John Durso, Esq., a partner at Ungaretti & Harris and a senior member of its Health Practice Group, has dedicated his 29-year legal career to serving health care providers, religious organizations, churches, and other not-for-profit organizations in virtually every area of legal practice. His clients have included hospitals and health systems, integrated delivery networks, post-acute long-term care facilities, CCRCs, assisted living facilities, senior housing community-based services, and other senior care providers of every type and size. Over the years, Durso has appeared as an expert on a number of television shows and has testified before Congressional committees on legal issues related to health care. We asked him to comment on some of the challenges to their tax-exempt status that not-for-profit senior care providers are facing and, of course, to offer suggestions and strategies to apply to meet those challenges.
What challenges to their tax-exempt status are not-for-profits facing? I see three different kinds of challenges: (1) the general effect of corporate restructuring on the tax-exempt status of all the entities, (2) Congressional concern about executive compensation levels, and (3) the risk of losing local real estate tax and sales tax exemptions.
How does corporate restructuring challenge a not-for-profit’s tax-exempt status? When an organization restructures, often creating a parent and operating subsidiaries in order to protect against liability, the IRS has been making it more difficult for all of the entities within the parent/subsidiary structure to get tax-exempt status. It’s not that they can’t get it. They just have to jump through more hoops — and it takes longer.
What’s the issue with executive compensation? Senator Chuck Grassley (R-IA) wants the IRS to take a new look at not-for-profit salaries to ensure that the organizations aren’t overcompensating their executives. There’s no challenge to, or loss of, the tax-exempt status if salaries are at fair-market value, so the rules have not changed. Frankly, I think that the top people at not-for-profits are paid below fair-market value and, therefore, underpaid. They don’t receive the stock options and other benefits that their for-profit colleagues get, for example. Contracts and benefit packages for not-for-profit executives should be restructured so they’re compensated appropriately. People shouldn’t be afraid of the Grassley committee.
Does executive undercompensation compromise an organization? My perspective is that not-for-profits are becoming more and more complex. And without top-line management, they won’t be able to position themselves into the future. In fact, AAHSA identified maintaining their position in the marketplace as a future problem for not-for-profits. Running a not-for-profit system today requires a lot more high-level people within the organization, and they must be compensated appropriately. Finding talented people to fill the top jobs is very hard to do under current compensation structures. The best people are likely to be attracted by the compensation packages that for-profit entities offer.
Again, the IRS requires only that compensation does not exceed fair-market value to maintain the tax-exempt status. So I think the not-for-profit boards have got to figure out a way to value what their people are really doing for the organization. We’re working on a lot of executive compensation benefit packages that don’t violate 501(c)(3) requirements yet provide the necessary funding to attract the talent needed to run the organization today and in the future. You certainly don’t want the most critical position in the organization to be paid in the 50th percentile for average pay. You want CEO pay to be in the 90th percentile, considering that person’s importance to the organization.
Can local real estate tax and sales tax exemptions be challenged? Nationwide, not-for-profit organizations are creating higher end facilities with higher entrance fees. And even though they may do some charity care, these groups must be sure they’re fulfilling the charity care requirements under state law in order to maintain their exemptions. The regulations vary, of course, from state to state; but the impact can be enormous. For example, the real estate tax exemption on a typical CCRC project costing $100 million might represent $1 million to $2 million a year. Similarly, the sales tax exemption can involve a big number. On a brand-new $100 million project, about $50 million to $70 million might be hard costs. A five percent sales tax on those purchases could represent a $2.5 million to $3.5 million bite out of the apple — at the very beginning — that could be avoided with an exemption.
Is the “religious use” exemption an issue? Many not-for-profit organizations are religiously “controlled,” as opposed to “owned.” It doesn’t matter if the organization is separately incorporated. Providing quality care for seniors doesn’t make the facility any less of a church mission, and having good business operations doesn’t defeat the religious purpose.
Are challenges more apparent in a choice-driven market? Programs that provide physical, financial, and emotional security to wealthier seniors can be considered charitable, as people who are healthier and happier longer ultimately relieve the burden of government. That’s one reason why not-for-profit organizations have historically been granted the tax-exemption privilege.
How can not-for-profits make sure that these challenges don’t become real problems? Good business practices, good strategic planning, and high-quality services attract people to for-profit homes and are why for-profit companies are successful. Not-for-profits can and should follow those same strategies.
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