NJ Non-Profit Hospitals Beware: You May Be Nothing More Than a Legal - PDF document

NJ Non-Profit Hospitals Beware: You May Be Nothing More Than a Legal Fiction By David N. Crapo July 2015 All across the United States, cash-starved municipalities are seeking to increase revenues. Fear of driving out businesses and residents, however, has made them wary of increasing property taxes. One source of revenue that municipalities are increasingly tapping are the larger nonprofits within their borders – particularly medical centers and universities that occupy sizeable amounts of often prime real estate. Some municipalities have negotiated or are negotiating payments in lieu of taxes (so-called “PILOTS”) with nonprofits. Other municipalities are seeking to revoke the nonprofit status of medical centers deemed not to be sufficiently charitable. On June 26, 2015, in an opinion that has already generated substantial commentary, the Tax Court of New Jersey (“Tax Court”) issued its fourth and final opinion (“2015 Opinion”) in AHS Hospital Corp., d/b/a Morristown Memorial Hospital v. Town of Morristown (Docket Nos. 010900-2007; 010901-2007; and 000406-2008), revoking, “essentially in its entirety,” the property tax exemption of Morristown Memorial Hospital (“MMH”). The Tax Court grounded its opinion on a purported “failure of evidence” – that is, the failure by MMH “to meet its burden of proof under law establishing that it meets the criteria to qualify for the exemption.” Background MMH is a subsidiary of Atlantic Health System, Inc. (“Atlantic”) and is, therefore, part of the Atlantic Healthcare System. Historically, MMH enjoyed an exemption, pursuant to N.J.S.A. 54:4-3.6, from paying property taxes on the property it occupies in the Town of Morristown (“Morristown”). However, Morristown denied MMH’s claim for the property tax exemption for tax years 2006, 2007, and 2008 on the basis that MMH’s property is being used and operated for profit. MMH timely challenged the denial, initiating an action before the Tax Court. In all four opinions issued in the action, the Tax Court applied the three-part test for determining entitlement to a property tax exemption enunciated by the New Jersey Supreme Court in Paper Mill Playhouse v. Millburn Twp ., 95 N.J. 503 (1984). In three opinions, issued in 2010 and 2013, the Tax Court ruled that MMH had met the first two prongs of the Paper Mill Playhouse test, finding that: (i) MMH owns the property on which it conducts its operations and is organized exclusively for a tax exempt purpose; and (ii) nearly all of MMH’s property was used for hospital purposes. In the 2015 Opinion, however, the Tax Court ruled that MMH failed to present sufficient evidence that it met the third prong of the Paper Mill Playhouse test – that its property was not used “for profit.” It was that ruling that provided the basis for the revocation of MMH’s property tax exemption. Analysis The Tax Court began its analysis with a lengthy discussion of the structure and operations of the Atlantic Health System. Relying on various treatises of which judicial notice was taken, the Tax Court then addressed the history of hospitals, noting their origination as voluntary, generally religious charitable institutions established to care for the poor. Hospitals generally did not charge fees, and physicians generally offered their services for free. With technological

developments in the late nineteenth century, hospitals began their evolution into hybrid institutions receiving substantial charitable support that was used for capital improvements, but charging fees to those who could pay and operating on a day-to-day basis like businesses. Indeed, by 1903, self-paying patients constituted a substantial majority of those treated at hospitals in a number of jurisdictions in the United States. Nevertheless, the Tax Court concluded that, when the predecessor to N.J.S.A. 54:4-3.6 was enacted in 1913 , hospitals were being run essentially the same way that they had been run in the early to mid-nineteenth century. The Tax Court then engaged in a detailed discussion of the development of the exemption of hospitals from property taxes. In this discussion, the Tax Court makes it clear that the exemption could be forfeited if the hospital property was used “for profit.” Based on this analysis, and although it acknowledged that the Legislature was aware of the evolving nature of hospital operations at the time the statute was enacted, the Tax Court concluded that “[t]he existence of private, for-profit doctors who earned and retained fees generated on hospital property would have defeated a claim for property tax exemption under the clear language” of the predecessor to N.J.S.A. 54:4-3.6. An analysis of the components of the Tax Court’s decision follows. Medical Staff Physicians and RAP Doctors In light of its interpretation of the predecessor to N.J.S.A. 54:4-3.6, it is no surprise that the Tax Court concluded that the provision of medical services at MMH by non-employee, independent, voluntary physicians, who were members of MMH’s Medical Staff (“Medical Staff Doctors”) physicians with exclusive contracts with MMH who provided services in the areas of radiology, anesthesiology, pathology and emergency services (collectively, “RAP Doctors”), defeated MMH’s property tax exemption. The Tax Court was unable to “discern between the non-profit activities carried out by [MMH], and the for-profit activities carried out by [the Medical Staff Doctors and the RAP Doctors].” Similarly, the Tax Court was unable to delineate the specific areas in which the Medical Staff and RAP Doctors worked (or, more accurately, didn’t work) at MMH. Indeed, MMH’s president acknowledged that Medical Staff Doctors did their work everywhere at MMH. Also fatal to the property tax exemption, Medical Staff and RAP Doctors used the MMH facility to generate private bills to their patients and were paid directly (and not through MMH) by their patients. The Tax Court’s findings demonstrate that MMH operates in the same manner in which most U.S. hospitals have operated for some time. Nevertheless, by doing so, MMH has, according to the Tax Court, forfeited its property tax exemption. MMH’s Relationships with For-Profit Affiliates The Tax Court was also troubled by MMH’s relationships with a number of affiliated and non- affiliated entities, including: (i) the physician practices it owns (“Captive Practices”); (ii) Atlantic Health Management Corp. (“Health Management”), a subsidiary of Atlantic that owned other for-profit entities; and (iii) AHS Insurance Co. Ltd. (“AHS Insurance”), another Atlantic subsidiary. The Tax Court found that MMH used its property for profit-making purposes by entangling its activities and operations with those entities, thereby conferring substantial benefits on them. Additionally, the Tax Court found that the connections and interrelationships between MMH and those entities made it impossible for transactions between the entities and MMH to be considered arm’s length. 2