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Tax-Exempt Status of California Hospitals Called Into Question

SAN FRANCISCO — A new push is on in California to address whether some nonprofit hospitals deserve their tax-exempt status.

The controversial question reemerged this summer with the release of an audit on the status of the community benefit requirements that nonprofit hospitals in California need to provide to receive tax-exempt status.

The state auditor released the report just ahead of a Senate ­Select Committee on Charity Care and Hospitals hearing Wednesday led by Senate Majority Leader Ellen Corbett, D-San Leandro, who also requested the audit.

Corbett said during the hearing that a move will be made this fall in the Legislature to address the issue based on testimony and audit findings.

Lawmakers need to “determine how we can preserve this system and allow for tax-exemptions for those that deserve them,” Corbett said.

Hospitals in California receive their nonprofit tax-exempt status as a result of a commitment to provide charity care. However, concerns have swirled for years as to whether some hospitals provide enough care to their communities.

The new drive began in August 2011 when the Joint Legislative Audit Committee voted to conduct an the audit of the state’s hospitals.

The audit, released last week by state auditor Elaine Howle, found a number of obstacles in determining whether the nonprofit hospitals provide adequate community benefits in return for their tax-exempt status.

The obstacles include a lack of definition about what those benefits should be, differing methodologies to determine such benefits and the fact that neither federal nor state law requires nonprofit hospitals to deliver specific amounts of community benefits.

According to the audit report, state law is clear that the state and county governments cannot predicate the tax-exempt status of a nonprofit hospital on the amount of community benefit it provides.

“Instead, they grant tax-exemptions based on other information about the organization, including the distribution of its net earnings and the entities’ articles of incorporation,” the report said.

California law requires most of the hospitals to prepare annual reports on the amount of benefit they provided during the year.

The bureau’s audit of four nonprofit hospitals around the state discovered that no statutory standard or methodology on calculating benefits exists for hospitals to follow and that the specific hospitals surveyed each used different methods.

Howle recommended that lawmakers would need to change the law to specify the amount of community benefit that is necessary for hospitals to get tax-exempt status, and would also need to develop a methodology for calculating benefit requirements.

The auditor also said penalties would be needed to be put in place to encourage hospitals to submit their benefit reports on time.

In 2007, the state auditor released a similar report with similar recommendations, but a legislative effort to implement changes ran into political headwinds.

The hearing and the audit have also set up a proxy fight between a powerful nurses’ union and large nonprofit hospital organizations in the state.

The California Nurses Association, a long-time antagonist of many nonprofit health care employers in California, timed the release of its own report to this week’s committee hearing. The CNA report said nonprofit hospitals get $2 billion of tax benefits a year above what they return to communities.

The union said Cedars-Sinai Medical Center, Stanford University Hospital and Sutter Health’s California Pacific Medical Center and Alta Bates Medical Center have the worst records.

The CNA is a powerful influence among the Legislature’s Democratic majority. In the first six months of this year, it reported more than $500,000 in campaign contributions, many of them for Democratic legislative campaigns, including $1,000 to Corbett in February.

During Wednesday’s hearing, a representative of the California Hospital Association defended nonprofit hospitals, saying the hospitals provide many kinds of community benefits.

The conflict between the CNA and big nonprofit hospitals was most pronounced in 2006, when the union almost succeeded in quashing the sale of almost $1 billion of bonds by Sutter Health.

The California Health Facilities Financing Authority eventually approved the transaction after Sutter agreed to make $8.5 million in grants to small and rural nonprofit health care organizations to demonstrate a public benefit.

Since Bill Lockyer took office as treasurer and therefore as chairman of the CHFFA board in 2007, the authority has taken steps to streamline the process for nonprofits to use it as a conduit, in an effort to remain competitive with other conduit issuers such as the California Statewide Communities Development Authority.

Concerns about hospitals’ tax-exempt status is not limited to California. In March, a court upheld a decision by the Illinois Department of Revenue to deny three Chicago-area hospitals their property tax exemptions for failing to provide sufficient charity care.

But the long-running Illinois debate appeared to have been settled in June in hospitals’ favor when Gov. Pat Quinn signed legislation expanding the definition of activities that will count toward their “charity care” threshold.

In 2009, the Internal Revenue Service conducted a survey of 500 hospitals and found the average community benefit for a nonprofit hospital to be relatively small. The IRS has since instituted new tax-reporting requirements for nonprofit hospitals that took effect in 2010.

Hospitals’ tax-exempt status affords them the ability to issue tax-exempt bonds and exemption from property taxation and taxes on net operating income.

In California, during the first six months of 2012, hospitals and health care facilities issued more than $1 billion of new-money municipal bonds for infrastructure projects, more than any other project type by local agencies, according to the State Treasurer’s Office.

Several California nonprofit health care organizations have filed for bankruptcy protection over the last decade, some under the pressure of serving smaller, low-income communities.

Last year, Verdugo Mental Health in Glendale filed for Chapter 11 protection after substantial cost overruns on its new buildings, the cancellation of lines of credit, falling donations and reduced government funding in the wake of the recession. It was absorbed into another nonprofit mental health organization.

In March, Downey Regional Medical Center in the Los Angeles suburbs emerged from Chapter 11 after a 30-month bankruptcy proceeding that ­resulted in the full redemption of its $20.6 million of outstanding tax-exempt bonds.

The financial pressures also affect some smaller government-run hospitals, and there have been several Chapter 9 filings by California health care districts in recent years.

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