Tax alert

Pennsylvania court rejects nonprofit hospital property tax exemptions

Feb 17, 2023
State & local tax Business tax Nonprofit

Executive summary: Exempt organizations must be diligent when claiming exemptions 

The Pennsylvania Commonwealth Court ruled against three hospitals because they could not prove they were operating as purely public charities. Pennsylvania property tax exemptions for purely public charities are highly nuanced and have been examined through decades of case law and statute. Diligence is required for exempt organizations claiming or considering claiming the exemption. 

Pennsylvania court rejects nonprofit hospital property tax exemptions

On Feb.10, 2023, the Pennsylvania Commonwealth Court ruled that three hospitals were not exempt from local property taxes because they failed to prove they were operating as purely public charities. The discussion below is a consolidation of the four cases at issue. For more information on these cases individually, please see the following: Pottstown Sch. Dist. v. Montgomery Cty. Bd. of Assessment Appeals, Brandywine Hosp., LLC v. Chester Cty. Bd. of Assessment Appeals, Phoenixville Hosp., LLC v. Chester Cty. Bd. of Assessment Appeals and Jennersville Hosp., LLC v. Chester Cty. Bd. of Assessment Appeals.

The three hospitals involved in the litigation were owned by a section 501(c)(3) exempt organization, Tower Health, LLC. Tower Health had purchased the hospitals to be run as nonprofit entities in northeastern Pennsylvania. The hospitals were operated as limited liability companies with Tower Health as the sole shareholder of each. The hospitals applied for exemptions from property taxes and were denied by the respective counties in which they operated. The denial of exempt status was affirmed on appeal to a trial court. 

The denial was affirmed again upon further appeal to the Commonwealth Court. The court noted that the hospitals paid “millions” of dollars to Tower Health in the form of management fees, central business office fees and bond issue interest payment obligations. Depending on the year and the hospital, the fees ranged from around $1 million to over $21 million, without explanation on why the fees continually increased or their reasonableness. The trial court also found the fees to be “exorbitant” and that the funds were applied for purposes other than support of the hospital. Tower Health in turn paid bonuses to its executives based on Tower Health’s financial performance component; at least 40% of executive bonuses were based on these financial metrics - a figure the court found to be substantial. Finally, the trial court found that interest payments on bonds for the purchase of other properties was improper and that no amount of the bond payments were applied to support the hospitals.   

The Pennsylvania Constitution offers general tax exemptions to institutions of purely public charity. This exemption has been clarified through both statute and case law, essentially providing a list of necessary criteria to qualify as a purely public charity. The 1985 Pennsylvania Supreme Court case of Hospital Utilization Project v. Commonwealth (HUP) advanced five criteria, one of which requires the entity to operate entirely free from private profit motive. The Commonwealth Court cited to the HUP decision as well as other case law and statutory provisions explaining these criteria. Statute further explains that criteria evidencing that an institution operates free from private profit motive include that neither the institution’s net earnings nor donations inure to the benefit of private shareholders or others and that compensation of officers or employees is not based primarily upon the financial performance of the institution. 

The trial court found, and the Commonwealth Court agreed, that the hospitals failed to demonstrate an absence of a profit motive behind the management fees and bond interest payments. The court noted that diverting money to employees through excessive salaries and fringe benefits was evidence of a profit motive. Additionally, the court found that tying executive compensation to Tower Health’s financial performance was “indicative of a profit motive.” Finally, the court rejected the hospital’s argument that it gave away a substantial portion of their services to Medicare and Medicaid patients because the hospitals provided no evidence to support that claim. 


While these related cases were based in Pennsylvania, virtually all states have similar rules regarding exempt status for tax purposes. However, Pennsylvania has an incredibly complex and nuanced local real property tax regime, as well as public charity exemptions granted in the state constitution and limited by case law. It is essential to understand the scope of state exempt organization tax rules which can vary not just among states but from federal exempt organization provisions. 

These cases illustrate some of the challenges of obtaining and retaining state and local tax exemptions, but they also highlight steps nonprofits can take to ensure they continue to qualify for those exemptions. Here, the court examined and took issue with not only the excessive compensation paid to executives but also the basis on which bonuses were paid. Every state has rules regarding excessive compensation, and in these cases, the executive bonuses were tied to financial performance. Excessive compensation is often subjective and can be addressed through studies analyzing whether that executive pay is in line with market standards. Companies should also consider that tying bonuses to financial performance may raise questions about an entity’s profit motives. 

Further, good record keeping and auditing can mitigate threats to an organization’s exempt status. In these cases, the hospitals could not support the amount of uncompensated services to Medicare and Medicaid patients. Indeed, the court noted that the hospitals did not follow generally accepted accounting principles. Exempt organizations should ensure that detailed and accurate records are kept to support the flow of funds, services and other resources to support the organization’s charitable cause.  

Exempt organizations should not assume an exemption, whether from property tax, sales and use tax or another state and local tax, simply because of a federal section 501(c) status. Many states have specific criteria or required actions that must be completed before claiming a state or local tax exemption. Exempt organizations that need help in navigating the complexity around state and local exemptions should speak to their tax adviser for more information.

RSM contributors

Tax resources

Timely updates and analysis of changing federal, state and international tax policy and regulation.

Subscribe now

Stay updated on tax planning and regulatory topics that affect you and your business.

Washington National Tax

Experienced tax professionals track regulations, policies and legislation to help translate changes.