How one lawsuit is threatening non-profit tax exemptions in NJ and beyond

Underway in the New Jersey court system is a case that could have dire implications for non-profit hospitals across the stateand possibly those in other states as well. Morristown Medical Center, a 656-bed non-profit that is part of the Atlantic Health System, is currently facing a lawsuit that could strip the facility of its property tax exemption, possibly costing the hospital (and its three affiliates) millions of dollars in tax expenses.

An unprecedented suit: The town's case against Morristown Medical Center

The town government claims that MMC fails one of three key tests used to determine a hospital's eligibility for tax exemption. While there is no argument that the hospital passes the organizational and use tests, the town questions whether or not the hospital satisfies the profit test, which under recent statutes requires not only that the entity itself (the hospital company) be operated on a not-for-profit basis, but that the physical property itself operate on a non-profit basis.

Tax Court Judge Vito Bianco has already handed down one ruling regarding the hospital's exemption status. In 2010, Bianco ruled that office space that the hospital rented to physician's offices and the cafeteria, which were operated by a for-profit business, were not eligible to receive the exemption. Now, the town of Morristown is going after the main hospital building's exemption, an apparently unprecedented suit.

Most non-profit hospitals rely heavily on voluntary physiciansfor-profit physicians who accompany their patients into the hospital to render services. The city attorney, Marin Allen, points to a 2010 New Jersey Supreme Court Case, International Schools Services Inc. V. West Windsor, as a defense for pulling the hospital's tax exemption because of this practice. In that case, the non-profit institution provided on-grounds space for a variety of for-profit businesses. The municipality succeeded in that instance in removing the organization's property-tax exemption. According to Allen, the voluntary physicians added to the fact that Atlantic Health's for-profit affiliates do business with the non-profit operations of the hospital. This includes receiving loans, although according to Atlantic's legal counsel, Ken Norcross, those deals are done "at arm's length" and are documented with enforced loan agreements.

Norcross vehemently disagrees that International Schools has any bearing on the current case against MMC, for two reasons. Primarily, in International Schools the institution in question was sharing permanent physical space with for-profit operations, which MCC does not do. Secondly, according to Norcross, there was some "indirect transfer of economic benefits by the tax-exempt entity to the for-profit affiliates," such as paying expensessomething he also claims MCC does not do.

Potential Rulings

There are some voluntary physicianssuch as radiology and emergency physicianswho have the exclusive right to provide their services in the hospital. There has been some talk, according to Norcross, that Bianco may rule that those sections would be the only ones held taxable. That possibility doesn't float with Norcross, however.

"If you're going to be intellectually honest about the [profit test] theory, you have to apply it to the entire hospital," Norcross said.

In other words, whatever ruling Bianco hands down is likely to be all or nothing.

The implications for Morristownand beyond

The problem with the town's case, Norcross says, is that MCC operates the same way as any other non-profit in the country. If the town succeeds in stripping the hospital of its property tax exemption, then all non-profit hospitals that rely on voluntary physicians (read: the vast majority) will be subject to the same loss of exemption.

"If you apply that [profit] ruling to hospitals, then all hospitals are taxable and have always been taxable," Norcross told Healthcare Dive.

The financial implications for Morristown if Bianco rules against the hospital are potentially enormous. While the exact magnitude will depend on a valuation of the property, Norcross estimates it will be in the several millions of dollars, because not only will the Morristown property be subject, but so will several other Atlantic facilities.

Atlantic, Norcross says, is a financially strong operation with something in excess of a billion dollars in revenue, but with a profit margin of only 2% or 3%, the hit could be huge. "That [margin] is only $20 or 30 million in profit, and you're talking about maybe $10 million in property taxes," Norcross said. "That's not insignificant."

That $10 million, according to Norcross, is the incentive for the town to pursue the suit. It's not that the hospital doesn't provide needed and valuable services of a high quality, but this is an opportunity for the involved municipalities to "collect several million dollars a year from the hospital."

"The real devastating thing here is that many hospitals in New Jersey are not doing [as well as Atlantic Health]," Norcross said. "They are going to be subject to tax too. Whether this will push them over the line or not, we'll have to see, but this is going to be a lot of money."

Given that financial pressure, Norcross suggests, there may be a tipping point for non-profits to make the jump to for-profit status.

What other non-profits should be thinking about

Should the town be successful, property tax attorney David B. Wolfe says, "I think you will see many municipalities reexamine whether or not their hospitals should be exempt."

"I would recommend hospitals examine their internal organization and structure to best optimize their chance of maintaining an exemption," said Wolfe, who is the chairman of the New Jersey State Bar Association's property-tax committee.

While property tax law is written on a state-by-state basis and the outcome of the Morristown case cannot therefore be used as precedent beyond the Garden State, in a post-recession worldand a healthcare environment that is increasingly scrutinizing the operations of non-profitsthis case could have a ripple effect wider than just New Jersey, suggested Joe Lupica, chairman of Newpoint Healthcare Advisors and a former hospital regional vice president.

Legal briefs are due on Jan. 23, with replies due in early February and Bianco's decision set to follow.

Filed Under: Health Law Hospital Administration
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