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Prentice Women's Hospital was denied a tax exemption last year.
Prentice Women's Hospital was denied a tax exemption last year.

Setting a standard

Illinois bill bases hospitals' tax-exempt status on charity-care levels; plan could be model for other states

By Joe Carlson
Posted: June 2, 2012 - 12:01 am ET

For decades, most hospitals around the country have avoided paying taxes under a hazy set of standards without strong public oversight—a state of affairs staunchly supported by hospital lobbyists and executives at the state and national level.

But in Illinois, hospital officials were among the most ardent cheerleaders for new laws that will define, for the first time in the Land of Lincoln, precisely how not-for-profit hospitals qualify for their exemptions from taxes. Gov. Pat Quinn has vowed to the sign the bills, which are headed to his desk.

Experts say the laws will inject a much-needed dose of legal and financial certainty after a nationally watched Illinois Supreme Court case two years ago that threw the system of hospital tax exemption into chaos. The new laws even give investor-owned hospitals tax credits for providing the same charitable services as not-for-profits.

The rules explicitly declare that hospitals' exemptions from state property and sales taxes are based on providing public service to the poor and indigent, although some critics say the system could give the most-charitable hospitals a financial incentive to pull back on services and force a larger burden for charity care onto organizations with fancy new buildings.

Though the laws are not without critics, observers said the Illinois laws may offer a new model for lawmakers in other states seeking to balance hospitals' fiscal health against gaping holes in Medicaid budgets and general tax coffers.

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Unlike Texas, which allows hospitals to get an exemption by devoting a fixed percentage of net patient revenue to charity care, Illinois has opted to force hospitals to define the dollar-value of the taxes they're exempt from and then prove they provide at least as much value in caring for the poor and relieving the government's healthcare burden. Any that don't meet that standard face the loss of their tax-exempt status.

The law allows hospitals to use a three-year average of charity care to meet their annual tax-burden targets. It also includes a safety-valve: Hospitals can make direct cash contributions to other charitable healthcare organizations to bring up their charity-care numbers and preserve their exemptions.

“There is great relief by all of the hospitals in Illinois that this issue has been resolved,” said Maryjane Wurth, president and CEO of the Illinois Hospital Association. “Hospitals have been on hold for a year-plus in making improvements and investments in their communities and have had many projects on hold because this has been hanging over their head … many hospitals were concerned about their future survival.”

The Illinois Hospital Association waged a pitched battle on public airwaves and in legislative offices in support of the law. The long-simmering issue gained a higher profile after the state Department of Revenue denied tax exemptions last year for three hospitals in the state under criteria laid out in a 2010 Supreme Court decision to deny an exemption for 181-bed Provena Covenant Medical Center in Urbana.

Critics, however, say the Legislature's new rules were drafted to include expansive definitions of care for the poor that were favored by hospitals during the writing of the laws.

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And since the rules are based on estimated taxes using assessed property values, that means hospitals with gleaming new buildings and high-dollar real estate will be liable to provide more care for the poor than those with older plants in lower-income areas.

Hospitals can do some charity-shifting within existing health systems, but it's not clear whether shifting charity care among systems or allowing some systems to “buy” others' charity care will be allowed in the final regulations.

Some observers even fear that the rules could give hospitals an incentive to do less if they already far exceed their state-mandated minimums for charity care.

In a March 2011 interview with Modern Healthcare, U.S. Sen. Chuck Grassley (R-Iowa) said that fear was one primary reason why he chose to abandon a widely discussed proposal to set a national “bright line” test for how much money not-for-profit hospitals ought to spend to justify their exemptions (See related story: "Short of the mark").

Alan Channing, CEO of Sinai Health System on Chicago's West Side, said that charitable hospitals are committed to their communities and that executives would never ask boards to approve changes to decrease help for needy residents just because the state defined the standards.

“I would be shocked and dismayed by anybody who did that, and I can't imagine any of my colleagues recommending that to their boards,” Channing said.

Perennial not-for-profit hospital skeptic John Colombo, a professor and associate dean at the University of Illinois College of Law, agreed that CEOs would be loathe to announce plans to pull back on charity care. But that doesn't mean it won't happen in subtle ways over a period of time.

“No hospital CEO is going to stand in front of the board and say we need to cut back on charity care in order to meet the state number. I think that's true,” he said. “But call me in five years … and see if we have a remarkable convergence on a number.”

Internal Revenue Service figures show that Illinois hospitals and health systems are already far more stingy than their peers nationally when it comes to distributing community benefits.

A Modern Healthcare review of more than 1,800 tax-exempt hospitals and health systems' 2009 tax filings shows that the median U.S. hospital devoted 6.6% of its total expenses to community benefit programs including charity care, shortfalls in Medicaid and the State Children's Health Insurance Program, medical education and research.

In Illinois, hospitals' and systems' median community benefit figure was 1.4% of total spending.

But as is the case nationally, the burden for charity care in Illinois is distributed unevenly. Sinai Health System, for example, has one of the higher community benefit figures in the state, with more than 14% of its total expenses going toward community benefit spending, according to its 2009 tax forms, the most recent publicly available.

Experts say that unevenness could lead to some interesting situations in the future, because the system of basing charity-care goals on estimated property taxes is roughly opposite of how it works in the real world, where often the oldest and least-valuable hospitals provide the most free care.

“The whole problem is charity care and Medicaid shortfalls are inversely distributed relative to property taxes,” said Nancy Kane, a professor in Harvard's Department of Health Policy and Management.

Kane wondered whether hospitals in wealthy areas would be able to use the cash-payment safety-valve option in the law to support those that provide far more charity care—a system that would operate like a “cap and trade” system for urban charity care that Channing has long advocated.

But it's not clear whether that would even be necessary. The definitions under the law give hospitals credit for a wider range of public-support activities than has been advocated in the past at the state level.

For example, in the Provena case the Supreme Court did not count shortfalls in Medicaid spending toward the hospital's charity-care outlay. The new law changes that.

The law also allows hospitals to count broadly defined “health services to low-income and underserved individuals,” direct or in-kind contributions to government programs like federally qualified health centers, and relieving the healthcare “burden of government” for services like trauma and emergency care, medical education and research.

Those definitions mean most hospitals will not have to do more to qualify for their exemptions, said Mark Deaton, general counsel for the Illinois Hospital Association.

Take Northwestern Memorial Hospital in Chicago's tony downtown Streeterville neighborhood, near the Lake Michigan shore.

One of the wealthiest health systems in the state by revenue, Northwestern was stunned last year when its subsidiary, Prentice Women's Hospital, was denied a tax exemption based on criteria in the Supreme Court's ruling in the Provena case.

After the denial, Prentice was hit with a bill for $66 million for tax years 2008-11.

But tax disclosures on file with the IRS say Prentice's parent system, Northwestern Memorial, provided $159 million in 2009 for services that would count toward Illinois' new public benefits standard.

Kane said the ultimate success of the new rules will likely come down to how closely regulators scrutinize the hospitals' filings to enforce the law.

“Whether it's a national blueprint or not depends on how they enforce it,” she said.

TAKEAWAY: Some worry Illinois not-for-profit hospitals may pull back on charitable programs as their responsibility to be charitable becomes tied to the value of their property-tax breaks.

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