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Atlantic Health Systems Loses Property Tax Exemption in Morristown
By Craig A. Gargano on June 2, 2015

On June 30, 2015, the New Jersey Tax Court released its decision in the case of AHS Hospital Corp d/b/a/ Morristown Memorial Hospital v. Town of Morristown.¹ The Court determined that AHS Hospital Corp., d/b/a Morristown Memorial Hospital (“Hospital”) was not eligible for property tax exemptions under New Jersey law as a non-profit corporation.

On June 30, 2015, the New Jersey Tax Court released its decision in the case of AHS Hospital Corp d/b/a/ Morristown Memorial Hospital v. Town of Morristown.¹ The Court determined that AHS Hospital Corp., d/b/a Morristown Memorial Hospital (“Hospital”) was not eligible for property tax exemptions under New Jersey law as a non-profit corporation. In making its finding, the Court analyzed, among other things: (i) the corporate structure of the Hospital; (ii) the Hospital’s multiple for-profit and non-profit affiliated entities; (iii) loans and financial transactions between those entities; (iv) the Hospital’s financial relationships with employed physicians, contracted physicians and private practice physicians; and (v) the compensation of hospital executives. This decision has potentially far-reaching impact on both hospitals and physicians in New Jersey, as well as on municipal taxing authorities.

Brief Summary:

This case was heard in connection with the denial by the Township of Morristown, County of Morris, New Jersey (“Township”) of a property tax exemption for the Hospital. The Township challenged the Hospital’s designation as a non-profit entity entitled to such exemption. The Court ruled in favor of the Township, finding that the excessive commingling of non-profit and for-profit purposes of the Hospital violated the statutory requirements for a non-profit hospital in N.J.S.A. 54:4-3.6 and, more specifically, did not satisfy the test for non-profit exemption from property taxes established in Paper Mill Playhouse v. Millburn Twp., 95 N.J. 503 (1984). This test requires a non-profit entity to demonstrate that: (i) it is organized for purposes that furthered the public’s moral and mental improvement; (ii) the property on which the entity is located was actually and exclusively used to further the moral and mental improvement of society; and (iii) the entity’s operations and use were not conducted for profit.

Analysis of the Court:

The Court went on at length to discuss the history of hospitals, the operation and use of the Hospital generally, and the origins of the property tax exemption for hospitals. After providing this informational background, the Court proceeded to provide an in-depth review of various aspects of the operation of the Hospital that led to its finding of for-profit status for the purpose of property tax exemption. The remainder of this memorandum will focus on that analysis.

Relationship with Affiliated and Non-Affiliated Entities:

The Court analyzed the impact of the Hospital’s affiliated and non-affiliated entities on its overall non-profit status. The Hospital maintained relationships with a number of affiliated and non-affiliated for-profit entities, including: (i) physician practices owned by the Hospital with the sole shareholder holding the shares in the practice in trust for the Hospital; (ii) Atlantic Health Management Corp., a subsidiary of Atlantic that owned a number of other for-profit subsidiaries affiliated with the Atlantic Healthcare System; (iii) AHS Insurance Co., Ltd., a subsidiary of Atlantic; and (iv) other unrelated for-profit entities.

The Court summarized the interaction between the Hospital and each of the affiliated and non-affiliated entities including: (i) working capital loans; (ii) capital loans; (iii) recruitment loans; (iv) transfers of funds to subsidize for-profit physician groups that were routinely operated at a loss; and (v) Hospital employees working at these for-profit practices and serving as officers. Ultimately, the Court determined that “By entangling its activities and operations with those of for-profit entities, the Hospital allowed its property to be used for profit. This commingling of effort and activities with for-profit entities was significant, and a substantial benefit was conferred upon for-profit entities as a result. Accordingly, the Hospital failed to satisfy the profit test as set forth in Paper Mill Playhouse, and is precluded from exemption.”

Relationship with Physicians:

There are three separate categories of physicians performing services at the Hospital: (i) employed physicians, selected by the Hospital based on “community need” with respect to certain fields of medicine (“Employed Physicians”); (ii) voluntary physicians who are private, for-profit, self-employed physicians who practice in the community and have privileges to treat patients at the Hospital (“Voluntary Physicians”); and (iii) exclusive contract physicians who provide medical services in the fields of radiology, anesthesiology, pathology and emergency services who also operate for profit (“RAP Physicians”). The fees for the voluntary and RAP Physicians are billed to the patients separately from the technical fees of the Hospital, but the Court determined that they nevertheless constituted profit-making activities for the Hospital.

The contracts entered into with the Employed Physicians are not standard and vary depending on individual circumstances and by department. However, many of the contracts contain incentive compensation that is paid out of a portion of the revenues of the department in which each Employed Physician works. The Court believed that a portion of the incentive compensation was derived from departmental expenses and the profit was split between the Hospital and the Employed Physicians. The Court found that this profit sharing incentive compensation indicated that the Hospital was conducted for a profit-making purpose. Accordingly, the Court found that the incentive provision of the Employed Physicians’ contracts violated the profit test of Paper Mill Playhouse.

In order to provide the Hospital with a property tax exemption, the Court had to determine where the for-profit physicians (particularly, the Voluntary Physicians and the RAP Physicians) practice at the Hospital, in order to identify the areas of the Hospital that are subject to taxation. Likewise, the Court analyzed where these for-profit physicians do not practice at the Hospital in order to identify the areas where a property tax-exemption may be preserved.

Ultimately, the Court determined that the for-profit physicians (including both the Voluntary Physicians and the RAP Physicians) were commingled throughout the Hospital, utilized Hospital equipment and were granted essentially the same rights and privileges as the Employed Physicians. Given this pervasive commingling, the Court was unable to discern between the non-profit activities carried out by the Hospital and the for-profit activities carried out by private physicians. Furthermore, the Employed Physicians’ compensation packages violated permissible payment structures for a non-profit entity. Given each of the above, the Court determined that the Hospital was not being conducted as a non-profit entity.

Executive Compensation:

The Court reviewed the compensation of four (4) key employees of the Hospital to determine if they were on par with other hospital systems of comparable size and standing. Notably, Joseph Trunfio, the then President and CEO of Atlantic Health Systems, received total compensation of $5,034,313 in 2005. The Hospital attempted to demonstrate that the salaries paid to its employees were comparable to the salaries paid at comparable health systems in the Greater New York Metro area and produced an expert witness to establish that this was the correct comparable market and that the salaries were in fact comparable. The Court was not satisfied that the Hospital met its burden to establish that the Hospital’s best practices met the requirements for the presumption of reasonableness in executive compensation.

Third Party Agreements:

The Hospital has entered into agreements with third parties to provide a number of support services, including a parking garage, cafeteria, laundry/linen and other support services. The Court specifically reviewed contracts with Gateway Security Systems (parking garage operation) and Aramark (laundry/linen and environmental services). While the Court found no objections to the Gateway Contract, the Aramark contract contained a provision whereby the Hospital would receive a percentage of the budgetary savings achieved by Aramark supervision. The Court considered this share of savings (which the Court deemed to be revenues) as a for-profit motivation. Additionally, the Court went on to find that the Hospital Gift Shop, Cafeteria and Day Care Facilities also were operated for profit.

Conclusion

Based on its extensive analysis, the Court found that the Hospital did not meet the requirements for property tax exemption in New Jersey, stating that “if the property tax exemption for modern non-profit hospitals is to exist at all in New Jersey going forward, then it is a function of the Legislature and not the courts to promulgate what the terms and conditions will be.” The Court also stated that “If it is true that all non-profit hospitals operate like the Hospital in this case . . .modern non-profit hospitals are essentially legal fictions.” In closing, the Court stated “Clearly, the operation and function of modern non-profit hospitals do not meet the current criteria for property tax exemption under N.J.S.A. 54:4-3.6 and the applicable case law.” If this decision stands, it will require both non-profit hospitals and all physicians affiliated with them to evaluate their current operations to determine if any similar issues with regard to their non-profit status exist.

¹AHS Hospital Corp d/b/a/ Morristown Memorial Hospital v. Town of Morristown, 2015 N.J. Tax LEXIS 12 (N.J. Tax Ct. 2015)

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