As nonprofit hospitals reap big tax breaks, states scrutinize their required charity spending

The public school system here had to scramble in 2018 when the local hospital, newly purchased, was converted to a tax-exempt nonprofit entity.

The takeover by Tower Health meant the 219-bed Pottstown Hospital no longer had to pay federal and state taxes. It also no longer had to pay local property taxes, taking away more than $900,000 a year from the already underfunded Pottstown School District, school officials said.

The district, about an hour's drive from Philadelphia, had no choice but to trim expenses. It cut teacher aide positions and eliminated middle school foreign language classes.

"We have less curriculum, less coaches, less transportation,” said Superintendent Stephen Rodriguez.

The school system appealed Pottstown Hospital's new nonprofit status, and earlier this year a state court struck down the facility's property tax break. It cited the "eye-popping" compensation for multiple Tower Health executives as contrary to how Pennsylvania law defines a charity.

The court decision, which Tower Health is appealing, stunned the nonprofit hospital industry, which includes roughly 3,000 nongovernment tax-exempt hospitals nationwide.

"The ruling sent a warning shot to all nonprofit hospitals, highlighting that their state and local tax exemptions, which are often greater than their federal income tax exemptions, can be challenged by state and local courts," said Ge Bai, a health policy expert at Johns Hopkins University.

The Pottstown case reflects the growing scrutiny of how much the nation's nonprofit hospitals spend — and on what — to justify billions in state and federal tax breaks. In exchange for these savings, hospitals are supposed to provide community benefits, like care for those who can't afford it and free health screenings.

More than a dozen states have considered or passed legislation to better define charity care, to increase transparency about the benefits hospitals provide, or, in some cases, to set minimum financial thresholds for charitable help to their communities.

The growing interest in how tax-exempt hospitals operate — from lawmakers, the public, and the media — has coincided with a stubborn increase in consumers' medical debt. KFF Health News reported last year that more than 100 million Americans are saddled with medical bills they can't pay, and has documented aggressive bill-collection practices by hospitals, many of them nonprofits.

In 2019, Oregon passed legislation to set floors on community benefit spending largely based on each hospital's past expenditures as well as its operating profit margin. Illinois and Utah created spending requirements for hospitals based on the property taxes they would have been assessed as for-profit organizations.

And a congressional committee in April heard testimony on the issue.

"States have a general interest in understanding how much is being spent on community benefit and, increasingly, understanding what those expenditures are targeted at,” said Maureen Hensley-Quinn, a senior director at the National Academy for State Health Policy. "It’s not a blue or red state issue. It really is across the board that we've been seeing inquiries on this.”

Besides providing federal, state, and local tax breaks, nonprofit status also lets hospitals benefit from tax-exempt bond financing and receive charitable contributions that are tax-deductible for the donors. Policy analysts at KFF estimated the total value of nonprofit hospitals' exemptions in 2020 at about $28 billion, much higher than the $16 billion in free or discounted services they provided through the charity care portion of their community benefits.

Federal law defines the sort of spending that can qualify as a community benefit but does not stipulate how much hospitals need to spend. The range of community benefit activities, reported by hospitals on IRS forms, varies considerably by organization. The spending typically includes charity care — broadly defined as free or discounted care to eligible patients. But it can also include underpayments from public health plans, as well as the costs of training medical professionals and doing research.

Hospitals also claim as community benefits the difference between what it costs to provide a service and what Medicaid pays them, known as the Medicaid shortfall. But some states and policy experts argue that shouldn't count because higher payments from commercial insurance companies and uninsured patients paying cash cover those costs.

Bai, of Johns Hopkins, collaborated on a 2021 study that found for every $100 in total spending, nonprofit hospitals provided $2.30 in charity care, while for-profit hospitals provided $3.80.

Last month, another study in Health Affairs reported substantial growth in nonprofit hospitals' operating profits and cash reserves from 2012 to 2019 "but no corresponding increase in charity care."

And an April report by the Lown Institute, a health care think tank, said more than 1,350 nonprofit hospitals have "fair share" deficits, meaning the value of their community investments fails to equal the value of their tax breaks.

“With so many Americans struggling with medical debt and access to care, the need for hospitals to give back as much as they take grows stronger every day," said Vikas Saini, president of the institute.

The Lown Institute does not count compensating for the Medicaid shortfall, spending on research, or training medical professionals as part of hospitals' "fair share."

Hospitals have long argued they need to charge private insurance plans higher rates to make up for the Medicaid shortfall. But a recent state report from Colorado found that, even after accounting for low Medicaid and Medicare rates, hospitals get enough from private health insurance plans to provide more charity care and community benefits than they do currently and still turn a profit.

The American Hospital Association strongly disagrees with the Lown and Johns Hopkins analyses.

For many hospitals — after dozens of closures over the past 20 years — "just keeping your doors open is a clear community benefit,” said Melinda Reid Hatton, general counsel for the AHA. "You can't focus entirely on charity care" as a measure of community benefit. Hospitals deliver nine times the community benefit for every dollar of federal tax avoided, Hatton said.

The 2010 Affordable Care Act, she noted, imposed additional community benefit mandates. Tax-exempt hospitals must conduct a community health needs assessment at least once every three years; establish a written financial assistance policy; and limit what they charge individuals eligible for that help. And they must make a reasonable attempt to determine if a patient is eligible for financial assistance before they take "extraordinary collection actions,” such as reporting people to the credit bureaus or placing a lien on their property.

Still, the Government Accountability Office, a congressional watchdog agency, argues that community benefit is poorly defined.

"They're not requirements,” said Jessica Lucas-Judy, a GAO director. "It's not clear what a hospital has to do to justify a tax exemption. What's a sufficient benefit for one hospital may not be a sufficient benefit for another." The GAO, in a 2020 report, said it found 30 nonprofit hospitals that got tax breaks in 2016 despite reporting no spending on community benefits.

The GAO then recommended Congress consider specifying the services and activities that demonstrate sufficient community benefit.

The tax and benefit question has become a bipartisan issue: Democrats criticize what they see as scant charity care, while Republicans wonder why nonprofit hospitals get a tax break.

In Georgia, Democratic lawmakers and the NAACP spearheaded the filing of a complaint to the IRS about Wellstar Health System's nonprofit status after it closed two Atlanta-area hospitals in 2022. The complaint noted the system's proposed merger with Augusta University Health, under which Wellstar would open a new hospital in an affluent suburban county.

"I understand you pledged over $800 million" in the deal with AU Health, state Sen. Nan Orrock, an Atlanta Democrat, told Wellstar executives at a recent legislative hearing, citing the system's disinvestment in Atlanta. "Doesn't sound like a nonprofit. It sounds like a for-profit approach."

Wellstar said it provides more uncompensated health care services than any other system in Georgia, and that its 2022 community benefit totaled $1.2 billion. Wellstar attributed the closures to chronic financial losses and an inability to find a partner or buyer for the inner-city hospitals, which served a disproportionately large African American population.

In North Carolina, a Republican candidate for governor, state Treasurer Dale Folwell, said many hospitals "have disguised themselves as nonprofits."

"They're not doing the job. It should be patients over profits. It's always now profits over patients," he said.

Ideas for reforms, though, have run up against powerful hospital opposition.

Montana's state health department proposed developing standards for community benefit spending after a 2020 legislative audit found nonprofit hospitals' reporting vague and inconsistent. But the Montana Hospital Association opposed the plan, and the idea was dropped from the bill that passed.

Pennsylvania, though, has a unique but strong law, Bai said, requiring hospitals to prove they are a "purely public charity" and pass a five-pronged test. That may make the state an easier place to challenge tax exemptions, Bai said.

This year, the Pittsburgh mayor challenged the University of Pittsburgh Medical Center over the tax-exempt status of some of its properties.

Nationally, Bai said, "I don't think hospitals will lose tax exemptions in the short run."

But, she added, "there will likely be more pressure from the public and policymakers for hospitals to provide more community benefit."

Mountain States editor Matt Volz contributed to this report.

This article was reprinted from khn.org with permission from the Henry J. Kaiser Family Foundation. Kaiser Health News, an editorially independent news service, is a program of the Kaiser Family Foundation, a nonpartisan health care policy research organization unaffiliated with Kaiser Permanente.