CHICAGO — Illinois erred in stripping Provena Covenant Medical Center in Urbana of its property tax exemption over charity-care levels and it should be restored because the hospital treats all patients regardless of their ability to pay, a Provena attorney told the state Supreme Court in oral arguments Wednesday.

Illinois assistant attorney general Evan Siegel, however, asked the court to affirm an appellate court decision stripping the hospital of its exemption. He said that the level of care is relevant even though the state does not mandate a specific amount. “All the court need do … is decide that 0.7 % of revenue … is not substantial,” Siegel said. He added that “the facts here show they did not provide charity to everyone who needed it.”

Provena attorney Patrick S. Coffey argued that the hospital “provided free care to all in need and without limit.” The hospital contends that it merits the tax-exemption because of its charity care combined with other community benefits, including unlimited free care to the poor and underserved as well as other, non-reimbursed Medicaid costs and community services.

When pressed by Justice Robert R. Thomas over whether the court was being asked to ignore the level of charity care as a factor in its decision, Coffey argued that a hospital’s level of charity care “has never been part of the standard in Illinois” for charitable status. He said the amount “may be considered but it is not determinant” in deciding an institution’s status.

Any change in the requirements is best “left to the Legislature,” Thomas added. The Urbana hospital is one of six operated by the Mokena, Ill.-based Provena Health System.

Thomas questioned Siegel as to whether the court was being asked to set a “floor for the amount of free care that has to be given?”

Siegel said no, but stressed the state’s position that a percentage below 1%, aiding 302 patients, fails the test that requires a property be used for charitable purposes because so much of the hospital’s revenue came from paying customers. He also contended that community benefits have never been considered as charity care under Illinois law.

Siegel and Coffey laid out their positions before the court Wednesday in arguments that lasted nearly an hour in a case that is being closely observed by the nonprofit health care sector nationally. It comes at a time of  heightened scrutiny for hospitals at the local, state and federal level on their charity care practices.

The case began more than six years ago when the Champaign County tax review board stripped the Provena hospital of its property tax exemption due to its allegedly inadequate charity-care levels. The case went to the Illinois Department of Revenue, which in 2006 sided with the local review board, contending the hospital failed to meet state standards that govern charitable and religious organizations.

A Sangamon County Circuit Court judge disagreed with the state, restoring the tax-exemption and ruling that the state should return the $5 million in property taxes Provena had paid. A Fourth District Appellate panel in August 2008 reversed the lower court decision, finding that if the “operation of the property is businesslike and more characteristic of a place of commerce than a facility used primarily for religious purposes, the property is not exempt from taxation.”

Provena petitioned the Illinois Supreme Court to review the case, arguing that the appellate opinion unfairly impugned the hospital’s charitable and religious record and threatened its operations. The high court announced late last year that it would take the case.

Health care market participants have long monitored the case as the pressure on hospitals to justify their tax-exempt perks — from their exemptions from certain taxes to their ability to access the tax-exempt bond market — has intensified. Hospital groups have warned that imposing strict charity standards could erode their balance sheets — especially during a recession — hurt their access to the capital markets, and in some cases bankrupt facilities.

“The fact that this case, which has been closely watched by the entire hospital industry since 2004, has gone to the Illinois Supreme Court makes it a very high-risk proposition for all U.S. hospitals if Provena loses. Such an outcome would be momentous because this Supreme Court’s decision will be incessantly cited in other similar hospital tax-exemption challenges,” said Jim Unland, president of the Health Capital Group and editor of the Journal of Health Care Finance.

In Illinois, Attorney General Lisa Madigan has pushed legislation to set a minimum charity-care threshold if hospitals want to keep their perks, including their ability to access the tax-exempt market through the Illinois Finance Authority.

Nationally, Senate Finance Committee chairman Max Baucus’ health care reform legislation would impose new reporting standards on 501(c)(3)hospitals. They would be required to conduct regular assessments of community health needs, implement financial assistance programs, and limit how much they could bill certain patients and how far they could go to collect to justify their status.

The committee has previously discussed requiring nonprofit hospitals to meet national minimum standards of charitable care. Ranking minority member Sen. Charles Grassley of Iowa has suggested the more dramatic move of stripping all nonprofit hospitals of their exemption and replacing it with tax credits or deductions in exchange for charity care.

The national attention aside, the final decision stands to affect Provena, its business practices, and credit profile as it struggles with declining volume levels. It is working with Wellspring Partners on a financial turnaround plan.

Provena’s six hospitals, 16 long-term care and senior facilities, and 28 clinics in Illinois and Indiana had operating revenue of $1.25 billion in fiscal 2008. The system’s $645 million of debt is rated Baa1 with a negative outlook from Moody’s Investors Service and BBB-plus with a negative outlook by Standard & Poor’s.

Both agencies downgraded the credit this year. Analysts have said resolution of the property tax challenge would be viewed as a credit positive as it would free management to focus their attentions on their turnaround plans.

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