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January 27, 2014
Short on Revenue, State and Local Governments Turn to Nonprofits
by Jennifer DePaul

Full Text Published by Tax Analysts®

by Jennifer DePaul --

Recession-related fiscal problems are forcing lawmakers around the country to closely review tax expenditures and look for innovative ways to save money. That has left nonprofits, particularly universities, colleges, and hospitals, on the defensive as they increasingly find their tax benefits on the chopping block.

Most recently, Vermont's Property Tax Exemption Study Committee called on the General Assembly to approve language that could tax some of the state's $6 billion in tax-exempt property. On January 17 the committee released its final report, proposing to reinforce the property tax exemption for colleges and universities, but on the condition that those institutions enter into municipal service fee agreements with the cities where they are located.

"We all need to be paying for the services we enjoy and for the public goods that we are dependent on to conduct our business," Sen. Kevin Mullin (R), the committee's chair, told Tax Analysts. "There is no particular reason that nonprofits shouldn't be contributing to that at some rate."

Tax Commissions, Legislation Abound

Data from the National Conference of State Legislatures and the National Council of Nonprofits show that in the last three years, most states have established task forces to scrutinize tax exemptions and credits, and about a dozen have seriously considered repealing tax exemptions for nonprofits.

"States are looking for money," said Max Behlke of the NCSL. "Collecting taxes that are already owed or eliminating exemptions in the existing tax code is much easier politically."

In New Hampshire, Rep. David Hess (R) has introduced a bill (HB 1509) to expand the business enterprise tax to include large nonprofits, colleges, and universities. It would exempt churches and other religious institutions and would apply only to nonprofits with more than $1.5 million in gross operating expenditures annually, according to a fiscal note.

HB 1509 would reduce the tax rate from 0.75 percent to 0.68 percent. It is unclear how much revenue the bill would raise, but Hess has estimated that approximately 200 of the state's 10,000 nonprofits currently exempt from the tax would be affected.

"Hospitals and private universities are big businesses," Hess said, arguing that despite being organized as nonprofits, they are among the state's largest accumulators of wealth. "I think we need to start a conversation about why we are carving out a special exception for them."

Legislation enacted in Maine last year directed the Nonprofit Tax Review Task Force to study options for collecting $100 million in revenue from the state's nonprofit organizations, which the task force called "neither feasible nor desirable" in its draft final report.

"A lot of us on the task force kept saying we are sympathetic to municipalities with financial struggles, but we don't feel the nonprofit sector is the appropriate source of revenue to relieve those pressures," said Brenda Peluso of the Maine Association of Nonprofits. "It's really just taking money and putting it in another pocket."

The task force recommended allowing municipalities to assess a service fee on nonprofits for services such as road maintenance and fire and police safety. A bill (LD 936) to authorize those service charges is awaiting consideration by the Joint Standing Committee on Taxation.

In North Dakota, a similar bill (HB 1380) would allow municipalities to levy special assessments on tax-exempt nonprofits for safety and emergency services. The House voted against the bill, but the taxation committee has expressed interest in revising it for consideration during the 2015 legislative session, according to Dana Schaar Jahner of the North Dakota Association of Nonprofit Organizations.

The District of Columbia Tax Revision Commission in December issued recommendations for tax reform, including a proposal to make nonprofits pay a local services fee of $25 per quarter for each person they employ. (Prior coverage: State Tax Notes, Dec. 23, 2013, p. 731.)

Local Leaders Negotiate With Nonprofits

As state lawmakers continue weighing their options for generating new revenue, they may want to take their cues from local elected officials, who have had some luck persuading large, tax-exempt nonprofits to make voluntary payments.

In October 2013 the New York State Comptroller's Office released a report noting the success several college towns had after appealing to their schools. "In an era of limited resources, the impact of property tax exemptions complicates the financial picture of our local governments," Comptroller Tom DiNapoli (D) said in a statement. "Local leaders will need to continue to find creative ways to offset these exemptions and must carefully weigh any decision to offer new exemptions."

DiNapoli pointed to Syracuse University, which pays the city of Syracuse about $1 million annually -- one of a handful of nonprofits that make an annual payment in lieu of taxes (PILOT) to the city.

PILOT setups vary by municipality, but they have been used in 218 cities in at least 28 states since 2000, with the largest concentration in the Northeast, according to a 2012 report from the Lincoln Institute of Land Policy. One of the most prominent examples is Boston, which has required payments for decades. As of 2011, the city subjected all nonprofits with $15 million or more in property holdings to PILOTs, representing a portion of what the entities would otherwise owe in property taxes.

Nonprofits have incentive to contribute through PILOTs as a way to maintain a good relationship in a community, but the "landscape is dramatically shifting as local governments instead use coercive tactics to exact PILOTs from tax-exempt organizations," according to Maria Di Miceli, a tax law specialist in the IRS Tax-Exempt and Government Entities Division. Di Miceli wrote in 2013 that some of those coercive techniques include assessing property taxes and threatening to revoke the entity's exemption.

In Pittsburgh, city officials have done just that. They have been in a legal fight with the University of Pittsburgh Medical Center (UPMC) over its tax-exempt status and have threatened to revoke it. (Prior coverage: State Tax Notes, Nov. 4, 2013, p. 290.)

"When a city goes after a hospital system as influential as UPMC, it emboldens other cities that are hurting financially to take a look at their hospitals," said Gary Young of the Northeastern University Center for Health Policy and Healthcare Research.

Residents of Princeton, N.J., filed a suit against Princeton University claiming it should lose its exemption because it shares royalties with faculty, even though the school reports providing millions of dollars in voluntary contributions to the city every year.

While the Lincoln Institute has reported that PILOTs typically generate a small share of cities' revenue, accounting for less than 1 percent of total general revenue, some observers say they are a better way to collect revenue than fiddling with the tax code.

"Changing state and local property taxes would be a huge and difficult undertaking," said Robert Katz, professor of law at Indiana University. "It would disrupt arrangements that have been in place for centuries and result in unintended negative consequences that are hard to predict," Katz told Tax Analysts. "The more prudent approach is to let localities work out PILOT arrangements on an institution-by-institution basis."

Di Miceli drew the same conclusion in her paper. She acknowledged that PILOTs can bring in much-needed revenue during an economic downturn, but she questioned not just the legality of "coercive" PILOT arrangements but also the implications of the "legislative rationale" behind the exemptions.

"Nonprofits provide a benefit to society by delivering services the government itself lacks the resources to provide," Di Miceli wrote. "Municipalities may risk removing or hindering a vital player in a balanced and healthy society by pressuring nonprofits to remit PILOTs instead of spending nonprofit funds on program activities."

Benefits of the Tax Exemption

For states, the property tax exemption for nonprofits is the biggest loss of revenue, costing between $17 billion and $32 billion, followed by the exemptions from state income taxes (up to $9 billion) and sales taxes ($3.3 billion), according to Di Miceli.

Delia Coleman of the Donors Forum, an Illinois association of nonprofits, said nonprofits earn their tax-exempt status through the work they do in communities, helping those who fall through the cracks of the government's safety net. Tinkering with that status would endanger their work, she said.

"With the decrease in funding that nonprofits have experienced over the past five years due to the recession, going after nonprofits for revenue really endangers the stability nonprofits provide for communities," Coleman said.

At a national level, it's difficult to determine the extent to which benefits such as charitable hospital care or increased economic productivity can be offset by the accompanying exemption. But several regional studies have helped provide clues.

Econsult Solutions Inc. found that the benefits of colleges and universities in Philadelphia were worth more than $850 million annually.

Policy Matters Ohio analyzed the property holdings of two major hospital networks in Cleveland, finding that the Cleveland Clinic and University Hospitals would owe the city $34 million annually if they were not exempt. But the two institutions report spending more than $800 million on community benefits such as charity care, education, and research. (Prior coverage: State Tax Notes, Dec. 16, 2013, p. 654.)

And in April the New England Journal of Medicine reported that tax-exempt hospitals in some states spent 7.5 percent of their operating expenses on community benefits in fiscal 2009. But the level of benefits varied widely among the hospitals; some devoted approximately 20 percent of operating expenses to community benefits, while others spent just under 1 percent, the Journal said.

A better understanding of the benefits provided by hospitals will likely develop as a result of Schedule H attachments to Forms 990, a new form, mandated as part of the Affordable Care Act that requires nonprofit hospitals to detail the community benefits they provide.

Eliminating Tax Exemptions Is Typically Unsuccessful

Woods Bowman, professor emeritus at the School of Public Service at DePaul University, said that because the tax exemption is primarily a political issue, not an economic one -- he says the costs of the property tax exemption are substantially offset by tax capitalization -- cost benefit analyses become pointless. "People who buy into a community are getting a break on the price they pay for a property," he said. "After one generation of property being off the tax rolls, the community as a whole experiences very little net cost."

Cost benefit analyses may be moot for another reason: Despite the successes some local governments have had, proposals at the state level to collect revenue from hospitals, universities, and other nonprofits are proving much more difficult to enact.

In Maine, lawmakers assigned to the Nonprofit Tax Review Task Force were statutorily required to devise a system to impose and collect revenue from exempt organizations, but in their report, they seem poised to accept the infeasibility of the system and ignore the mandate to draft a proposal.

And in North Carolina, lawmakers and leaders of nonprofits fought a bitter battle last year over exemptions for nonprofits. Ultimately, HB 998 capped nonprofits' sales tax refunds at $45 million and required them to begin collecting sales and use taxes on admission charges to entertainment activities. Their property, income, and payroll tax exemptions were left intact.

Meg Wiehe of the Institute on Taxation and Economic Policy said that with property tax exemptions proving difficult to alter, repealing the nonprofit sales tax exemption is a newer tactic that states like North Carolina and Oklahoma have undertaken.

David Thompson of the National Council of Nonprofits said nonprofits feel as if they are being attacked from all directions:

    States are reevaluating their tax policies and looking at nonprofits. We see the frantic money grabs. They don't want to raise property taxes, so they ask who we can raise taxes on.

As hard as they were to secure, the more modest changes North Carolina made are unlikely to generate the kind of revenue that would come from eliminating the exemptions nonprofits receive, which is a far more elusive goal.

Efforts to eliminate the exemptions face stiff resistance from the nonprofit industry lobby, which is well financed. Hospitals, schools, and nonprofits of all kinds spent nearly $130 million in 2013 lobbying at the federal level alone, according to the Center for Responsive Politics. Millions more are being targeted at statehouses, though those totals are far harder to calculate, according to Peter Quist of the National Institute on Money in State Politics.

The New Hampshire Hospital Association is already preparing for a fight over Hess's bill, saying it would increase healthcare costs for residents. During a January 14 hearing on HB 1509, opposition came from both nonprofits and the New Hampshire Business and Industry Association, whose members would presumably benefit from the bill's rate cut. Hess was the only one who spoke in support of the bill. (Prior coverage: State Tax Notes, Jan. 20, 2014, p. 140.)

Although their success in eliminating exemptions for nonprofits hasn't been promising, lawmakers aren't expected to back down anytime soon. Adam Langley of the Lincoln Institute explained why he thinks there will be continued interest in proposals to curb those exemptions. "The economy has changed over the past few decades, and the fastest-growing parts of the economy are higher education and hospitals, which are largely tax exempt," he said. "If that part of your economy is growing, then that will put more pressure to raise revenue from them."

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