Two hundred and thirty-eight years ago, George Washington put this north-central New Jersey town in the history books when he used it as a wintertime encampment during the colonies’ bid to break from British rule.
Now, Morristown is involved in another battle — this time, with its biggest employer — that could have major implications for some of New Jersey’s biggest institutions.
On one side of the battle is the county seat of Morristown with a population of more than 18,000.
On the other is Morristown Medical Center, the workplace for more than 5,500 employees and the biggest facility in the $1.6 billion-a-year hospital section of Atlantic Health System, recognized nationally for clinical excellence.
The two sides have been in court since the town’s tax assessor in 2008 denied the hospital’s property tax exemption for portions of the hospital that were deemed for-profit operations in 2006-2008.
The question they’re fighting over — whether the entire hospital is operating as a legal charity or a for-profit business — is in the hands of Tax Court Judge Vito Bianco. How he rules could have an impact on health care and educational institutions and the tax base in their host communities.
Hospitals and potentially other large non-profits such as colleges and universities could have their property tax-exemptions put at risk if several events occur: if the town wins its case, and if Bianco’s ruling is broadly written, affecting the wide range of institutions regulated under the state’s general exemption statute, said David Wolfe, a property tax attorney with Skoloff & Wolfe in Livingston.
“This is the first case where the issue is the main hospital,” said Wolfe, who teaches a course on property tax exemptions for the New Jersey Institute of Continuing Legal Education. “Other cases have dealt only with portions of hospitals. If the judge rules in Morristown’s favor, it certainly will have a wide-ranging impact.”
The issue before Bianco concerns the hospital’s property tax exemption only. His ruling would not directly affect the hospital’s federal exemption.
Wolfe noted that Princeton University is also fighting a court challenge to its property tax exemption, also before Bianco. There, the university is fighting over whether its sharing of patent royalties with faculty constitutes for-profit activity.
Morristown already has one win in the case, when the court ruled in 2010 that the hospital’s Au Bon Pain cafe, children’s hospital and cancer center were taxable.
If the court undermines the main hospital’s property tax-exempt status, more than the medical center will be hurt, said its attorney Kenneth Norcross.
“This won’t just affect the hospital,” he said. “All nonprofits would be subject to tax. If the town of Morristown prevails, the same thing would be applied to every nonprofit.”
Kerry McKean Kelly, vice president for communications and member services at the New Jersey Hospital Association, declined to comment directly on the case, but said hospital executives statewide are concerned it could threaten their hospitals’ property tax exemptions.
“I think that’s a very real concern,” she said.
THE ROOTS OF NON-PROFIT HOSPITALS
To understand the conflict, first it’s important to understand hospitals as non-profits. Hospitals can be operated as for-profit businesses with shareholders or they can be run as non-profits, where revenues after expenses are put back into the organization in the form of capital investment or employee compensation.
Historically, most hospitals in the United States have been non-profits, since many were established by philanthropic or religious groups serving the poor, according to the National Bureau of Economic Research. A majority of hospitals in the United States are non-profit, with most for-profit hospitals operating in southern states and California, it said. In New Jersey, Bayonne Medical Center and Meadowlands Hospital Medical Center are for profit hospitals, for example. Mountainside in Montclair converted to a for-profit in 2007.
Having a surplus after expenses does not make an operation for-profit, nor does offering substantial executive salaries and bonuses, Norcross noted.
Non-profits have to meet certain obligations to qualify for federal and state tax-exemptions. Federal law requires hospitals to provide “community benefits.” Under New Jersey law, a property owned by a non-profit has to be used “exclusively” for a charitable purpose to be entitled to a property tax exemption. If part of the property is used as a for-profit operation, that portion should be taxed, according to the law.
If they qualify for the federal tax exemption, hospitals earn a significant benefit. One widely cited study from 2006 by the congressional Joint Committee on Taxation pegged the value of hospitals’ tax exemptions nationwide at $12.6 billion. The benefit goes even further by allowing tax-exempt hospitals to raise tax-deductible charitable donations and borrow money at favorable rates.
Access to tax-exempt bonds is critical, noted Dr. John D. Colombo, a national expert on hospitals and tax-exemption. If the hospital loses its federal tax-exemption, new bond issues would be more costly and current bondholders could “call” or redeem theirs early.
That makes hospitals’ tax-exempt status for bonds “an even bigger deal” than property taxes, said Colombo, the interim dean of the University of Illinois School of Law.
“There are very strong financial reasons for hospitals to seek federal tax-exempt status even if they lose at the local level,” he said.
Losing in a state property tax-exemption case would not necessarily trigger a change in the hospital’s federal tax-exempt status, Columbo added. He cited the example of Presence Covenant Medical Center in Champaign, Ill., which lost its local tax case but kept its federal tax-exempt status.
For Morristown Medical, losing the property tax exemption on its 40 acres in the town would cost it $2.5 million to $3 million a year, said Norcross.
Being responsible for property taxes would force the hospital to cut back on services it provides at a loss or at no cost to Morristown and the surrounding area, Norcross said. Such “community benefits” include charity care, Medicare services, training for future physicians and operations at the Goryeb Children’s Hospital.
“Community benefits would probably have to be contracted,” he said, even though they are an important part of the “hospital’s mission.”
It’s too early to discuss what services might be cut, hospital spokeswoman Janina Hecht said.
The threat of cutting services surprised Mayor Timothy Dougherty, who said in a prepared statement that cuts would be “inconsistent” with the hospital’s position in court.
“Their executive testified that [Atlantic Health System] can afford to pay their share of property taxes and that such payment would not have an adverse affect on services rendered to the community,” Dougherty said.
Higher taxes on hospitals cut into the economic engines of their communities, Kelly added. In many cases, they are the largest employers in their host communities, with the economic benefit of professional salaries and wages rippling through the region, she said.
Hospitals “have a profound and expanding impact on the financial well-being of the community,” she said.
THE ARGUMENTS
To Martin Allen, who is representing Morristown in the case, the medical center is operating as a for-profit entity. The hospital hires for-profit physician groups to operate many of its functions, including the radiology, pulmonary and anesthesia groups, the emergency department and the lab, he said.
“Our position is that if you carve out areas for these groups, they are taxable,” he said.
Further, Atlantic makes loans to physicians to attract them to the region, and “if they stay in the area and do what the hospital tells them to do, they forgive the loan,” Allen said.
The medical center has the financial muscle to pull it off, Allen said, because its patient charges are unreasonably high.
“The hospital said they are reasonable because they were negotiated with insurance companies, but they did not prove they were reasonable,” Allen said.
Atlantic Health Ambulance and three of Atlantic Health’s hospitals — Morristown Medical, Overlook Medical Center in Summit and Newton Medical Center — brought in $1.6 billion in revenues in 2013, up more than $100 million from 2012, the hospital’s tax records show.
That’s not including revenues from 21 other Atlantic Health facilities such as outpatient centers, rehabilitation facilities and urgent care centers.
“What we have in this case is a conglomerate,” Allen said.
Norcross argues that hiring for-profit physicians does not make the hospital itself for-profit. “That,” he said, “is the way hospitals have always been organized.”
As at most hospitals, the majority of doctors are not on staff, Norcross said. They have privileges at the hospital to see patients.
“You get a bill from the doctor, and a bill from the hospital,” he said. These “voluntary physicians see more than 80 percent of the hospital’s patients, which is typical in the business, Norcross said.
“What shouldn’t be prevented is a doctor coming on the premises, taking out someone’s tonsils and being paid for it,” Norcross said.
The hospital uses the loan forgiveness program to attract physicians in areas of need, such as pediatrics, he added. Morristown medical center also routinely loses money on caring for children, but “sometimes we provide a service to the community knowing we’re going to lose money, because there is a need,” Norcross said.
The hospital’s charges, he said, are the result of negotiations with insurance companies. “It’s a fiction that hospitals have the power to charge whatever they want,” Norcross said.
The hospital’s 4-percent margin after expenses gives it enough to run the facility and invest in constantly changing and expensive technology, Norcross said.
“We have various loans on the hospital for improvements,” he said. “To get loans, you need to get some profits.”
COMPENSATION
Compensation also is a point of contention. Joseph Trunfio, the CEO of Atlantic Health Systems and other high-level executives, are paid salaries that are not justifiable for non-profits, Allen said.
Trunfio’s compensation stood out in 2012, when the system paid him a $1.2 million base salary, a bonus of $687,000 and an additional one-time bonus that contributed to a total compensation package of more than $10 million, the health system’s 2012 IRS record shows.
Rob Seman, a hospital spokesman, said compensation is performance-based, aligned with industry standards and intended to retain top executive talent.
Executive compensation is approved by the hospital’s board and fashioned with the assistance of a third-party consultant, he said, and is based on a number of factors, including what other executives are paid at comparable health systems in the market.
But allowing the hospital to determine its peer group is not a fair way to set reasonable executive salaries, Allen said.
“It is like Alice In Wonderland,” he said.
Salaries don’t become a problem until they are deemed “excessive” under federal law, Colombo said. Salaries for non-profit institutions are measured against salaries in similar industries, including those in the private sector, he said.
“This may strike you as odd, but it is the law,” Colombo said. “The CEO’s salary … is hardly out of line with the salaries of other CEOs once you look at the universe of all CEOs, including those in the private sector.”
CHALLENGES ELSEWHERE
Morristown is not the only community to challenge a hospital’s property tax-exempt status in recent years.
After courts in Illinois ruled that several hospitals should not have their tax exemption in 2010, state legislators crafted a law allowing hospitals to keep them if they are able to show that they provide free or discounted care equal to or greater than their property tax liability.
Litigation is ongoing and may be one reason few communities undertake such challenges, although Colombo wonders why communities aren’t more aggressive about getting hospitals to pay up.
“They’re not going anywhere,” he said.
The University of Pittsburgh Medical Center backed off a federal lawsuit against the city of Pittsburgh last year after new Mayor Bill Peduto first dropped the city’s challenge of UPMC’s tax-exemption.
Instead, Peduto is in talks with UPMC as well as other big non-profits in the city, including Highmark Blue Cross/Blue Shield, the University of Pittsburgh and Carnegie-Mellon University, said spokesman Timothy McNulty.
The city is hoping the institutions will find areas of mutual interest and put their financial muscle into them, McNulty said.
“Perhaps they can help us with long-term capital and debt needs that are holding the city back,” he said. “They aren’t good for the city and thus aren’t good for the non-profits.”
Finding a way to work with the institutions seemed a better course than fighting in court, McNulty said.
Peduto, he said, “decided that trying to negotiate these things with a gun to each of our heads wasn’t going to work, so he dropped it.”
Neither the town nor the hospital is at that point, however.
“We will definitely appeal” if the hospital loses, Norcross said.
The medical center is not exempt from taxes just because it offers “a wide spectrum of qualify medical and health care services,” Dougherty responded. “The town’s position is and always has been that [Atlantic Health System] should pay their fair share of property taxes for properties that are being operated for profit.”
It is unknown when Bianco will issue his ruling.