A non-profit hospital chain buys a for-profit hospital and its property tax exemption application for the hospital is denied by the county.
M&A Stories
July 8, 2023
Introduction:
Most hospitals in the United States are non-profit corporations, comprising over two-thirds of the market. These non-profits don’t pay federal income taxes or local property taxes.
Background:
This case revolves around the sale of an underserved, stand-alone acute care hospital located 40 miles west of Philadelphia. The seller is a publicly traded company and a leading healthcare provider in the nation, operating in 44 markets across 15 states. The buyer is a not-for-profit healthcare system based in Pennsylvania, operating hospitals, and medical centers in the region.
The buyer purchased the hospital in 2017 for $82 million, with $40 million in cash and the remainder invested in capital improvements. The buyer operated the hospital in a new LLC.
Lawsuit:
The acquired hospital applied with the county for a real estate property tax exemption. The county denied the hospital’s property tax exemption application, and the buyer challenged the denial in a Pennsylvania trial court.
Outcome:
The trial court upheld this denial, stating that the hospital did not qualify as a tax-exempt charity. The court found that the hospital was not a charity, because it had not provided free, uncompensated patient care and highlighted an excessive compensation scheme for the hospital’s senior executives and management fee for the buyer’s services.
An intermediate appellate court dismissed the buyer’s appeal on procedural grounds but expressed agreement with the trial court that the hospital did not operate as a charity. The appellate court emphasized the criteria for a tax-exempt charity, including advancing a charitable purpose, relieving government burdens, donating a substantial portion of services, and operating without profit motives. The court said that the hospital did not act like a charity because of excessive compensation for the hospital’s senior executives, excessive management fees to the buyer, and not providing donated or gratuitous medical services to those unable to pay. The court stressed that donated or gratuitous medical services do not include treating individuals reimbursed by Medicaid at rates lower than desired.
Case Reference:
See Brandywine Hosp. v. Bd. of Assessment, 291 A.3d 467 (2023), Commonwealth Court of Pennsylvania (Argued November 16, 2022. Decided February 10, 2023. Reargument Denied April 14, 2023).
Comment: The buyer will likely appeal to the Pennsylvania Supreme Court.
In the first quarter of 2023, 14 out of 15 announced hospital acquisitions involved non-profit healthcare system buyers. In the future, non-profit buyers must consider the risk of denial of their application for property tax exemptions for acquired hospitals. To manage this risk, non-profit healthcare system buyers should structure acquisitions with commercially reasonable management fees, and executive compensation within IRS guidelines, and provide adequate evidence of uncompensated care.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
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