Not-for-profit hospital-owned physician groups can lose money on operations and treat poor patients, but-at least in Massachusetts-they may still have to pay property taxes, according to a recent ruling by the Massachusetts Appeals Court that may have national implications.
On March 4 the court upheld earlier decisions by the Massachusetts Appellate Tax Board and the North Attleborough (Mass.) Board of Assessors compelling the Sturdy Memorial Foundation, parent company of 124-bed Sturdy Memorial Hospital in Attleboro, Mass., to pay approximately $11,000 in annual property taxes on the land it leases to a six-physician clinic in neighboring North Attleborough, population 27,826. The single clinic is the only subject of the case, but the foundation operates a total of 11 tax-exempt clinics with more than 40 physicians in southeast Massachusetts under the name Sturdy Memorial Associates, and the other practices may face similar tax requests from local authorities.
At issue is whether Internal Revenue Service-conferred federal tax-exempt status is enough to inoculate hospitals and their foundations from paying local property taxes to revenue-hungry municipalities on their not-for-profit physician practices. Many of those practices behave the same way as commercial physician clinics that pay taxes. The Massachusetts court decision comes on the heels of heightened interest by state and federal officials in the tax-exempt status of not-for-profit hospitals (See related story, p. 8). Municipalities and state tax boards have successfully compelled tax-exempt hospitals in Illinois, Indiana and other states to pay property taxes on some of their not-for-profit affiliates. In addition, the Massachusetts case may affect the level of flexibility hospitals have in rewarding their physicians for loyalty at a time when physician-hospital relations are becoming increasingly strained nationwide thanks to mounting competition between them.
American Hospital Association spokesman Richard Wade said while the AHA doesn't track how many hospitals operate not-for-profit physician clinics, a government crackdown on the arrangements could hurt patients.
"We're beginning to see more interest in hospital-physician partnering and those options are being narrowed and that can't be good," Wade said. "When you start knocking these things down, it makes it harder for some communities having trouble attracting doctors to recruit new physicians. This may be the only way hospitals can retain physicians who would otherwise be driven out by liability issues."
Wade predicted if the decision holds, hospitals like Sturdy will have to find other ways to structure deals or they'll become property tax-paying entities.
In its legal filings, the foundation said it founded Sturdy Memorial Associates because the hospital, which it sponsors and financially supports, has been unable to recruit enough doctors. The foundation has paid more than $5 million in the past decade to subsidize the clinics, paying startup and recruiting costs.
The Massachusetts case drew the interest of the Massachusetts Hospital Association, which filed a "friend of the court" brief supporting Sturdy Memorial.
"This is a very common business model in Massachusetts," said Chris Jedrey, a healthcare tax lawyer with the Boston office of McDermott, Will & Emery who is familiar with the case. "Almost all of the state's teaching hospitals have physician clinic affiliates. They're the heart and soul of academic medicine in this state. And many, if not most, community hospitals also operate affiliated clinics that employ physicians as well and most of those are tax-exempt, too."
Association spokesman Paul Wingle said 63 of the state's 67 acute-care hospitals are tax-exempt. While Wingle said the association didn't track the number that operate tax-exempt physician clinics outside traditional hospital walls to serve community needs, he noted: "We assume it's widespread."
"If those clinics cannot retain not-for-profit status, we feel those communities will be hurt," Wingle said. "The problem with the latest ruling is that it creates a powerful disincentive to providing services outside a hospital's main campus. We have a shortage of doctors in this state. And hospitals partnering with physicians is a strategy for bringing needed care to the communities we serve."
The Sturdy Memorial tax case came to a head in 1997, when the local assessor ordered the foundation's North Attleborough clinic to pay property taxes for tax years 1996 and 1997, saying it operated as a commercial medical clinic for the primary benefit of its six employed doctors. The assessor and later the state tax board acknowledged that the hospital and foundation operated as charitable organizations.
But they concluded that the foundation's tenant, the North Attleborough doctors, offered little in the way of charity care, providing less than 1% of gross income to such cases. The physicians were paid fair-market value, even receiving bonuses based on productivity and collections, which the government contended amounted to a diversion of charity funds.
The tax agencies said the clinic did not accept walk-ins, treated patients only on an appointment basis and did not charge lower prices to those who couldn't afford care. The assessor and local tax board found that "the dominant purpose of the corporation was to benefit its physician members." The Massachusetts Appellate Tax Board affirmed the local ruling in 1997. Sturdy appealed to the state appeals court in 1999.
The foundation contended that the clinic served a wide patient base, admitted many patients to Sturdy for needed medical treatment and deserved the property tax abatement because the land was owned by a tax-exempt charity and served charitable purposes. The state appeals court remanded the case to the tax board for another hearing. The board reached the same decision and demanded property tax payments for the years 1998-2000. That decision was upheld by the appellate tax board in 2002. The hospital appealed and the state appeals court released its decision on March 4.
No decision on appeal
In a news release Linda Shyavitz, the longtime president and chief executive officer of Sturdy Memorial Hospital, said the foundation has paid property taxes annually while the case winds its way through the system.
"Sturdy Memorial Associates disagrees with the appeals court decision because it thinks the practice clearly fulfills its charitable mission," said Shyavitz, who also serves as executive director of Sturdy Memorial Associates. "Moreover, this appeals court decision contradicts an earlier appeals court decision on the same matter. Sturdy Memorial Associates is assessing its options under the law."
While Sturdy officials declined to say whether they'll appeal the case to the Massachusetts Supreme Judicial Court, health lawyers predicted they would.
However, officials from Sturdy and the Massachusetts Hospital Association declined to provide further details about the case. The North Attleborough assessor's office said the property-tax levy amounted to about $11,000 per year for the single clinic.
According to federal tax filings, Sturdy Memorial Associates lost money from 2000 through 2002 on its physician practices. In its 2002 tax filing, Sturdy Memorial reported losing $600,000 on total revenue of $18.2 million. It lost $1.4 million in the two previous years. In court filings the state tax board said the losses were because Sturdy Memorial Associates pays the startup and recruiting costs for its practices and even rent for some of the doctors. Its tax forms reveal it paid five physicians alone more than $2.1 million annually during those years.
Sturdy Memorial Hospital, with little competition in its market, earned an operating profit of $10.7 million and net income of $16.5 million on 2002 revenue of $146.3 million, according to the most recent Medicare cost report data available from the American Hospital Directory. The hospital that year reported 443 days of cash on hand and a 10.4% operating margin. The hospital paid CEO Shyavitz an average of $500,000 from 1998 through 2002 in annual salary and benefits, according to the hospital's tax filings.
North Attleborough Assistant Assessor Deborah Foley said she believes Sturdy is fighting so hard because of the case's potential regional impact. "I think because it could be a landmark case for facilities like that in the state," said Foley, who pointed out that Sturdy operates other clinics in southeast Massachusetts that could be subject to property tax payments. She said Sturdy recently began paying taxes on a different physician clinic it owns in Attleboro, after not being assessed for years.
"You can't go into the North Attleborough facility if you don't have an appointment, and the doctors there don't provide free care to people who walk in off the street, and those are the conditions you have to comply with in Massachusetts to qualify to be tax-exempt," Foley said. "And the hospital is making a huge profit."
Robert Bliss, the town counsel for North Attleborough, said if the appeals court decision stands, the foundation, not the doctors, would pay the property taxes. Bliss said the state court's decision does not affect the federal tax-exempt status of Sturdy Memorial Associates, the hospital or its foundation.
Indianapolis healthcare attorney Gregory Pemberton of the firm Ice Miller said the case could have national implications. Pemberton said in the 1990s hospitals were gobbling up physician practices to develop integrated health-delivery systems. Pemberton said the IRS, through private letter rulings, set up conditions that would ensure that these practices had a charitable mission and allow those purchased practices to qualify for tax-exempt status through their hospital foundations.
"But as economic times worsened and budgets got squeezed, local politicians and tax agencies began to see these not-for-profit organizations as a natural target for expanding the tax rolls, because many of them looked identical to commercial physician practices," Pemberton said. "At a minimum there are hundreds of these around the country."
Exemption not automatic
Boston lawyer Jedrey said historically in Massachusetts a federal tax exemption has precluded not-for-profit hospitals from paying state income and excise taxes. "The local property-tax exemption was not automatic," he said. "That's determined by city or town assessors." He said the state appeals court reaches two "completely unjustified conclusions: that a charity serving 18,000 patients is not a sufficiently large enough indefinite class for them and that a charitable institution can't pay fair-market value to its doctors and maintain tax-exempt status. It's nuts to me and irrelevant."
He said if that's allowed to stand, the state's well-regarded teaching hospitals might have to pay property taxes because they pay their doctors fair-market value. "It's not consistent with my understanding of the law and has potentially very broad applications," he said.
William Jessee, a pediatrician and the president and CEO of the Medical Group Management Association, said that last year's MGMA cost survey of 389 integrated delivery system group practices found 293, or roughly 75%, were exempt from federal taxes. He said it became a very popular business model for tax-exempt hospitals that acquired physician groups to make those groups tax-exempt as well. "When they acquired the group they transferred ownership to a hospital foundation. And you had large foundations employing large numbers of physicians who previously paid taxes on those practices."
But Jessee cautioned against overreading the impact of the Sturdy decision. "If the only issue is whether they have to pay property taxes, it's just an additional operating expense that will somewhat reduce the amount of bonuses the doctors get," he said. "I don't think it will become a source of tension between physicians and hospitals. They both got a good deal in not paying property taxes and are no worse off than when they were free-standing."
David Hilgers, a healthcare lawyer with Brown McCarroll in Austin, Texas, said: "It's very unusual for a hospital to be so bold to get tax-exempt status for a clinic that doesn't even offer free care. Clearly there are many hospitals around with tax-exempt physician clinics. This is growing into a big issue for state and municipal taxing bodies who feel that charities operating essentially as commercial physician offices need to pay their way. This is an issue coming out from under the covers."
Hilgers disagreed with Jessee, noting that the case has the potential for making it much more difficult for hospitals to carry out the integration they need to succeed in implementing quality goals.
"What these charity hospitals are trying to do is provide physicians for needed healthcare and they are meeting those needs by bringing doctors into their organizations. It will be interesting to see whether the Massachusetts case will carry over."
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