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January 28, 2015

Tax-Exempt Hospitals: Recent New Jersey Court Decision May Impact Property Tax Exemptions

The New Jersey Tax Court recently ruled that space leased by a tax-exempt hospital to physicians and a food vendor was not exempt from property tax.  More importantly, the court denied the hospital’s request to dismiss claims challenging the tax-exempt status of the remaining hospital property.  The common element of the two rulings was the Tax Court’s conclusion that nonprofit hospital property is not exempt from property tax if profits generated by its use can be traced into the hands of a private individual.
This decision is significant because: (i) it may demonstrate a trend of greater enforcement of rules prohibiting property tax exemption of space leased by nonprofit hospitals to private, for profit entities for customary patient services; and more importantly (ii) it may open the door to more challenges in the future to property tax exemptions of non-profit hospitals based on the amount of charity care they provide and the level of compensation they pay to their executives.  This update provides a brief summary of the case.
Facts of the Case
This case involves a tax-exempt hospital that leased office space in its cancer center and children’s hospital to private physicians on its medical staff at fair market value and provided free parking in its garage to those physicians.  The hospital also rented space in its main hospital building to a private food vendor at a rental which included 8% of gross sales above $375,000.
The Township assessed property taxes against the hospital for the entire property, and the hospital filed an appeal.  The Township requested a ruling in its favor on the assessment for taxes on the leased offices and restaurant.  The hospital requested a ruling in its favor dismissing the assessment on remainder of the property, including the hospital building, its cardiovascular institute and a parking garage, claiming an exemption under N.J.S.A. 54:4-3.6 as property of a nonprofit entity used for hospital purposes.
Physician Office Space and Food Vendors
The statutory property tax exemption excludes portions of hospital property that are either leased to for-profit entities or used for purposes not exempt from taxation.  The Tax Court ruled that the physician office space was not exempt from property tax because it was used by private physicians on a for profit basis.  The court noted that the office space was used by private physicians to conduct private medical practices and that many were incorporated as for-profit entities, thus giving rise to a presumption that the space was used to generate a profit.
The court also noted that its decision would not have been any different even if the physicians cared only for hospital patients in the space, paid fair market value rent, maintained membership on the medical staff, or were included in the management of the hospital.  Due to the fact that the physicians leased the space in question for their private medical practices and used the space for their individual profit, the court ruled that the commercial nature of the arrangement could not be negated.
Further, relying on existing law, the Tax Court ruled that space leased to the restaurant, which was operated within the hospital and whose profits were split between the hospital and the food vendor, was a profit making organization and hence not exempt.
The Remaining Hospital Property
The most important aspect of the case was the Tax Court’s refusal to grant summary judgment to the hospital on the issue of whether the remainder of the hospital’s property was exempt from property tax.  The Tax Court stated that various information contained in the hospital’s Form 990 (filed annually with the IRS) -- the level of executive compensation paid to hospital officials, the amount of unrelated business income earned by the hospital, and the proportion of charity care provided by the hospital in comparison to its total revenues -- all raised an issue of material fact as to whether the hospital as a whole was being operated for profit.
While the Tax Court’s reasoning was less than clear, one of its apparent concerns was that the payment of allegedly excessive executive compensation raised an issue regarding whether profits from a hospital’s operations could be traced to private individuals.  It also was concerned about the level of charity care provided, which varies among hospitals depending on several factors, such as location.  In addition, the court ruled that portions of the parking garage might also be subject to property tax because the hospital provided parking privileges to private physicians.  All of these are potentially thorny issues that, in light of this decision, may be litigated in courts throughout New Jersey.
In light of current economic challenges, local governments can be expected to aggressively challenge, in whole or part, the real estate tax exemptions enjoyed by nonprofit hospitals.  In addition to piecemeal attack on portions of hospital property leased to profit-making entities or individuals, this case demonstrates that municipalities may increasingly challenge, on a more global basis, property tax exemptions of hospitals based on the level of their executive’s compensation, as well as the proportion of charity care they provide relative to their overall revenues.

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About this Author

Gary Herschman, Health Care Attorney, Sills Cummis, Law firm

Gary W. Herschman is Co-Chair of the Sills Cummis & Gross Health Care Practice Group and serves on the Firm’s Management Committee. His health care practice experience includes the representation of a diverse group of health care clients, including health systems, hospitals, nursing homes, long-term care facilities, ambulatory surgery centers, home health companies, investment funds specializing in health care, dialysis companies, imaging centers, medical groups, ambulance companies, specialty care networks, management companies and other health care...

Anjana Patel, Health care attorney, Sills Cummis Law Firm

Anjana Patel is Co-Chair of the Sills Cummis & Gross Health Care Practice Group. Ms. Patel represents a diverse group of health care providers, including hospitals, nursing homes, home health agencies, ambulatory surgery centers and other ambulatory care facilities, pharmaceutical and medical device companies, investment funds specializing in health care, physician groups, dialysis companies and various other health care facilities and businesses.  

Ms. Patel represents health care providers in a variety of complex business...