10.27.2015

The New Jersey Tax Court’s recent decision to deny a property tax exemption for Morristown Memorial Hospital has some non-profits concerned about the continued exemption of their properties from burdensome taxes.  While a federal income tax exemption generally results in exemption from state income tax, property tax exemptions for non-profits vary more widely from state to state, and such exemptions are often construed more narrowly.

The property tax exemption addressed in AHS Hospital Corp. d/b/a Morristown Memorial Hospital v. Town of Morristown required that the owner of the property (i) be organized for an exempt purpose, (ii) actually and exclusively use the property for such exempt purpose, and (iii) not operate and use the property in for-profit activities.  According to the Court, while the hospital met the first two prongs of this test, the Court concluded it was operating as a for-profit business and thus failed to meet the third requirement.  The Court acknowledged that a large facility, such as a hospital, may be used in both exempt and non-exempt activities; however, the burden is on the taxpayer to conduct and account for such uses separately.  The Court closely examined the structure, economics and operation of the hospital and its affiliated entities, including its taxable and tax-exempt functions, as well as the compensation of its doctors, officers and directors.  Ultimately, the Court found that the hospital’s tax-exempt activities were too closely commingled with its taxable business, leading to the conclusion that the hospital’s non-profit property tax exemption would subsidize its for-profit activities and therefore the hospital was not eligible for the property tax exemption.

This Court’s reasoning and conclusion raise concerns for non-profit health systems.  In applying the “Profit Test,” the Court focused not only on the nature of the hospital’s operations, but also on the compensation paid to its physicians and executives and other benefits flowing to affiliated and unaffiliated entities.  Acknowledging that the entity is not required to operate at a loss, the Court focused upon whether any profit was distributed to individuals or for-profit entities.  Based on its findings of unreasonable executive compensation, inappropriate physician incentive compensation plans, and profit-sharing arrangements with both related and unrelated for-profit entities, the Court concluded that the hospital was operating as a for-profit business and was therefore not entitled to property tax exemption for its large campus.

It is not currently known whether Morristown Memorial will appeal the New Jersey Tax Court’s decision or whether other jurisdictions may seek to tax exempt organizations’ property under the same reasoning. New Jersey’s property tax exemption requirements are not unique and other states may see this ruling as an opportunity to raise revenue from large non-profit organizations.  Exempt organizations should be prepared to prove that the use of any property for which the property tax exemption is claimed is used predominantly, if not exclusively, for non-profit purposes, that compensation paid to executives and physicians is reasonable, and that for-profit and non-profit  activities are appropriately segregated.

Please contact Natalie Sherman, Kevin Brandon or another member of the firm’s Tax Group to discuss this Legal Alert.




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Natalie B. Sherman

Partner

410.347.1336

nsherman@gejlaw.com

Natalie Sherman works with the firm's tax, transactions, and education groups, concentrating particularly on tax and business matters.

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