More on Operations

Atlantic Health loses tax case, spurs worry over nonprofit healthcare

Morristown Medical Center failed to meet the legal “profit test," judge says.

Photo of Morristown Medical Center from Google Plus

Hospital systems and other nonprofit healthcare institutions could soon find themselves losing long-held tax exemptions, as another major health system, New Jersey's Atlantic Health System, has lost its legal fight to avoid paying property taxes.

The battle started when the Morristown assessor overturned the property tax exemption for Morristown Medical Center for 2006-2008, prompting parent organization Atlantic Health System to sue the town, arguing that New Jersey's nonprofit law along with federal income tax rules guaranteed an exemption from local property taxes.

But Atlantic lost in a ruling by New Jersey Judge Vito Bianco that said the 667-bed Morristown Medical Center has "operated and used its property for a profit-making purpose. If it is true that all nonprofit hospitals operate like (Morristown), then for purposes of the property tax exemption, modern nonprofit hospitals are essentially legal fictions," Bianco wrote.

Atlantic Health and Morristown Medical Center failed to meet the legal "profit test" to qualify for a nonprofit property tax exemption and the town is free to apply property taxes, Bianco concluded.

One reason is it basically functions as part of a corporation, Bianco argued. "The hospital provided substantial subsidies to various related and unrelated for-profits in the form of working capital loans, capital loans, and recruitment loans … physician groups routinely operated at a loss and money from profitable departments at the hospital was transferred to these 'loss leaders' to subsidize them," he wrote.

He added that Morristown Medical Center "has entangled its activities and commingled its efforts" with Atlantic's burgeoning health plan, by loaning an unspecified amount and guaranteeing a $10 million line of credit. There "is no meaningful separation between the for-profit and non-profit subsidiaries of Atlantic," Bianco wrote. "In short, the hospital called all the shots."

How much is too much?

Bianco also highlighted executive compensation -- a fractious public issue in the age of income inequality awareness and never-ending healthcare inflation. The New Jersey Supreme Court "has long held that a tax-exempt organization is permitted to pay salaries to its staff as long as those salaries are not excessive," based on their comparative levels with similar institutions and market costs of living, he said. But Atlantic and Morristown "failed to meet its burden to establish the reasonableness of the compensation paid to its executives."

For instance, Joseph Trunfio, Atlantic Health System's CEO from 2000 to 2015, was paid a total of $5 million in 2005. The next year, he earned $1.5 million, and then in 2007 earned $5.9 million. In 2012, Trunfio earned more than $10 million, almost $8 million of it in deferred compensation.

Ronald Del Mauro, the former CEO of Barnabas Health, New Jersey's largest hospital system, earned $21 million in 2012, the year he retired, about $2 million of it as a base salary and $13.9 million in accrued benefits, according to data compiled by NJBIZ. In 2013, the most recent year available, Hackensack University Medical Center president and CEO Robert Garrett was the state's highest-paid nonprofit health system executive, at $2.8 million. (In 2013, the CEO of Horizon Blue Cross and Blue Shield of New Jersey, Robert Marino, brought in $4.4 million; the insurer is a nonprofit, paying federal and state income taxes as well property taxes.)

While other New Jersey and metropolitan New York hospital CEOs may earn the same range as Atlantic executives, Bianco argued that that's not really a good measure to use on the property tax applicability question. "This is similar to why comparing assessments of different  properties in a property tax appeal is disallowed--the other assessment may be incorrect," Bianco wrote. He also dismissed the argument that since Atlantic's compensation meets the IRS standard for income tax exemption it should also be a standard for the property tax exemption.

Follow Healthcare Finance on Twitter and LinkedIn.

Atlantic Health System has not yet decided whether to appeal the decision, which could reach an appeals court and then the New Jersey Supreme Court.

Moody's dubbed the decision a potential credit positive for Morristown, which could gain more than $6 million for its budget. If the decision is upheld, cash-strapped municipalities in New Jersey and elsewhere could have a new source of tax revenue.

"The tax court decision that denied Morristown Medical Center's property tax exemption will have repercussions beyond one hospital," said Elizabeth Ryan, president and CEO of the New Jersey Hospital Association. "The implications of this decision will be the topic of much further discussion and perhaps will need a legislative solution."

Meanwhile, in California

The court decision in New Jersey was limited to property taxation, not the issue of state or federal income tax exemptions. But the 50-plus-year-old tax structures and exemptions governing nonprofit healthcare may be unravelling amid concerns that healthcare spending is crowding out public investments in infrastructure and education. 

In 2013, Pittsburgh tried to tax the University of Pittsburgh Medical Center, the largest land-owner in the county. Under a new mayor, the city dropped the bid, but the option may remain to Pittsburgh and other local government thanks to Pennsylvania's Supreme Court, which in a 2012 ruling established a nonprofit tax exemption standard. That rule said that an organization must "operate entirely free of profit motive" and donate "a substantial portion of its services." In Connecticut and Maine, there have also been proposals from governors to tax nonprofit hospitals, though those measures never made it to state budgets.

The New Jersey decision is notable because it focused on the issue of a nonprofit organization and whether it was actually different from a for-profit corporation. "This is the first time a judge has been willing to come straight out and say the modern nonprofit hospital is not a charity," John Colombo, a law professor at the University of Illinois at Urbana-Champaign, told the Wall Street Journal.

Meanwhile, in California, a revoked tax exempt status for the state's third largest insurer is raising questions about whether nonprofit hospitals systems should face added scrutiny.

Earlier this year, the California Franchise Tax Board stripped Blue Shield of California of its state income tax exemption, after an audit concluded that the company's "objectives, particularly those which stress profitability, are inconsistent with an organization organized as a nonprofit which desires tax-exempt status."

Blue Shield is appealing the decision, though plans to stay a nonprofit even if it has to pay an estimated $40 million in extra state taxes each year.

Critics of nonprofit health organizations, skeptical of their high executive pay and billions in public funding, are hoping the Blue Shield ordeal spurs further audits -- and maybe tax changes.

"The findings of the Blue Shield audit raise a lot of questions about Kaiser, Dignity, Sutter and others," said Carmen Balber, executive director of the California-based Consumer Watchdog. "Do they fail to meet the same benchmarks?" Those and other nonprofit health institutions "needs the scrutiny of a public audit, and to return money to consumers if they haven't met their public benefit obligations."

Here's the full ruling:


Twitter: @AnthonyBrino