AHS Hosp. Corp. v. Town of Morristown – June 2015 (Summary)

HOSPITAL PROPERTY TAX EXEMPTION

AHS Hosp. Corp. v. Town of Morristown, Docket Nos: 010900-2007, 010901-2007, 000406-2008 (N.J. Tax Ct. June 25, 2015)

UPDATED SUMMARY — November 2015

As being reported by national and local media, the Morristown Medical Center, which is part of the Atlantic Health System, has agreed to pay $15.5 million, including fines and interest, to the municipality of Morristown, New Jersey, thereby settling this hospital property tax exemption case.  In addition, the Medical Center will begin paying annual taxes of roughly $1 million. This settlement could have an impact on the tax-exempt status of other not-for-profit hospitals, certainly in New Jersey, but quite possibly nationwide as cities look for ways to plug holes in their budgets.

ORIGINAL SUMMARY — June 2015

In a case of first impression, the Tax Court of New Jersey denied a New Jersey hospital’s property tax exemption for the main hospital campus. To reach this decision, the court applied the New Jersey state law profit test to different aspects of the hospital’s operations including: the “for-profit activity carried out by private physicians,” executive compensation, employed physicians’ contracts, third-party agreements, the gift shop, the auditorium, the day care area, fitness center, and the cafeteria.

Notably, the court found that the hospital failed the profit test because the hospital allowed its property to be used for forbidden for-profit activities, by entangling and comingling its activities with for-profit entities. Perhaps most surprising was the court’s focus on the work performed at the hospital by private “for-profit” physicians. According to the court, the hospital had for-profit doctors using its facilities to generate private medical bills to patients. Since the activities of for-profit physicians could not separately be accounted for (from employed physicians who preform distinctly non-profit activity), the arrangement with the for-profit physicians directly violated the requirement articulated in New Jersey case law.

The court also examined several executive salaries. The court recognized that tax-exempt organizations are permitted to pay salaries to staff that are not excessive and which are comparable to the salaries paid by similar institutions. However, the court found that the hospital had failed to meet its burden of establishing the reasonableness of the compensation paid to its executives. With respect to the compensation paid to a number of employed physicians, the court also found that the hospital had demonstrated a prohibited “profit-making purpose.”

Thus, the court concluded that the property tax exemption could be preserved only in three areas: the parking garage contract, the operation of the auditorium, and the operation of the fitness center.