Fatal Flaw Defeats Illinois Property Exemption Statute in Nonprofit Hospital Case

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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. 

 Quantifiable “Charity” – Lessons from Provena

A continuing challenge for nonprofit property owners has been to understand just how much “charity” (i.e., goods or services given away) is enough.  Stated differently, may an organization waive or reduce its fees for charitable services only minimally, if at all, or must it provide benefits on a more widespread basis?  If the latter, just how extensively?  

These questions were addressed at length in the Illinois Supreme Court’s 2010 Provena hospital decision.  In that case, the Court heavily criticized the hospital’s practice of charging fees for services as being inconsistent with traditional notions of charity, particularly since the hospital derived only minimal revenues from charitable contributions, acted in a businesslike manner in charging fees and making collection efforts, and made a profit even from significantly reduced fees.  Going further, the Court emphasized that relieving government’s financial burdens, such as by providing free or reduced-fee services, is an extremely important aspect of charitable tax exemption (though perhaps more as an underlying policy rationale than an absolute condition).  

The Legislative “Fix” Rejected in Carle

The Illinois legislature responded to Provena by enacting a formulaic modification of the charitable property tax exemption statute.  New Section 15-86(c) of the Illinois Property Code provides as follows: 

A hospital applicant satisfies the conditions for an exemption under this Section with respect to the subject property, and shall be issued a charitable exemption for that property, if the value of services or activities [listed elsewhere in the statute] for the hospital year equals or exceeds the relevant hospital entity’s estimated property tax liability . . . .

 This approach was flatly contrary to the Provena Court’s explicit instruction to not apply a “direct, dollar-for-dollar correlation between the value of tax exemption and the value of the goods or services provided by the charity.”   Indeed, this statutory provision requires that exemption “shall be” provided based solely on a financial comparison between a hospital’s charitable services and its potential tax bill.

The Legislature’s desire to provide clarity may have been laudable.  As the Carle court ruled, however, the legislation is fatally defective without additional statutory language requiring, consistent with applicable constitutional constraints, that the subject property also be “exclusively used” for charitable purposes.  That use cannot be assumed. 

In other words, the legislature may include a financially related formula as a strong indicator of charitable exemption qualification.  But it may not replace the Methodist Old Peoples Home constitutional test with such a simplistic, narrow approach.  As the Carle court explained, “[a] property owner cannot buy a charitable exemption.”

Back to Methodist Old Peoples Home Test for Charitable Qualification

Hospitals (as well as other charitable property owners) thus may not skirt the constitutional requirement that their property be used for charitable purposes, by only measuring the financial benefit of providing charitable goods or services.  Under Methodist Old Peoples Home, the owner must be organized as a nonprofit, provide benefits widely, impose no “undue obstacles” for accessing such benefits, and charge fees only to cover actual costs rather than to make a profit.  This “facts and circumstances” test admittedly may be challenging in application, particularly to discern how much “charity” is enough for exemption qualification.  Here’s one pragmatic answer:  provide plenty!

Nothing New – Eden Revisited

The Carle case is reminiscent of the Illinois Supreme Court’s 2004 decision in Eden Retirement Center, Inc., which addressed a similar legislative effort to provide clarity for property tax exemption qualification.  In Eden, the statutory amendment provided that an organization could qualify for charitable exemption simply by (a) being recognized as tax-exempt under Section 501(c)(3) of the Internal Revenue Code, and (b) having bylaws that provide for fee waivers and reduction, for those in financial need. 

Relying on Methodist Old Peoples Home, the Illinois Supreme Court rejected this simplistic test and struck down the provision as unconstitutional.  In doing so, the Court affirmed the severe constitutional constraints on property tax exemption:  “An applicant for a charitable-use property tax exemption must ‘comply unequivocally with the constitutional requirement of exclusive charitable use.’”  The above elements thus may provide helpful support for charitable exemption qualification (as with the financial elements in Carle).  But they are insufficient – alone – to establish exemption qualification.

 What’s Next?

 The Carle case may be appealed further to the Illinois Supreme Court for final adjudication of the legislative provision’s constitutionality.  In the meantime, hospitals may not enjoy assurance of exempt property qualification based solely on the financial benefits of their charity care compared to otherwise applicable property tax liability.  They must go further, and more comprehensively, in providing charitable care.   

Other Illinois charitable property owners that charge fees should take note as well.  Dollars and cents information is relevant but far from determinative.  Charitable property tax exemption is a constitutional privilege, measured qualitatively, strictly, and based on clear evidence of actual charitable property usage.  Stated more colloquially:  the more “free soup” given away, the better for exemption qualification!