Fatal Flaw Defeats Illinois Property Exemption Statute in Nonprofit Hospital Case

How much “charity” is enough to qualify for Illinois property tax exemption?  A statute enacted to quantitatively answer that question for hospitals has been struck down as unconstitutional.  The law’s fatal flaw:  its misplaced emphasis on the financial value of its charitable activities, rather than the qualitative requirement of exclusively charitable property usage.  The case is Carle Foundation v. Cunningham Township, issued on January 5, 2016, by the Illinois Fourth District Court of Appeals.  It is particularly instructive for Illinois charitable property owners that charge fees.  

Constitutional Requirement for Fee-Charging Charities

Many nonprofit organizations have long enjoyed broad entitlement to property tax exemptions under Illinois (and other state) law, such as for religious activities, educational programs, traditional social services, and other charitable programs.  Article IX, Section 6, of the Illinois Constitution permits the legislature to exempt certain property from taxation, including property “used exclusively . . . for school, religious, cemetery, and charitable purposes.”   This constitutional provision authorizes the state legislature to provide for property tax exemption, but not to add to or broaden this significant benefit. 

The test for whether an organization satisfies the charitable exemption standard was established in the Methodist Old Peoples Home case.  In that 1968 landmark decision, the Illinois Supreme Court identified several critical factors including whether (a) the organization’s activities reduce governmental burdens and (b) its benefits are widely distributed “without undue obstacle.” 

These elements are key for any Illinois organization that charges fees for its charitable services, such as child care centers, social service agencies, and medical providers.  Consistent with the constitutional language, the Court required the subject property to be “exclusively” – that is, “primarily” – used for charitable purposes.  Any fees charged thus should not necessarily keep away those in need, at least broadly speaking. 

Nonprofit Tax Exemption: Post-Obergefell

As described in our law firm’s preceding blog article, nonprofits’ tax-exempt privileges are increasingly being questioned.  It thus may be helpful to understand not only the underlying rationales for income and property tax exemptions, but also to consider what may lie ahead in the aftermath of the U.S. Supreme Court’s recentObergefell same-sex marriage decision.

During oral argument in Obergefell, U.S. Solicitor General Verrilli indicated that religious colleges’ tax-exempt status could become an issue for colleges that prohibit same-sex relationships.  Post Obergefell, questions have now been raised as to whether this prediction will become a reality, not only for religious colleges but also for churches and other faith-based organizations.  

Such debate inevitably harkens back to the historic Bob Jones[1] decision, in which the U.S. Supreme Court approved the IRS’s rejection of a university’s tax-exempt status based on the school’s racially discriminatory policies.  In that case, the IRS claimed the power to withhold tax-exempt status for any organization that participates in any activity “contrary to a fundamental public policy.”  In siding with the IRS, a seven-justice majority rested its decision on the government’s “compelling . . . interest in eradicating racial discrimination in education.”[2]  In so ruling, the Court noted that it was dealing only with schools, not churches or other purely religious institutions.[3]  Two justices expressed great concern that the “public policy” authority accorded to the IRS strays dangerously from Section 501(c)(3)’s confines and is too heavy-handed.[4]

PILOT Programs – The Nonprofit Property Tax

    If it walks like a duck and quacks like a duck…    

In an era of waning revenue streams and increasing demand for government services, some cash-strapped municipalities cast a longing eye at nonprofits’ real property as a missed source of revenue.  Through Payment in Lieu of Taxation (“PILOT”) programs, states and municipalities encourage – and sometimes require – nonprofits to pay what they consider the nonprofit’s “fair share.”   PILOT programs, however nicely packaged, are still essentially property taxes.  The trend toward PILOT programs in the last fifteen years should concern the nonprofit sector because of the potential for substantial financial implications, as explained herein. 

Background

PILOT programs have long been used to compensate localities for lost property tax revenues.  Historically, both state and federal governments have utilized PILOTs to reimburse municipalities containing exempt state- and federally-owned land.[1] In addition, some large educational nonprofits for decades have made voluntary PILOT payments to municipalities to help offset their considerable use of municipal services.  For example, Harvard and MIT have made voluntary payments to the City of Cambridge, Massachusetts since 1928.[2]   

Recently, use of PILOT programs has increased dramatically.  From 2000 to 2010, eighteen states implemented PILOT programs affecting nonprofits.[3]  However, these programs have not gained universal approval; some states have expressly declined to implement PILOT programs.  Florida, for example, determined its PILOT program statute violates Florida’s constitution.[4]  The overall trend, however, favors PILOT programs for nonprofits.  Municipalities continue to pressure state legislatures to assist local communities facing tough economic realities.