TAX ASSESSMENT AND TAX EXEMPTION APPEALS: HOW TO SURVIVE LURKING DANGER. There is much to talk about!

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1 TAX ASSESSMENT AND TAX EXEMPTION APPEALS: HOW TO SURVIVE LURKING DANGER Stephen B. Skrocki North Penn School District (215) Howard L. Kelin, Esq. Kegel Kelin Almy & Lord LLP (717) There is much to talk about! 1. Every Business Manager Must Know 2. Aftermath of Downingtown Decision 3. District Initiated Appeals 4. Recent Developments and Best Practices in Tax Exemption Appeals 2 Following are ten basic rules school business officials must understand regarding tax assessment cases. 3 Tax Assessments and Tax Exemptions 1

2 1. Laws against spot reassessments prohibit a county assessment office from adjusting a property s tax assessment based on the price at which the property is sold. Taxpayers can file an appeal based on a recent purchase price. School Districts and municipalities can also file an appeal based on a recent purchase price. Weissenberger v. Chester County Board of Assessment Appeals, 62 A.3d 501 (Pa. Cmwlth. 2013). The County, though, can only adjust the tax assessment if: (1) there is a change in the size of the tax parcel, (2) there is a change to the improvements on the property, or (3) there is a countywide reassessment The tax assessment amount for each parcel is intended to reflect the fair market value of the property during the base year, which is the valuation year used for the county s last countywide reassessment. Example: Montgomery County uses a base year of 1996, the year of valuation for its last countywide reassessment. All properties in Montgomery County are currently assessed based upon their perceived fair market value in Some other base years : Lancaster County = 2005 York County = 2006 Dauphin County = 2001 Berks County = 1994 Chester County = Tax Assessments and Tax Exemptions 2

3 3. There are two arguments permitted to challenge an assessment. First, appeal the value as of the base year. In Montgomery County, where the base year is 1996, a property assessed at $1 million can be appealed by arguing it was not worth $1 million in This approach is rarely used. 7 Second, appeal the current value of the property as of the date the appeal is filed. This is the more frequent type of appeal 8 4. To translate a parcel s tax assessment amount to the property s current fair market value, you must apply the common level ratio (the CLR ) to the property s assessment amount for the applicable tax year. This gets complicated! The common level ratio for each county is issued each year by the State Tax Equalization Board or STEB. CLR figures for every county are supposed to be issued before June 30 each year but sometimes are issued later. 9 Tax Assessments and Tax Exemptions 3

4 5. The CLR is in part retroactive. The CLR figures issued each year are based upon real estate sales information from the prior year. The CLR figures issued in June 2014 are thus called the 2013 CLR figures. The 2013 CLR figures for each county compare 2013 real estate values within the county to real estate values within the county during the county s base year. 10 Example of retroactivity of the CLR: The 2013 CLR for Montgomery County, which was issued in 2014, is 57.5%. This means that real estate values within Montgomery County during the base year of 1996 were 57.5% of what they were during 2013 (the valuation year for the CLR issued in 2014). 11 Some other 2013 CLRs issued in June 2014: Lancaster County = 79.1% York County = 88.0% Dauphin County = 74.2% Berks County = 76.3% Chester County = 57.7% 12 Tax Assessments and Tax Exemptions 4

5 6. The CLR is not only in part retroactive, it is also in part prospective. The CLR is applied prospectively to tax assessments for the year after it is issued. The 2013 CLR figures, issued in 2014, are applied to the 2015 tax year (for school districts, the school year). Thus, 2013 values are used for 2015 appeals this two year gap is a big problem when values drop quickly! 13 Example of prospective application of the CLR: o As noted previously, the 2013 CLR for Montgomery County, issued in 2014, is 57.5%. o The 2013 CLR of 57.5% is applied to tax assessments in Montgomery County for 2015 (or in for Montgomery County s school districts) There are two ways the CLR is used in tax assessment appeals: First, if a property has been appealed, and you want to know the fair market value necessary to uphold the current tax assessment, divide the assessment by the CLR: o Example: A property is assessed at $1 million, and the CLR applicable to the tax year is 80%. o $1,000,000 divided by.80 = a fair market value of $1,250,000 is necessary to maintain the current tax assessment of $1 million. o This figure of $1,250,000 is sometimes called the implied fair market value, meaning the fair market value implied for a property that is assessed at $1 million where the CLR is 80%. 15 Tax Assessments and Tax Exemptions 5

6 Second, if a taxpayer (or a taxing authority) submits an appraisal providing an opinion of a property s fair market value, and you want to know the new tax assessment based on that opinion, multiply the appraiser s opinion of fair market value by the CLR: o Example: A property is assessed at $1 million, the CLR applicable to the tax year is 80%, and an appraiser says the fair market value of the property is $750,000. o As stated in the prior example, a fair market value of $1,250,000 is necessary to maintain the current assessment of $1 million. o To see what the new assessment would be if the taxpayer s appraisal if found to be correct: ($750,000 FMV opinion of appraiser) x (CLR of.80) = $600, Appraisers use three methodologies to determine a property s fair market value typically all three approaches are not used. Sales comparison approach determining the property s value based on recent sales prices of other properties that are comparable to the subject property. Income approach determining the property s value based on what an investor would pay for the stream of rental income to be derived from the property. Cost approach determining the property s value based on what it would cost to reproduce the subject property in today s dollars, with deductions for the property s physical depreciation and obsolescence Only the real estate is valued for an assessment, not the value of the going concern of a business. Value derived from operating a business is not included in the assessment, unless value is derived from use of the real estate itself. For instance, income from operating a hotel is considered, but income from operating a manufacturing plant is not considered. Fixtures to real estates are considered, unless they comprise part of the machinery and equipment of an industrial plant (i.e., a large concrete dam at a hydroelectric plant is a fixture, but is excluded from the tax assessment as machinery and equipment integral to the generation of electricity). 18 Tax Assessments and Tax Exemptions 6

7 10.Where taxpayers are entitled to a tax refund as the result of a court decision, the taxpayer is entitled to receive interest on the refund from the date the overpayment was made not from the date the court established a new assessment. 53 Pa. C.S 8854(c). Need to move cases along! Business managers should urge prompt action by legal counsel at the outset of the appeal. Include in all settlement stipulations that no interest will be paid on the refund. 19 Downingtown Decision under Uniformity Clause of the PA Constitution Pursuant to the Consolidated County Assessment Law, 53 Pa. C.S. 8844(e)(2): The assessment = o (FMV) x ( Established Predetermined Ratio or EPR as set by each county, which is 100% in 42 of 67 counties). o UNLESS the Common Level Ratio varies by more than 15% from the EPR, in which event the assessment = (FMV x CLR). 20 Downingtown Decision under Uniformity Clause of the PA Constitution But, in Downingtown Area School District v. Chester County Board of Assessment Appeals, 590 Pa. 459, 913 A.2d 194 (2006) PA Supreme Court held that even if the CLR is within 15% of the EPR, the assessment does not necessarily equal the FMV as required by statute, because the Uniformity Clause of PA Constitution permits appeals that compare the tax assessment of a parcel to the tax assessment of other similar parcels. 21 Tax Assessments and Tax Exemptions 7

8 Downingtown Decision under Uniformity Clause of the PA Constitution Uniformity Clause requires that taxes are uniform upon the same class of subjects. In Downingtown, shopping center assessed at $5.8 million sold for $10.4 million. The parties stipulated the FMV was $8.5 million. The CLR was 85.2% and the EPR was 100%. School district appealed and argued that under the statutory scheme, because the CLR of 85.2% was within 15% of the EPR of 100%, the assessment should be $8.5 million, with no decrease due to the CLR. 22 Downingtown Decision under Uniformity Clause of the PA Constitution Taxpayer presented uncontested evidence that the ratio of assessed value to actual value for comparable properties within the County was as high as 69% and as low as 34%. Based on this wide range, the Supreme Court held that prohibiting a uniformity challenge under the statutory language rule violates the PA Constitution. 23 Downingtown Decision under Uniformity Clause of the PA Constitution Bottom line: Regardless of whether CLR is within 15% of the EPR, taxpayers can argue lack of uniformity by comparison to assessments of other similar properties. A taxpayer can argue that although its assessment is accurate based on FMV of the property, the assessment must nonetheless be reduced, because other similar properties within the same county are underassessed, and thus, the taxpayer s assessment violates the Uniformity Clause. Since Downingtown, courts have been working out rules for the extent of evidence of other similar properties that is necessary to prevail on a Uniformity Clause challenge. Commonwealth Court has indicated that a taxpayer has a high burden to prove its case. In re Sullivan, 37 A.3d 1250 (Pa. Comnwlth. 2012). 24 Tax Assessments and Tax Exemptions 8

9 Downingtown Decision under Uniformity Clause of the PA Constitution More bottom line on Downingtown: Although not required by Downingtown, some county assessment boards have concluded that CLR must be applied even if the CLR is within the 15% rule and Downingtown type argument is not asserted by taxpayer. 25 District Initiated Assessment Appeals Legal Background Myth: A district initiated assessment appeal is considered a spot assessment and is not legal. Reality: Commonwealth Court recently confirmed the right of taxing bodies to initiate appeals of assessments on properties. Weissenberger v. Chester County Board of Assessment Appeals, 62 A.3d 501 (Pa. Cmwlth. 2013). 26 District Initiated Assessment Appeals Preliminary Decision Points School board must support appeal concept. School board may decide revenue increase is not worth the potential political fallout. School board should provide parameters on the type of cases to appeal. 27 Tax Assessments and Tax Exemptions 9

10 District Initiated Assessment Appeals Process for recent sales: Examine the monthly report from county Recorder of Deeds Office which lists monthly sales transactions. Compare sales price to implied value based on tax assessment. Seek large discrepancies (% or $) between the assessed value and sales price. Employ an appraiser to provide an appraisal report for those properties with large discrepancies. 28 District Initiated Assessment Appeals File appeal with county board of assessment. Send a letter to property owners informing them of appeal. Submit materials to legal counsel. Attend assessment appeal hearing. After assessment board renders a decision, determine if additional appeal to Court is necessary. 29 District Initiated Assessment Appeals Outcomes: Penn Manor School District in Lancaster County initiated well over 100 assessment appeals over a 13 year period. Cumulative new revenue over $1 million. 30 Tax Assessments and Tax Exemptions 10

11 District Initiated Assessment Appeals Outcomes: Upper Merion Area School District in Montgomery County initiated 41 appeals over a 4 year period. 8 settlements to date: $650 K retroactive revenue $750 K new annual revenue 31 District Initiated Assessment Appeals Outcomes: North Penn School District in Montgomery County initiated over 30 appeals over a 4 year period. Settlements are generating over $2 M per year in additional revenue. 32 Legal Developments and Best Practices in Tax Exemption Appeals Start by distinguishing between concepts of tax immunity and tax exemption. Immunity from taxes applies to the Commonwealth including agencies and instrumentalities of the Commonwealth such as municipalities, municipal authorities and school districts. Property owned by sovereign entity is presumed to be immune burden of proof is on locality seeking to demonstrate property is taxable. City of Philadelphia v. Cumberland County Board of Assessment Appeals, 81 A.3d 24 (Pa. 2012). 33 Tax Assessments and Tax Exemptions 11

12 Immunity not lost simply because sovereign entity holds real estate as a buffer around its own use. Delaware County Solid Waste Authority v. Berks County Board of Assessment Appeals, 626 A.2d 528 (Pa. 1993). But immunity is lost if sovereign entity leases property to rent paying private interest. SEPTA v. Board of Revision of Taxes, 833 A.2d 710 (Pa. 2003). 34 In contrast, a tax exemption is not presumed to apply. It is a carve out from property presumed to be taxable. Burden of proof is on party seeking tax exemption. Lehigh Northampton Airport Authority v. Lehigh County Board of Assessment Appeals, 889 A.2d 1168 (Pa. 2005). This presentation will focus on exemptions, not immunity issues. 35 For exemptions, start by looking at the Pennsylvania Constitution, Article VIII, entitled Taxation and Finance. As an initial premise, under the uniformity clause, the Constitution requires that taxes shall be uniform upon the same class of subjects, within the territorial limits of the authority levying the tax. Article VIII, Section Tax Assessments and Tax Exemptions 12

13 However, Article VIII, Section 2(a) of the Constitution then provides that uniformity is not required in all instances, by authorizing the General Assembly to adopt laws exempting the following from taxes: places of worship non profit cemeteries public property used for public purposes property owned and used by veterans for charitable or patriotic purposes institutions of purely public charity 37 In response to this invitation in the Constitution, the General Assembly has adopted legislation approving tax exemptions for a number of different classifications, including for real estate owned and used by purely public charities. 53 P.S. 8812(a)(3) provides a tax exemption for hospitals, universities, colleges, seminaries, academies, associations and institutions of learning, benevolence, or charity, including fire and rescue stations... founded, endowed and maintained by public or private charity. 53 P.S. 8812(a)(11) provides a tax exemption for real estate owned and occupied by institutions of purely public charity that is necessary for the occupancy and enjoyment of such institutions so using it. 38 Important point: Simply because a non profit organization qualifies for a federal tax exemption as a Section 501(c)(3) charitable organization, it is not automatically entitled to a real estate tax exemption as a purely public charity under Pennsylvania law. Rather, the entity must meet the tests to qualify as a purely public charity under both (1) the Pennsylvania Constitution, and (2) a state law adopted by the General Assembly as Act 55 of 1997, called the Institutions of Purely Public Charity Act. Mesivtah Eitz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa. 2012) 39 Tax Assessments and Tax Exemptions 13

14 Constitutional Test for Purely Public Charity Under the Supreme Court s HUP Decision The test for whether an institution qualifies as a purely public charity under the Pennsylvania Constitution has been established by the Pennsylvania Supreme Court, through what is known as the HUP Test, named after Hospital Utilization Project v. Commonwealth, 487 A.2d 1306 (Pa. 1985). 40 HUP Test Under the HUP Test, for an entity to qualify as a purely public charity it must possess all of the following five characteristics: 1. Advances a charitable purpose; 2. Donates or renders gratuitously a substantial portion of its services; 3. Benefits a substantial and indefinite class of persons who are legitimate subjects of charity; 4. Relieves the government of some of its burden; and 5. Operates entirely free from private profit motive. 41 Supreme Court HUP Test for Retirement Communities In re St. Margaret Seneca Place, 640 A.2d 380 (Pa. 1994). 156 bed nursing home no independent living or assisted living component. Almost 60% of patients were on Medicare or Medicaid. 48% were on Medicaid, which covered only 2/3 of the cost of services provided. 42 Tax Assessments and Tax Exemptions 14

15 St. Margaret Seneca Place Commonwealth Court had rejected tax exemption in St. Margaret Seneca Place, finding that accepting Medicare/Medicaid payments for services does not count as providing charity care. Analogized to an airline selling seats at different rates in order to fill the plane. Supreme Court reversed, finding that accepting Medicare/Medicaid patients at reimbursement substantially below the full cost of providing service constitutes charitable care, which relieves the government of its burden of caring for the elderly in public nursing homes. 43 St. Margaret Seneca Place The Supreme Court s definition of the HUP Test in the context of retirement communities in St. Margaret Seneca Place substantially eased the burden for nonprofit retirement communities to qualify as a purely public charity. In retirement community cases after St. Margaret Seneca Place, courts began to look closely at the percentage of patients or residents served on Medicaid or Medicare, analyzing the amount of the actual cost of care not covered by these government sources. The courts then determined if uncovered costs met the subjective test under HUP of donating a substantial portion of services. 44 After St. Margaret Seneca Place There is no objective measure under the Constitution for meeting this requirement: [T]he determination as to whether the services donated are substantial under the HUP test is to be made based on the totality of the circumstances; there is no bright line test, based on a certain percentage of donated services, for resolving this question. Lehighton Area School District v. Carbon County Board of Assessment, 708 A.2d 1297, 1303 (Pa. Cmwlth. 1998) (citations omitted, emphasis added). 45 Tax Assessments and Tax Exemptions 15

16 Statutory Test Under Act 55 In response to criticism that the Supreme Court s HUP test was too subjective and under significant lobbying pressure seeking liberalization of the exemption the General Assembly passed Act 55 in Act 55 essentially retains the same five factors for courts to evaluate from the HUP test, but with objective fiscal guidelines for obtaining exempt status. Although the stated purpose of Act 55 was to supplant the more subjective HUP test, the Supreme Court ruled in 2012 in Mesivtah that as a threshold matter before considering the statutory exemption test under Act 55, an entity must first pass the Supreme Court s traditional exemption test under HUP. 46 Statutory Test Under Act 55 Thus, to obtain tax exempt status as a purely public charity, an institution must qualify under both the HUP test and Act 55. As with the HUP test, under Act 55 often the most significant of the five qualifying factors is whether the institution donates or renders gratuitously a substantial portion of its services. 10 P.S. 375(d)(1). Act 55 lists seven different ways an institution can meet this requirement; the institution needs to meet only one of the following financial criteria to donate or render gratuitously a substantial portion of its services. These are very specific tests, which require very detailed analysis to evaluate. 47 Statutory Test Under Act 55 One of the seven ways to meet the substantial donations test: Provide financial assistance or uncompensated goods or services to at least 20% of those receiving similar goods or services from the institution if at least 10% of the individuals receiving goods or services from the institution either paid no fees or fees which were 90% or less of the cost of the goods or services provided to them, after consideration of any financial assistance provided to them by the institution. 48 Tax Assessments and Tax Exemptions 16

17 Statutory Test Under Act 55 Under this approach, meet the substantial donations test if: 10% of residents receive 1% donated services; and another 10% of residents receive 10% donated services Compared to 40% Medicaid in St. Margaret Seneca Place! 49 Statutory Test Under Act 55 Another of the seven ways to meet the substantial donations test: Provide uncompensated goods or services that in the aggregate are equal to at least 5% of the institution's costs of providing goods or services. Notably, for purposes of calculating the amount of their donated services under the foregoing standards, Act 55 permits institutions to include the financial value of volunteer hours contributed by students and other community members. 50 Menno Haven Decision: Some Good News On March 7, 2007, the Commonwealth Court decided Menno Haven, Inc. v. Franklin County Board of Assessment and Revision of Taxes, 919 A.2d 333 (Pa. Cmwlth. 2007), appeal denied, 940 A.2d 367 (Pa. 2007). Menno Haven operated a nursing home, an assisted living facility and an independent living center. Only the nursing home component was tax exempt. Chambersburg Area School District joined with the other taxing authorities in seeking to revoke the exempt status of the nursing home. 51 Tax Assessments and Tax Exemptions 17

18 Commonwealth Court concluded that Menno Haven failed the second and third components of the HUP Test: o Does not donate or render gratuitously a substantial portion of its services. o Does not benefit a substantial and indefinite class of persons who are legitimate objects of charity. Key factor in the Commonwealth Court s decision is that fewer than 30% of Menno Haven s nursing home patients were eligible for Medicaid. Comparing this to the 48% of Medicaid eligible patients in the nursing home in St. Margaret Seneca Place, the Commonwealth Court concluded that 30% was not adequate to meet the requirement of donating a substantial portion of services. 52 Another key factor was that although Menno Haven lost money through the operation of its nursing home, those losses were subsidized by the up front fees paid by residents moving into the independent living facility. Fee ranged between $45,000 and $225,000 depending on the unit chosen. Menno Haven provided continuing care for independent living residents into assisted living and nursing home care even if such residents ran out of money. The Commonwealth Court noted that only 8% of nursing home residents who came from outside Menno Haven s independent living and assisted living community were Medicaid eligible. 53 Thus, Menno Haven primarily caters to well to doelderly and to those already within their community. Menno Haven charges a hefty entrance fee and is caring for the Medicaid eligible residents that come from within the Menno Haven community because of an obligation to do so rather than a sense of charity or out of a bona fide effort to service those that cannot afford the per diem rate. 54 Tax Assessments and Tax Exemptions 18

19 Bottom line of Menno Haven: Evaluated solely as a nursing home residence. Serving 30% Medicaid patients is an insufficient donation to qualify as a purely public charity under the HUP Test even if the nursing home operates at a loss if the nursing home is subsidized by up front fees paid by residents of an independent living facility that is part of the same Continuing Care Retirement Community ( CCRC ). 55 Similar Result in In Re Appeal of Dunwoody Village 52 A.2d 408 (Pa. Cmwlth. 2012) Although the retirement community met the 5% rule under Act 55 (donating at least 5% of its cost to provide goods and services), it did not accept Medicaid residents and failed the totality of the circumstances test. Only 8 or 9 of 400 residents received donated care from Dunwoody Village. Found not to be a purely public charity. 56 Alliance Home Decision 919 A.2d 206 (Pa. 2007) Alliance Home of Carlisle operates Chapel Pointe, a licensed CCRC that includes a 59 bed skilled nursing home, a 53 bed assisted living facility and an independent living facility with 93 apartments. The skilled nursing and assisted living facilities had already enjoyed tax exempt status, and Chapel Pointe sought a further tax exemption for its independent living facility. This request was denied by the Cumberland County Board of Assessment Appeals, the Court of Common Pleas for Cumberland County and the Commonwealth Court. 57 Tax Assessments and Tax Exemptions 19

20 At all levels, the basis for denial was that Chapel Pointe s independent living facility did not donate or render gratuitously a substantial portion of its services and thus did not qualify by itself as a purely public charity under the HUP Test or Act 55, even though Chapel Pointe s nursing home/assisted living component qualified as a purely public charity. This parcel by parcel approach to evaluating tax exempt status of a retirement community had been previously approved by the Commonwealth Court in Appeal of Lutheran Social Services, 539 A.2d 895 (Pa. Cmwlth. 1988), and Appeal of Bethlen Home, 557 A.2d 828 (Pa. Cmwlth. 1989). 58 The Supreme Court, though, determined that a parcel by parcel review of a CCRC is unlawful, and reversed the Commonwealth Court s decision. Very importantly, the Supreme Court noted the parties all agreed that Chapel Pointe as an institution qualifies as a purely public charity under both HUP and Act 55. This removed from the Court s evaluation whether the entire institution (including the independent living facility) meets the HUP Test and the requirements of Act The Court then concluded that because the independent living facility is actually and regularly used for the purposes of the institution and to advance the charitable purpose of the institution, it should be included as part of the tax exempt property. Id. at 31. The Court added that [a]lthough the independent living facility, if it were viewed in isolation or as a separate institution, might not on its own qualify as a purely public charity, its role in the comprehensive care scheme provided by appellant is consistent with, is tied to, and advances appellant s charitable purpose. Id. at Tax Assessments and Tax Exemptions 20

21 The Court also notes that its Alliance Home decision is strictly limited to components of CCRCs that serve the overriding purpose of the institution. The Court made clear that a side business venture on CCRC property that is wholly unrelated to a charitable purpose (for instance, a commercial movie theatre) would not be exempt from taxation. Id. at 33 n Legislative Efforts to Negate Judicial HUP Test in Response to Mesivtah Eitz Chaim of Bobov v. Pike Co. Brd. of Assessment App., 44 A.3d 3 (Pa. 2012) The Supreme Court had stated before Mesivtah, in non binding dicta (a statement in a court decision that is not part of the formal holding of the case), that the HUP test remains applicable notwithstanding the adoption of Act 55, and that both tests must be satisfied. Community Options, Inc. v. Board of Property Assessment, 813 A.2d 680 (Pa. 2002). Mesivtah, though, was the first time the Supreme Court expressly made such a ruling. In response, the General Assembly had expressed shock and dismay that the Supreme Court would dare to construe the Pennsylvania Constitution. 62 Legislative Efforts to Negate Judicial HUP Test in Response to Mesivtah Eitz Chaim of Bobov v. Pike Co. Brd. of Assessment App., 44 A.3d 3 (Pa. 2012) Senate Bill 4, passed by both legislative chambers in 2013, seeks to amend the Constitution to provide that only the General Assembly may define a purely public charity. Passed again by the Senate on February 17, 2015, and is now before the House. 63 Tax Assessments and Tax Exemptions 21

22 Legislative Efforts to Negate Judicial HUP Test in Response to Mesivtah Eitz Chaim of Bobov v. Pike Co. Brd. of Assessment App., 44 A.3d 3 (Pa. 2012) Steps to amend the PA Constitution: Bill must be approved by the Senate and House in two consecutive legislative sessions. Voters must approve change in a statewide public referendum. Expect to see big dollars expended by hospitals and retirement communities in support of this effort! At request of PASBO, KKAL provided testimony on this issue before the Pa. House Finance Committee in August 2013 (attachment). 64 QUESTIONS? 65 Tax Assessments and Tax Exemptions 22

23 Perspective of the Pennsylvania Association of School Business Officials (PABSO) Regarding Act 55 of 2007, the Institutions of Purely Public Charity Act Testimony of Howard L. Kelin, Esq. Before the Pennsylvania House Finance Committee, August 15, 2013 I. Introduction Mr. Chairman, and members of the House Finance Committee, on behalf of the Pennsylvania Association of School Business Officials (PASBO), thank you for the opportunity to present PASBO s perspective regarding Act 55 of 2007, the Institutions of Purely Public Charity Act, 10 P.S PASBO is very pleased the Committee is taking a hard look at Act 55. The Pennsylvania Supreme Court s decision in Mesivtah Eiz Chaim of Bobov, Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa. 2012), confirmed the Supreme Court s statement from ten years previous in Community Options, Inc. v. Board of Property Assessment, 813 A.2d 680 (Pa. 2002), that Act 55 did not replace the HUP test in establishing qualifications for a purely public charity, but instead added a legislative test that supplements the constitutional HUP test. As a result of the General Assembly s adoption of Senate Bill 4 earlier this year, with the possible result of a Constitutional amendment authorizing the General Assembly to establish the sole criteria for institutions of purely public charity, it is vitally important to closely evaluate Act 55. Time constraints associated with this hearing preclude a thorough, comprehensive presentation on PASBO s views of Act 55. This testimony will provide a summary of PASBO s key perspectives regarding tax exemptions for purely public charities. PASBO would, of course, welcome further dialogue with the Committee on this critical issue. II. Background

24 Before addressing Act 55, it is important to explain the fiscal context in which PASBO is providing this testimony. A. Heavy Reliance on Real Estate Taxes Thus, Impact of Exemptions is Acute To appreciate the impact of tax exemptions for purely public charities on school districts ability to fund educational programs, it is important to stress that the Commonwealth s funding scheme for public schools requires districts to rely heavily upon local real estate taxes. Notably, the General Assembly s practice of requiring school districts to depend heavily upon local real estate taxes to fund educational programs is increasing, and shows no sign of abating. This trend is reflected through data from the website of the Pennsylvania Department of Education. During the school year, local real estate taxes comprised 39.4% of total school district revenues, and the state provided 42.3% of total school district revenues. In contrast, in the school year (the most recent year for which PDE s website provides such data), local real estate taxes increased to 45.9% of total school district revenues, and state contributions decreased to 38.7% of total school district revenues. In sum, as the state s percentage of contributions toward total school district revenues has decreased over time, local real estate taxes have replaced state funding as the leading source of school district revenues. It is important to recognize that because reduced state contributions have increased the relative significance of real estate tax revenues to school districts, reductions in real estate taxes due to tax exemptions for purely public charities have had (and will continue to have) an increasingly severe impact on districts ability to fund educational programs. B. Act 1 of 2006 Amplifies Severe Impact of Real Estate Tax Exemptions

25 Act 1 of 2006, the Taxpayer Relief Act, 53 P.S et seq., has increased even further the adverse financial impact of tax exemptions on school districts. Before Act 1, a school district had somewhat of a Hobson s Choice in addressing a tax exemption granted to one of its taxpayers. The district could either assimilate the lost revenue from the new tax exemption by cutting educational expenditures in its next annual budget, or pass along the lost revenue to its other taxpayers through a real estate tax increase. As a result of Act 1, though, school districts no longer have the former option. Any annual real estate tax increase is limited to the adjustment permitted by the Act 1 Index. A school district cannot increase its real estate tax rate beyond the Act 1 Index due to the loss of revenue resulting from a new tax exemption. As originally adopted in 2006, Act 1 had allowed an exception to the Act 1 Index for losses resulting from implementation of court orders including court orders granting real estate tax exemptions but that Index exception was eliminated through 2011 amendments to Act 1. Thus, under Act 1, new tax exemptions for a purely public charity impose a direct dollarto-dollar reduction on school district revenues, and thus can have a striking, adverse impact on the financial ability of districts to provide educational programs. III. Concerns with Act 55 There is no doubt that many non-profit organizations play instrumental and positive roles in Pennsylvania s local communities. Certainly, PASBO applauds the efforts of staff and volunteers associated with all non-profit organizations that enhance our society. At the same time, though, it is important to recognize Pennsylvania law has never awarded exemptions from real estate taxes to all beneficial, non-profit organizations. To the

26 contrary, the Pennsylvania Constitution has reserved real estate tax exempt status to a very select group, such as non-profit institutions that qualify as purely public charities. PASBO s chief concern with Act 55 is that it substantially liberalizes the test to qualify as a purely public charity. It would allow tax exemptions to institutions that actually donate relatively little charitable care. Thus, if the constitutional test is removed as contemplated by the adoption of Senate Bill 4, and Act 55 becomes the only test necessary to qualify as a purely public charity, already scarce funding for public education will likely be further reduced. A. Constitutional Law on Purely Public Charities The Pennsylvania Constitution provides generally for uniformity in the treatment of Pennsylvania taxpayers. Pa. Const., Article VIII 1. As an exception to this general mandate of uniformity, the Pennsylvania Constitution permits the General Assembly the option to adopt laws allowing tax exemptions for certain types of real estate, including property owned by and utilized by institutions of purely public charity. Pa. Const., Article VIII, 2(a)(v). In turn, the General Assembly has accepted this constitutional invitation, and adopted laws providing for certain real estate tax exemptions, including for real estate owned and occupied by institutions of purely public charity that is necessary for the occupancy and enjoyment of such institutions so using it. Consolidated County Assessment Law, 53 P.S. 8812(a)(11). In deciding whether institutions qualify for a real estate tax exemption as a purely public charity, the Pennsylvania Supreme Court has developed and applied the HUP test, which provides that an institution is not a purely public charity unless it meets all of the following five criteria: 1. Advance a charitable purpose; 2. Donate or render gratuitously a substantial portion of its services; 3. Benefit a substantial and indefinite class of persons who are the legitimate subject of charity;

27 4. Relieve the government of some of its burden; and 5. Operate entirely free from a private profit motive. Hospital Utilization Project v. Commonwealth, 487 A.2d 1306 (Pa. 1985). Although all five of these criteria have been subject to judicial evaluation and further acknowledging that these five criteria are all somewhat interrelated as a practical matter, whether an institution qualifies under the HUP test often comes down to whether the institution donates or renders gratuitously a substantial portion of its services. With regard to this substantial donated care component of the HUP test, Pennsylvania courts have refused to adopt a precise, objective formula on how much donated care is required to meet the test. Rather, as the Supreme Court stated as follows in HUP. there is no bright-line test for what constitutes substantial donated care, and such evaluation must consider all circumstances relevant to whether a particular institution truly provides services to those in need: Whether or not the portion donated or rendered gratuitously is substantial is a determination to be made based on the totality of circumstances surrounding the organization. The word substantial does not imply a magical percentage. It must appear from the facts that the organization makes a bona fide effort to service primarily those who cannot afford the usual fee. HUP, 487 A.2d at 1316 n. 9. Pennsylvania courts have recognized the difficulty in establishing objective criteria that will fit a wide variety of institutions over a continuum of time, even by comparing facts of a case to prior court decisions, because of the continually changing nature of the concept of charity and the variable circumstances of time, place, and purpose. American Law Institute v. Commonwealth, 882 A.2d 1088, 1091 (Pa. Cmwlth. 2005). Among the leading Supreme Court decisions on the constitutional standard for purely public charities is St. Margaret Seneca Place v. Board of Property Assessment, Appeals and Review, 640 A.2d 380 (Pa. 1994). In St. Margaret, the Court held that accepting Medicare and

28 Medicaid payments that do not cover the full cost of care for nursing home residents can satisfy the HUP requirement of donating a substantial portion of the nursing home s services. Specifically, 48% of the nursing home s residents in St. Margaret paid for services through Medicaid. The Medicaid payments only covered two-thirds of the cost of care. The Court held the remaining one-third of the cost of care constituted donated services for purposes of the HUP test, and concluded the nursing home was a purely public charity. Since St. Margaret, courts have continued to look closely at the percentage of hospital patients or nursing home residents served on Medicaid or Medicare, and have analyzed the actual cost of care not covered by these government sources. Again, the courts have not developed any objective, bright line test to achieve the substantial donated care requirement under HUP, but have continued to apply a subjective evaluation of the overall circumstances involving the level of donated care: In order to satisfy its burden of establishing that the Hospital donates or renders gratuitously a substantial portion of its services, the Hospital must demonstrate that it makes a bona fide effort to service those persons who are unable to afford the usual fee or medical care.... [T]he determination as to whether the services donated by the organization are substantial is to be made based on the totality of the circumstances; there is no bright line test, based on a certain percentage of donated services, for resolving this question. Lehighton Area School District v. Carbon County Board of Assessment, 708 A.2d 1297, 1309 (Pa. Cmwlth. 1998) (emphasis added). B. Act 55 Lowers the Bar to Qualify as a Purely Public Charity Act 55 maintained the same five basic criteria from the HUP test for determining whether an institution qualifies as a purely public charity. A major difference, though, involves the donated care component of the test. Instead of the subjective evaluation of donated care under HUP, as defined through St. Margaret and other court decisions, Act 55 uses objective

29 measurements on whether donated care is substantial enough to qualify as a purely public charity. 10 P.S. 375(d)(1). Act 55 lists seven different ways an institution can meet the donated care requirement. Notably, an institution needs to meet only one of the seven financial criteria to achieve the legislative test to donate or render gratuitously a substantial portion of its services. Among the seven different ways an institution can meet the substantial donation test under 10 P.S. 375(d)(1), one stands out as a particularly low threshold: (iv) Financial assistance or uncompensated goods or services to at least 20% of those receiving similar goods or services from the institution if at least 10% of the individuals receiving goods or services from the institution either paid no fees or fees which were 90% or less of the cost of the goods or services provided to them, after consideration of any financial assistance provided to them by the institution. Under this approach, an institution can meet the substantial donation component of the Act 55 test by accepting 99% of its costs of care for 10% of the institution s customers, and accepting 90% of its costs of care for another 10% of the institution s customers. For instance, if a Continuing Care Retirement Community ( CCRC ) operates an independent living facility with 80 residents, an assisted living facility with 10 residents and a skilled nursing facility with 10 residents, the entire 100-resident complex would enjoy a complete real estate tax exemption under Act 55 by accepting 99% of the CCRC s actual cost of care for the 10 assisted living residents, and 90% of the CCRC s actual cost of care for the 10 skilled nursing residents. This scarcely sounds like a purely public charity particularly if the residents ultimately receiving either 1% or 10% donated care in the assisted living and skilled nursing facilities entered the CCRC by first paying a hefty up front admission fee, of tens or even hundreds of thousands of dollars, to reside initially in the independent living facility.

30 The foregoing scenario is essentially reflected in the case of Menno Haven v. Franklin County Board of Assessment and Revision of Taxes, 919 A.2d 333 (Pa. Cmwlth. 2007), appeal pet. den., 596 Pa. 711, 940 A.2d 367 (2007). In Menno Haven, the Commonwealth Court of Pennsylvania held that a skilled nursing component of a CCRC was not exempt under the HUP test, regardless of whether it met the objective substantial donation test under Act 55, because the overall framework of the CCRC reflected very little charitable care. The basic facts of Menno Haven are as follows: Menno Haven charged substantial entrance fees to residents for admission to its independent living facility. The entrance fee (in 2004 dollars) ranged between $45,000 and $329,500, depending on the type of residence selected. Menno Haven had a financial assets test for admission to its independent living facility, to ensure that after residents paid their entrance fee they could likely continue paying monthly fees, and could also ultimately pay for increased health care services in the assisted living and nursing home facilities. However, Menno Haven recognized that some of its residents would run out of money and become eligible for Medicaid. Menno Haven had a practice of allowing such residents to remain in the skilled nursing facility as Medicaid patients, with Menno Haven picking up the difference as donated care. Menno Haven did not have a contractual obligation to provide donated care when patients ran out of money indeed, such a contract would render the residents ineligible for Medicaid but provided such donated care as a matter of its routine practice, which was explained to residents during the CCRC s admissions process. The court ruled that providing donated care for 30% of skilled nursing residents at Menno Haven did not meet the HUP test for a purely public charity. The court recognized that most of the residents receiving donated care had initially been independent living residents at Menno Haven; thus, they had paid substantial entrance fees to the CCRC, as part of an overall understanding that donated skilled nursing care would later be available if a resident ran out of money. Indeed, only 8% of residents entering the skilled nursing facility from outside of Menno Haven were immediately eligible for Medicaid all others had to demonstrate they met the financial asset test for admission to the CCRC.

31 The Court held this low percentage of donated care to residents entering Menno Haven directly into its skilled nursing facility (who had not paid a large entrance fee to reside in the independent living facility) demonstrated the motivating factor behind most of Menno Haven s donated care was not charitable intent, but rather an obligation to continue providing care to its former independent living residents. Therefore, the Court found that Menno Haven primarily caters to well-to-do elderly and to those already within the community, and held it did not qualify as a tax-exempt purely public charity. Thus, even though Menno Haven provided 30% of its skilled nursing residents with donated care well above the 20% requirement in Act 55 that is addressed above the court properly recognized under HUP that no more than 8% of the residents received donated care that was truly motivated by charity. The other 22% of skilled nursing residents received donated care as a result of the overall arrangement, whereby they had paid a large up-front fee to enter the CCRC through its independent living facility, in recognition that the CCRC would later provide some degree of gratuitous skilled nursing care if the residents ran out of assets. Simply because the CCRC lived up to its end of the overall bargain with its residents did not make such donated care charitable under HUP, regardless of whether the overall quantity of donated care met the objective Act 55 test. The Menno Haven test is a good example of why the objective financial criteria for donated care in Act 55 are ill-suited to address the question of purely public charities and in particular, where an institution need only meet one of the seven objective financial criteria of Act 55, and one of the seven (as noted above) is relatively easy to meet. In a similar case, In re Appeal of Dunwoody Village, 52 A.3d 408 (Pa. Cmwlth. 2012), the Commonwealth Court held that a CCRC was not a purely public charity under HUP, even though it met one of the seven objective financial criteria in Act 55 donating care to residents equal to 5% or more of its cost of providing services, 10 P.S. 375(d)(1)(v) because the

32 donated care went almost exclusively to nursing home residents who had initially paid large upfront fees to enter the CCRC through its independent living facility: It does not appear from the facts that DVI makes a bona fide effort to service primarily those who cannot afford the usual fee. Id. at 418. According to information on the Pennsylvania Department of Insurance s website, there are 273 CCRCs in the Commonwealth. PASBO is concerned that many CCRCs share common characteristics with the situation in Menno Haven and Dunwoody Village, and could become fully tax exempt under Act 55, if the constitutional considerations of providing substantial charity are not considered as they were in Menno Haven and Dunwoody Village. In this regard, it is also notable that since the enactment of Act 55, the Pennsylvania Supreme Court has ruled that whether a CCRC qualifies as a purely public charity must take into account the combined operations of the CCRC, and separate facilities within a CCRC providing independent living, assisted living and skill nursing care cannot be considered separately for tax exempt treatment. Alliance Home of Carlisle v. Board of Assessment Appeals, 919 A.2d 206 (Pa. 2007). There are various other concerns with the financial criteria in Act 55 for instance, in quantifying its donated services to customers, an institution can include financial donations it has received from others and the financial value of volunteer hours contributed to the institution. 10 P.S. 375(d)(4)(v). It makes no sense, though, to include financial donations and volunteers received by the institution in calculating the amount of donated services the institution is providing to others. This is just another example of how Act 55 is too liberal in its qualifications for what constitutes a purely public charity.

33 The bottom line is Act 55 allows institutions that do not provide much true charitable care to qualify for a real estate tax exemption as a purely public charity. Should Act 55 as currently adopted become the sole test for determining tax exemptions for purely public charities, as a result of a constitutional amendment contemplated by Senate Bill 4, institutions that are clearly not purely charitable would qualify under the objective, lenient financial standards of Act 55. PASBO urges this Committee to take a hard look at Act 55, and to make appropriate changes to ensure the General Assembly does not open the floodgates to providing tax exemptions to non-profit institutions that are not purely public charities. IV. CONCLUSION PASBO appreciates this opportunity to share some of its concerns with Act 55. Although time available for this hearing does not permit a full discussion of all significant issues, PASBO would be very pleased to engage in more extensive dialogue with the Committee as it addresses Act 55 including providing more detailed input on specific ways to fix shortcomings in the Act 55 criteria for purely public charities. PASBO urges the Committee to look very closely at this vitally important issue. Thank you.