiliated and non-affiliated for-profit entities, and a for-profit insurance co. Facts: No use of captive P.C. s. Use employee doctors. Obtain federal non-profit status for P.C s. Alter or eliminate relationships with affiliated or unaffiliated for-profits. Avoid co-mingling -- separate accounting and use of space. Be able to show that NFP benefits not flowing to forprofit companies per International Schools). Do all transactions at market rates (transfer pricing).

23 Changing facts or trial presentation 2. Intermingling with captive P.C. s, affiliated and non-affiliated for-profit entities, and a for-profit insurance co. Trial presentation: Show inability to form captive P.C. s as NJ non-profits. Show no profit-driven motivation for for-profit affiliations Demonstrate separate accounting, and lack of benefits flowing to for-profits. Justify subsidizing of for-profits, e.g. community benefit, Medicare, charity care, and EMTALA requirements). Show inconsistencies between ISS and Pingry cases.

24 Changing facts or trial presentation 3. Executive compensation found to be excessive Facts: Make sure compensation is reasonable and comparable to compensation paid by similar institutions Have third-party compensation studies document work sufficient to meet legal standard (w/i legal limits) Trial Presentation: Show the process used by the comparables is proper Show the comparables were reasonable/not excess - investigate and confirm each

25 Changing facts or trial presentation 4. Incentive contracts with employee doctors, based on professional billings, increase in revenues from new patients, qualitative improvements and other arrangements Facts: No percentage sharing or incentive based comp (in spite of non-property tax policy reasons) Flat fee salaries seem the safest approach.

26 Changing facts or trial presentation 4. Incentive contracts with employee doctors (cont.) Trial Presentation: Present justifications for incentive contracts showing lack of profit motive, including legal requirements. E.g., Affordable Care Act, Medicare requirements, NJ Nonprofit Corporation Act, NJ s version of the Uniform Prudent Management of Institutional Funds Act (fiduciary duties). Hospitals triple aim motivation increase quality of care and patient satisfaction; improve health of the population; and reduce costs.

27 Changing facts or trial presentation 5. Third-party agreements entered into by the hospital Facts: Change outside service provider agreements to remove sharing of excess income or expense savings (incentives) Flat fee contracts were acceptable to Judge Bianco. Trial Presentation: Present justification for incentive contracts showing lack of profit motive, including legal requirements E.g., Affordable Care Act, Medicare requirements, NJ Nonprofit Corporation Act, and NJ s version of the Uniform Prudent Management of Institutional Funds Act.

28 Possible legislative solutions Legislative action? Clarify and confirm hospital exemption Payments in lieu of tax/mandatory contributions Valuation to include consideration of federal nonprofit requirements Clarify that third parties cannot appeal exemptions

29 Who else is in the cross-hairs? SNFs and ALFs, particularly if tied to a hospital found to be taxable? Charitable organizations? Religious organizations? Educational institutions? All (for-profit prong)?

30 Illinois In Illinois, taxation is the rule. Tax exemption is the exception. All property is subject to taxation, unless exempt by statue in conformity with the Illinois constitution. Provena Covenent Med. Ctr v. Dept of Revenue, 236 III. 2d 368 (2010) 30

31 Illinois Constitution- Article IX, Section 6 The General Assembly by law may exempt from taxation only the property of the State, units of local government and school districts and property used exclusively for agricultural, and horticultural societies, and for school, religious, cemetery and charitable purposes. 31

32 Exclusively Used Primary purpose for which property is used and not any secondary or incidental purpose. Methodist Old Peoples Home v. Korzen, 39 Ill 2d 149 (1968) 32

33 Charitable Use Charitable use is a constitutional requirement. An applicant for a charitable-use property tax exemption must comply unequivocally with the constitutional requirement of exclusive charitable use. Eden Retirement Center, Inc. v. Department of Revenue, 213 Ill. 2d 273 (2004) 33

34 Charitable Ownership Methodist Old Peoples Home v. Korzen, 39 Ill. 2d 149, (1968), Five distinctive characteristics of charitable institutions 35 ILCS 200/15-65(a)- institutions of public charity. 34

35 Charity A gift to be applied for the benefit of an indefinite number of persons for their general welfare or in some way reducing the burdens of government. Methodist Old Peoples Home v. Korzen, 39 Ill 2d 149 (1968) 35

36 Tax Exemption Must be determined on a case by case basis. Provena Covenant Med. Ctr. v. Dept of Revenue, 236 Ill 2d 368 (2010) 36

37 Provena Court denied a property exemption finding that the true owner of the property was not a charitable institution. Provena Covenant Med. Ctr. v. Dept of Revenue, 236 Ill 2d 368 (2010) 37

38 Charitable Use? Provena Court split Two justices concurred in part and dissented in part: by imposing a quantum of care requirement and monetary threshold, the plurality is injecting itself into matters best left to the legislature. Provena Covenant Med. Ctr. v. Dept of Revenue, 236 Ill 2d 368 (2010) 38

39 Property Tax Code Revised To be eligible for a property tax exemption, the value of qualifying services or activities for the hospital year must equal or exceed the hospital estimated property tax liability for the year for which the exemption is being sought. 35 ILCS 200/15-86(c), effective July

40 Hospital Owner The preamble of the new statute defines hospital owner as a not for profit corporation. 35 ILCS 200/15-86(b)(2) 40

41 Valuation Determining property tax liability per the Illinois Property Tax Code: Cost approach 35 ILCS 200/15-86(g) 41

42 Section constitutional? No! Per 4 th District Illinois Appellate Court. The statute does not state that the property must be used exclusively for charitable purposes. The legislature lacks constitutional authority to authorize an exemption regardless of whether the property is used for charitable purposes. Carle Foundation v. Cunningham Twp, 2016 IL app (4 th )

43 Section constitutional? Yes! Per 1 st District Illinois Appellate Court. The statute preamble referenced Provena and stated it is not the intent of the General Assembly to declare any property exempt ipso facto, but rather to establish criteria to be applied to the facts on a case by case basis. Oswald v. Hamer, 2016 IL App (1 st )

44 1 st District Appellate Court The word shall in the new statute is directory rather than mandatory. Oswald v. Hamer, 2016 IL App (1 st )

45 Illinois Supreme Court Vacated the unconstitutional ruling of the 4 th District Illinois Appellate Court because the appellate court did not have jurisdiction. The case was remanded to the trial court for further proceedings. Carle Foundation v. Cunningham Twp, 2017 IL (opinion filed March 23, 2017) 45

46 Oswald v. Hamer Oswald filed a PLA with the Illinois Supreme Court on May 24,

47 Hospitals Valuation Issues Use of value in settlements and PILOT agreements Settlements providing for partial taxation E.g., AHS settled at $105/SF for taxed areas Know your true tax liability exposure when negotiating PILOT agreements, contribution agreements, or settlements

48 Hospitals Valuation Issues Sales approach Relevant comparables? Going-concerns, dark buildings, and different highest and best use Income approach BEV? Many hospitals have negative net income

49 Cost approach? Hospitals Valuation Issues High RCN (taxing authority may advocate this approach) Measurements of obsolescence NJ s Borgata decision: Given that so much of the value of a casino-hotel s real property is tied to the earning potential of gaming operations, a credible analysis of economic conditions and the translation of those conditions into an appropriate measure of economic obsolescence are essential to reaching a reliable value under the cost approach.

50 Cost approach? Hospitals Valuation Issues Measurements of obsolescence Simplified income shortfall method, e.g. $400 PSF RCN x 10% return = $40 PSF expected income $8 PSF actual income $32 shortfall $32/40 = 80% depreciation from all forms

51 Emerging Trends Towards the Taxation of Non-Profits Brian Grossman Worsek & Vihon LLP Chicago, Illinois Jeff Gordon Archer Law Princeton, NJ