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Taxing Away an Exemption

With revenue down, states and localities are taking a second look at tax-exempt organizations.


Penelope Lemov

Penelope Lemov is a GOVERNING correspondent. She was GOVERNING's health columnist and was senior editor for several award-winning features.


Commented March 22, 2010

In Detroit Michigan it was announced yesterday that Detroit Medical Center a major not for profit ho...

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Pittsburgh's proposed tax would have been a first: a 1 percent levy on all tuition paid by the city's 100,000 college students. If it had passed, it would have raised $15 million a year by, in effect, rescinding a tax exemption.

Last year, Providence asked Rhode Island lawmakers to allow it to assess the city's four major private colleges $150 per semester for every out-of-state student.

Hawaii has some bright ideas along tax-exempt lines, too. The state is debating whether to require charities to pay a 1 percent tax, and Honolulu's City Council is considering eliminating property tax caps - it's currently $100 a year - on nonprofit organizations.

Over in Kansas, legislators are considering making nonprofits pay a sales tax on items they buy, while some of its localities want to revoke nonprofits' exemption from property taxes.

In Georgia, nonprofit hospitals would lose their state sales tax exemption under a new round of budget reductions announced last week by Governor Sonny Perdue.

The focus on the tax exemption for nonprofits is cyclical - it happens every downturn. States and localities looking for additional revenue see some nonprofits as fat cats who could afford to help out. But this time around, it's a little different. States and localities are not only looking to the nonprofit sector to recoup some property tax revenue, they are attacking on all tax fronts - income, sales and property. They may be emboldened by another phenomenon: increased scrutiny of nonprofits' business models. Where regulation of nonprofits was once the almost-exclusive purview of state attorneys general, the federal government - from the Internal Revenue Service to members of Congress - has turned a more skeptical eye on them. Nonprofit hospitals, for instance, have been asked to distinguish what they do from what for-profit hospitals do. Similarly, universities have been questioned about their various revenue streams and asked to delineate what is related to the public benefit of providing services and what is, in effect, unrelated business income.

To get a better picture of what's happening with the attempt to tap nonprofits for revenue, I checked in with several tax experts. Here's a synthesis of the three major points they make.

All nonprofits are not created equal. There are four different kinds of tax-exempt entities: health care institutions, colleges and universities, social service organizations and religious groups. One policy will not fit all.

Churches and religious groups are usually exempt from non-exemption discussions - taxing them raises constitutional issues and no one wants to go there.

Social service organizations are, in effect, an arm of government. Their existence relieves government of some of its burdens, which compensates a government for the loss of revenue. Moreover, governments fund most social service nonprofits by buying the services the agencies provide. If they then tax the income of the nonprofit, they are sending the money back to the government with the added layer of administrative costs. Two other points: Getting fees from the social service sector is like looking for nickels and dimes under couch cushions - it isn't going to be worth the effort. Also not worth it: the political backlash from trying to tax Meals on Wheels.

Health care facilities and universities generate the lion's share of revenue in the nonprofit sector. In many localities, they employ thousands of people and own lots of land. The argument for taxing them is a simple one: They consume government services - fire, police and the like - and should pay their fair share just as their for-profit counterparts or competitors do.

Taxing nonprofits is a tough row to hoe. Health care organizations and universities are economic engines with a lot of political clout. Universities have the additional backing of alumni, who are personally invested in their alma maters. One tax expert talked about buying season tickets to his university's football games. If the school had to raise the price of those tickets by $50 because the state or locality wanted to tax university property that is used for nonacademic purposes - such as a football stadium - he is going to make his unhappiness known to state or local officials.

Philadelphia's attempt to assess a nonprofit - the Dad Vail Regatta - shows how tough it is to assess a tax-exempt organization. The regatta, which has been held every May since 1955 on the Schuylkill River, is the largest collegiate rowing event in the country and is worth an estimated $2 million to Philly's economy. When the city tried to increase the fees the regatta pays for city services - police overtime, fire department emergency technicians, marine-police units and fees to the riverside park - regatta officials found a New Jersey township willing to pay it $250,000 to change the venue. Philadelphia was able to negotiate to keep the regatta - but with compromises on fees the group would have to pay.

PILOTs are an alternative. Many educational institutions make PILOT payment to city governments. PILOTs are Payments Made in Lieu of Taxes, and they are voluntary. A survey by the Chronicle of Higher Education found that nearly two-thirds of the 30 research universities with large endowments had no arrangements to make routine payments to their local governments. The full survey is on the Chronicle's Web site, but is only available to members. Some highlights, courtesy of Steve Hoffman, director of business and finance at the University of West Virginia: Harvard and Yale pay their local hosts in excess of $5 million and $7 million a year, respectively; Massachusetts Institute of Technology, Princeton University and the University of California at Berkeley top the $1 million mark.

Pittsburgh shelved its attempt to tax tuition in favor of pledges from the University of Pittsburgh and Carnegie Mellon University, among others, to donate more to the city than they had previously. Pittsburgh may have made its temporary peace with its universities but two state legislators - State Senator Wayne D. Fontana and Representative Timothy J. Solobay - have introduced legislation that would allow for the imposition of an "essential services fee" on tax-exempt organizations that own property within a municipality. While municipalities could continue to rely on existing voluntary agreements, the Fontana bill would give them the option of imposing a fee based on total square footage of properties or establishing a limited real estate tax for properties owned by charitable institutions. Will it pass? Stay tuned.

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