Illinois Hospital Charitable Exemption Controversy Draws National Attention
Illinois’ Denial of Property Tax Exemptions to Three Prominent Hospitals Maybe the First Volley In What Could Be Protracted Litigation
In recent years, as federal, state and local governments have battled ever-growing budget deficits, the tax-exempt status of not-for-profit hospitals has been under siege. Federal legislation has been discussed, which would require each tax-exempt hospital to provide a specified minimum amount of charity care in return for their federal income tax exemption. State and local governments also have begun questioning the tax exemptions they grant nonprofit hospitals. Most recently, in an action that generated much national attention, the Illinois Department of Revenue on August 16th announced its administrative denial of property tax exemptions to three major Illinois hospitals – Northwestern Memorial Hospital (Prentice Women’s Hospital), Edwards Hospital, and Decatur Memorial Hospital. The denials were not surprising, and indeed had been anticipated, in light of the Illinois Supreme Court’s plurality decision last year in Provena Covenant Medical Center v. Illinois Department of Revenue, 236 Ill. 2d 368 (Ill. Sup. Ct. 2010).
On September 23rd, in the aftermath of the Department’s action and the consequent public outcry, Governor Quinn placed a moratorium on further Department action on other hospital property tax exemptions. Prior to Governor Quinn’s action, it was anticipated that the Department was poised to deny another 15 hospital property tax exemption applications. As part of his moratorium, Governor Quinn asked for legislative recommendations more clearly defining the threshold level of charity care necessary to secure a property tax exemption. Assuming that there is not sufficient political will to enact such legislation, the August denials could serve as the first volley in what may be protracted litigation in Illinois over this issue. The eventual outcome of such litigation could serve as a bellwether for future litigation of this issue in other states.
Background – Illinois Supreme Court’s Provena Decision
In Provena, at issue was an application for exemption from 2002 Illinois real property taxes, as property used for charitable purposes, for Provenant Covenant Medical Center (“PCMC”), located in Urbana, Illinois. The owner of PCMC is Provena Hospitals, which owns and operates a total of six hospitals, including PCMC. Provena Hospitals is a not-for-profit corporation formed as a subsidiary of Provena Health, which is affiliated with the Roman Catholic Church. PCMC was one of two acute care facilities in the Champaign-Urbana area. As required by the Illinois Hospital Emergency Service Act, PCMC maintained an emergency room where emergency room services were offered to every person who sought emergency treatment.
The Illinois Constitution at Article 9, Section 6 authorizes the Illinois General Assembly to adopt an exemption from property taxes for property used “exclusively” for “charitable purposes.” The statutory exemption adopted pursuant to this authorization requires that exempt real property must: i) be “owned by an institution of public charity;” and ii) be “actually and exclusively used for charitable purposes.”
The court in Provena reiterated a five-part test it had enunciated in previous decisions for determining whether an institution was charitable. The test requires that the institution: (1) have no capital, capital stock, or shareholders; (2) earn no profits or dividends, but rather derive funds mainly from private and public charity; (3) dispense charity to all who need and apply for it; (4) not provide any gain or profit in a private sense to any person connected with it; and (5) not appear to place any obstacles in the way of those who need and would avail themselves of the charitable benefits it dispenses. For purposes of this test, the Court characterized “charity” as “a gift . . . . for the benefit of an indefinite number of persons . . . for their general welfare – in some way reducing the burdens of government.”
The Court upheld the Department’s denial of a charitable exemption for the PCMC facility, ruling that there was no evidence in the record that the statutory requirement of charitable ownership of the facility had been met. The Court observed that while the record was filled with details regarding PCMC’s operations and the charitable benefits it dispensed, PCMC was not the legal owner of the property for which exemption was sought. The PCMC facility was simply one of a number of hospital facilities owned and operated by Provena Hospitals. The Court found that there was no evidence in the record as to Provena Hospital’s charitable operations and denied the exemption on this basis.
As a separate basis for denial, the Court ruled that the PCMC facility also failed to qualify for the charitable exemption because use of this facility did not satisfy the criteria enunciated in its previous decisions. The Court held that PCMC derived its funds overwhelmingly from medical services, not from private or public charity – noting that of Provena Hospital’s total 2002 revenues of $739 million, the overwhelming majority, 96.5%, were derived from the provision of medical services to patients, and that the only revenue documented as a charitable donation totaled $6,398.
The court also held that PCMC failed to demonstrate that it dispensed charity to all who applied for it and failed to demonstrate it placed no obstacles in the way of persons who would avail themselves of its charity. In this regard the Court observed that it had previously characterized charity as relieving burdens on local government. The Court found that the record was entirely devoid of any evidence that Provena had relieved the burdens of local governments -- e.g. Champaign County, Champaign-Urbana Public Health District, and local Champaign-Urbana school districts -- that would lose property tax revenues if the PCMC facility were exempt from tax. The Court, therefore, ruled it had no way of judging how, if at all, use of the PCMC property lessened the burdens of these governmental bodies.
Finally, the Court held that while PCMC had a policy of providing charity care to all persons in need, as a practical matter it made no effort to publicize this policy, and its actual provision of charity care was de minimis. In this regard, the plurality opinion departed from longstanding precedent. Such precedent did not place a dollar threshold on charity care that must be provided in order secure an exemption, but instead simply examined the availability of charity care by the provider to all who needed it. In departing from this precedent, however, the Court failed to provide guidance as to the threshold level of charity care it would consider more than de minimis for purposes of securing an exemption. The Court, instead, observed that during 2002 the record reflected that charity care was only provided to 0.27% of patients, and that the cost of this care totaled only $831,724, which equaled 0.723% of PCMC’s revenues. The Court further observed that this cost was $268,276 less than the $1.1 million tax benefit recognized from the charitable property tax exemption. The Court found that there was little if any way to distinguish PCMC’s dispensation of “charity care” from the way a for-profit institution would write-off bad debts. The Court refused to consider as charity care the significant amount of care provided by PCMC to Medicare patients at less than cost, or PCMC’s community outreach efforts that included behavioral health services offered to the public and support for the graduate medical education of medical residents attending the University of Illinois.
Two of the seven Illinois Supreme Court justices recused themselves from taking any part in the Provena decision. The five remaining justices all joined in that portion of the opinion denying the exemption because there was no evidence in the record that the statutory requirement of charitable ownership had been met by Provena Hospital. Two of the five justices dissented from the remaining portion of the opinion, which ruled that PCMC had failed to demonstrate charitable use of the facility. Accordingly, under Illinois law, as noted by the dissent, the Court’s opinion regarding charitable use, because it did not command a majority (four or more) of the Court, does not constitute legally binding precedent beyond the parties to the decision itself.
Application of Provena by Department of Revenue
The Illinois Department of Revenue, as expected, in the exemption denials it issued in August, applied the portion of the Provena decision addressing charitable use to reject charitable property tax exemption applications by Northwestern Memorial Prentice Women’s Hospital, Edward Hospital, and Decatur Memorial Hospital. The Department predictably focused on the portion of the Provena decision ruling that charity care provided by PCMC was de minimis, in deciding that the hospitals applying for exemption in this instance similarly did not meet the necessary level of charity care based – with cost of charity care equaling 1.85%, 1.04%, and .96% percent respectively of the hospital’s patient revenues. As in Provena, the Department refused to consider as charity either the cost of medical services provided to Medicare patients at less than cost, or community outreach efforts by the hospitals in its denial of their exemption applications. The hospitals protested and requested administrative hearings addressing the Department’s denials of their tax exemption applications. An adverse administrative hearing decision will be appealable to the Illinois courts.
Implications of the Department’s Denial to Illinois Charitable Sales/Use Tax Exemptions
The Department’s action in denying tax exemptions to the three hospitals on August 16th was limited to their property tax exemptions. The Illinois sales and use tax acts, however, also adopt exemptions on purchases by charitable organizations. And, the standard applied in interpreting this sales/use tax charitable exemption is the same as applied for the property tax exemption. While the Department has not yet begun to actively deny sales/use tax exemptions, it would appear that, in light of the Department’s recent denial of property tax exemptions, hospital sales/use tax exemptions also may be in jeopardy.
Likelihood of Legislative Fix Uncertain
In the aftermath of the Department’s August 16th action denying charitable exemptions to three hospitals, health care industry groups, including the Illinois Hospital Association, called upon the Department to refrain from issuing further charitable exemption determinations to give interested parties the time to reach a legislative solution to the charitable exemption controversy. On September 23rd, Governor Quinn responded to this call by placing a moratorium on further exemption denials. In connection with this moratorium, he requested recommendations, by March 1, 2012, for legislation that would more clearly define what constitutes an adequate level of charity care necessary to secure a property tax exemption. Despite Governor Quinn’s moratorium, the Cook County Assessor in November initiated the administrative steps necessary to place Prentice Women’s Hospital on the tax rolls. If the hospital’s protest of the Department’s denial of its exemption ultimately is unsuccessful, this could result in property tax bills totaling as much a $66 million for 2008 through 2011.
Illinois hospitals have begun lobbying for legislation that would expand the definition of charity care to include patients’ unpaid debts, costs of medical care not covered by Medicare health insurance for the elderly, Medicaid coverage for the poor, and direct costs that teaching hospitals pay to train doctors and conduct research. The Illinois Hospital Association has initiated discussions with State law makers of legislation that would treat as charity care a hospital’s cost of subsidizing money-losing services like emergency care, trauma care, burn units, and neonatal intensive care units.
Statutorily defining the level of charity care provided by a hospital that is sufficient to secure a property tax exemption, however, could run afoul of the State's constitutional requirements. This is because the Illinois constitution requires that for real property to be exempt from tax as charitable, the property must be used exclusively for charitable purposes. Accordingly, as an alternative to legislation further defining charity care for property tax purposes, legislation has been discussed that would provide an Illinois income tax credit to hospitals for the charity care they provide. Unfortunately, because many hospitals are exempt from both federal and state income taxes as charitable institutions, such a tax credit may have limited utility.
Ultimately, whether there is sufficient political will to enact legislation necessary to bring clarity, or otherwise provide tax relief to hospitals in this area, is uncertain given the current unsettled political climate in Illinois and looming budget deficits with which the State is grappling. It seems likely that, if there is no legislative solution, the Illinois Department of Revenue will continue its current position of taking a hard-line approach in denying charitable property tax exemptions to hospitals that it deems to provide de minimis charity care. However, to date there is no indication that the Department has any intent of defining the threshold of charity care that exceeds de minimis for this purpose. If the Illinois General Assembly does not act to bring clarity to this area, this issue may be left once again to the Illinois Supreme Court to decide. In this regard, the plurality decision of the three justices in Provena would not be considered legally binding precedent defining charitable use. Rather, earlier precedent focusing on whether charity care is provided to all that needed it arguably should control the Court’s decision.
Developing Best Facts to Support Charitable Exemption
The Department’s actions in denying charitable exemptions emphasizes the need for hospitals to be proactive in defending their charitable exemptions and documenting the way in which their factual circumstances are favorably distinguishable from those at issue in Provena. In this regard, hospitals should proactively document their entitlement to exemption by focusing on developing documentation of the following:
- Adopting a Charity Care Policy Based on Patient Ability to Pay: Hospitals should be able to document that their charity care policy is based on an evaluation of a patient’s ability to pay rather than simply an ad hoc write-off of a bad debt or otherwise uncollectible account.
- Creating Public Awareness of Charity Care Policy: Hospitals should be able to document that they have advertised to the general public, as well as informed their own patients, of their charity care policy.
- Documenting Relief of Local Government Burdens: Hospitals should be able to document what local government burdens they relieve — specifically care that would otherwise be provided by local governments. In this regard, the Illinois Supreme Court has ruled that the providing medical care at deeply discounted rates can constitute charity care that reduces burdens on local government where the hospital providing the care is the only one in the area providing such care, and its acceptance of patients relieves local governments from transporting and paying for medical care of the patients elsewhere.
- Accounting for Charitable Revenues and Charity Care: All charitable donations recognized as revenues, as well as the cost of charity care, should be separately recorded and documented as such in hospital financial statements.
If you have any questions regarding the status of current proposed legislation in this area or how to best document entitlement to Illinois charitable property and sales/use tax exemptions , please contact one of the following attorneys.
| Chicago (312) 558-5600 | San Francisco (415) 591-1000 |
| Robert F. Denvir | Charles J. Moll III |
| Dennis J. Kelly | Troy M. Van Dongen |
| Alan Lindquist | Bradley R. Marsh |
| Jocelyn M. Wang | |
| Dina M. Bronshtein | |
| Jasmine I. Tollette |