Originally published on Forbes.com.
501(c)(3) is the gold standard of federal tax exemption . Unlike almost all the other categories of exempt organization (There are 29 under 501(c) alone) contributions to (c)(3) organizations are deductible. It’s not exactly a walk in the park to achieve the status, so it is understandable that not for profit managers will try to use it as a magic wand to ward off all taxes.
When it comes to playing for local property tax exemption, though, not for profit managers can be surprised to learn that 501(c)(3) status can be just table stakes in some states. Based on my unscientific sample of the case law, it appears tha t Pennsylvania may well be the toughest state in this regard . A recent decision by the Commonwealth Court – Fayettee Resources Inc v Fayette County illustrates the principles at work.
About Fayette Resources
The mission of Fayette Resources (FR)is to:
…support people with disabilities in the community by providing the highest quality individualized services, which promote independence, choice, growth, acceptance and respect.
One of the ways it achieves its mission is through its residential program.
At the heart of Fayette Resources is the residential program. Individuals with developmental disabilities live with others of like personalities, common interests and similar capabilities in fully staffed homes. These homes are often referred to as Community Living Arrangements.
A common term for this type of program is “group home”. In 2012 FR had 14 homes and a training center in six municipalities and four school districts in Fayette county. FR applied for property tax exemption on all the properties.
Why Are The Properties Not Exempt?
As best I can tell the short answer is because they are in Pennsylvania. You get federal 501(c)(3) status by having an exempt purpose and not having inurement. For a Pennsylvania property tax exemption, your organization must prove that it is a “purely public charity”. The Pennsylvania Supreme Court has ruled that there are five requirements for “purely public charity”. An organization has to meet them all:
1) it must advance a charitable purpose; (2) it must donate or render gratuitously a substantial portion of its services; (3) it must benefit a substantial and indefinite class of persons who are legitimate subjects of charity; (4) it must relieve the government of some of its burden; and (5) it must operate entirely free from private profit motive
The Court found that HR met four out of five of the requirement. Unlike horseshoes and hand grenades, almost doesn’t count in the Pennsylvania “purely public charity” game.
What Is Missing?
The Court found that FR did not “render gratuitously a substantial portion of its services”. The residents might not be paying to live in the homes, but FR is getting paid by Medicaid
Here, the record is devoid of any evidence that Resources provides any of its services for payments lower than the full cost of those services or even that it provides services at cost. Resources introduced no evidence that it receives any charitable contributions or donations of property or services of any kind. Compare Grace Center Community Living Corp., 796 A.2d at 1110, 1113 (operator of senior living home was staffed by unpaid volunteers). Nor did it make any showing that the Medicaid payments that it receives are less than the full costs of its services, including the acquisition and fixing up of its group homes, or introduce any evidence as to how those payments compare to the total cost of its services.
Resources’ assertions in its brief that government funds only partially cover the costs of the care and services that it provides and that it pays for purchase and renovation of group homes from funds other than government payments are unsupported by anything in the record. No financial statements were introduced in evidence from which the trial court could make any findings concerning Resources’ costs or the sufficiency of the payments it receives for its services. The only evidence concerning Resources finances was that it had a surplus of $820,000 over its expenses in one year, which does not show any providing of services at or below cost. While Resources’ Director of Operations testified that Resources was not directly reimbursed by government payments for the cost of fixing up the homes (H.T. at 26, R.R. at 68a), there is no evidence as to the source of the funds that Resources used for those purposes or that those funds were not derived entirely from fully adequate payments for its services.
Controversy
The Pennsylvania legislature had passed a statute to broaden and clarify the definition of “purely public charity”, but the Pennsylvania Supreme Court has ruled that its definition is based on the Pennsylvania constitution and cannot be overridden by the legislature. There is a movement for a constitutional amendment which requires positive votes in two consecutive sessions of the legislature and then a statewide vote. The second approval may come up in 2015. Last month the auditor general issued a report to give a feel for the stakes in the controversy. A sample of 10 out of the 67 counties in Pennsylvania showed over $1.5 billion in property taxes not paid by organizations with charitable status.
Phillip Lebowitz of Duane Morris noted how the Fayette case fits into the larger controversy.
Even apart from the dual standard itself, it is troubling that Fayette Resources, which provides staffed homes for the intellectually disabled (who are legitimate subjects of charity), is exempt from federal taxation, relieves the government of the duty and burden to care for the intellectually disabled and has no private profit motive, was found not to have established its entitlement to a real estate tax exemption because it did not show that its costs exceeded its revenues. This rationale appears to conflict with the evidence that Fayette Resources is compensated by Medicaid payments, that any surplus revenues are directed back into acquisition or fixing up of group homes and that distribution of any funds for a private purpose is prohibited by the organization’s by-laws.
Is the Court saying that an entity must lose money on a consistent basis to be entitled to a real estate tax exemption? Must it solicit charitable contributions to establish its claim? These are the types of questions the legislature answered in the Public Charity Act. The Supreme Court’s, and here the Commonwealth Court’s, insistence on applying the less detailed, court-established standard of the HUP test in addition to the Public Charity Act standards only creates confusion and additional costs to charities who must repeatedly litigate the vagaries of the HUP test — the very result the legislature attempted to avoid.
Who Is Right?
This is one of those fights that I find very interesting, but can’t make up my mind about. It is rather peculiar to have entities that call themselves charities, but get paid for everything they do by government funding. In my experience both as a volunteer and, long ago, as an auditor, advocacy type not for profits are mainly funded by donations, but not for profits that provide services to the disadvantaged are largely funded by state and federal government. Sometimes they start out as purely charitable, but the allure of government funds proves irresistible. How local communities that have to struggle to provide infrastructure services should respond to such institutions is an interesting question that I don’t know how to answer. Apparently I am not alone in that.