Taxing Times for Charity

More municipalities seek revenue from nonprofit groups

When the city of Bridgeport, Conn., asked a nonprofit home for the elderly to start paying taxes, the charity’s leaders balked, contending that it should retain the exemption it had enjoyed since its founding in 1922. But deciding to fight almost put the Bridgeport Rescue Mission out of business. By this summer it faced a property-tax bill that, with interest and penalties, had ballooned to $318,000 — nearly half of the group’s annual cash budget.

The charity finally resolved its dispute with the city this month, seven years after getting the initial bill. It agreed to pay $40,000 to buy back its building from the city, which had seized it for nonpayment of taxes. En route to the agreement, the charity lost two court decisions on the matter, but also helped persuade state legislators to amend the law to make clear that such homes are tax-exempt.

“It’s been a long, arduous journey,” says the Rev. Terry Wilcox, the mission’s executive director. Even with the lesser amount owed to the city, he says, the charity will have to take out a mortgage to pay it and must tighten its belt even further in providing housing services.

As state and local governments face what some experts are calling the worst financial situation since World War II, efforts like Bridgeport’s to get nonprofit institutions to help cover the cost of municipal services — such as police and fire protection, trash disposal, and snow removal — are expected to spread. And while many hospitals, universities, and other large institutions have been dealing with such requests for years, smaller social-service charities like the rescue mission increasingly are fielding them as well. Among recent examples:

• In Fairfax, Va., all property purchased by nonprofit groups since last fall is subject to taxes. The decision came after the state legislature voted to give control over property-tax decisions to local governments.
• In Pittsburgh, city officials are trying to persuade its major nonprofit organizations to contribute to a “public service foundation” that would be established to help pay for city services.
• In Somerville, Mass., the city’s mayor sent letters to more than 200 tax-exempt organizations this spring seeking a total of $2-million in donations to help close its budget gap.

“Cities are all desperately hurting for revenue, so this issue is not going to go away,” says Ed Mattison, an alderman in New Haven, Conn., who also runs a nonprofit social-services group there called the South Central Behavioral Health Network. “It’s absurd to say they’re going to solve their financial problems on the backs of the nonprofits,” but he adds that the pressure is not going to let up unless local economies improve enough to refill empty city coffers.

Who Foots the Bill?

For decades, many states followed the lead of the federal government in bestowing tax exemptions on any organization recognized as a charity under Section 501(c)(3) of the Internal Revenue Code. But during the past two decades, some states have narrowed the definition of which groups or activities qualify for exemption under their statutes.

At the same, time, for many cities around the country, property taxes remain the principal source of revenue. That creates major headaches for cities like Boston, where more than half the real estate is owned by the government or by nonprofit institutions and is therefore exempt from taxation.

“Nonprofits are wonderful institutions: They discover new drugs, educate our children, and take care of our citizens,” says Ron Rakow, Boston’s commissioner of assessing. “These institutions benefit not only the city but also the commonwealth, the country, in some cases the entire world. Yet the taxpayers of Boston are paying the whole bill for providing them with municipal services.”

Boston has succeeded in persuading more than 40 tax-exempt institutions to make voluntary payments in lieu of taxes, which this year total more than $23-million. The largest nonprofit contributors are hospitals and universities — Boston University is paying $3.2-million this year; Massachusetts General Hospital, $2.2-million; and Harvard, $1.6-million — but other donors include the Boston Symphony Orchestra (around $60,000) and the public-broadcasting station WGBH ($10,-000).

Mr. Rakow tries to negotiate such payments whenever an institution plans to expand. His goal is to get an organization to pay roughly 25 percent of the amount it would pay if it were not exempt.

Some nonprofit organizations say they don’t mind helping to pay for city services, saying they consider the taxes or payments simply a part of their operating costs. “It’s not a controversial issue for us,” says Thomas D. May, the Boston Symphony Orchestra’s chief financial officer. He notes that the orchestra also makes smaller payments to the towns of Lenox and Stockbridge, Mass., for its summertime venue, called Tanglewood.

Social-Service Groups

Connecticut has been the scene of some of the most aggressive efforts to collect property taxes from nonprofit groups, including social-service organizations. The state’s somewhat ambiguous definitions of tax-exempt organizations have given city assessors considerable discretion in deciding which groups may need to pay tax. Because nonprofit groups tend to cluster in urban areas, cities like Bridgeport and New Haven have been particularly diligent about scrutinizing their lists of tax-exempt properties.

In Bridgeport, more than a third of the property is tax-exempt because it is owned by charities or government. Russell D. Liskov, associate city attorney, says the city assessor has a fiduciary duty to identify every taxable property in town and make sure it is on the tax rolls. He says the city has plans to review some 3,000 cases. Despite passage of a law clarifying the tax-exempt status of some kinds of nonprofit housing groups, “there still are lots of issues open,” says Mr. Liskov. “I’m not closing the books on anything.”

Setting a Precedent

Some nonprofit leaders, while sympathetic to the fiscal plight of cities and towns, believe that forcing nonprofit groups to pay taxes, or to make voluntary payments in lieu of taxes, is a mistake for both practical and philosophical reasons.

“Any type of taxation of 501(c)(3) organizations is a dangerous precedent-setting move by any level of government — federal, state or local,” says Edward H. Able, chief executive of the American Association of Museums. “It in effect undermines the basic principles that have been longstanding in public policy regarding the tax benefits to 501(c)(3) organizations. It opens the door to increasing taxation by government when those governments are challenged financially, as we are experiencing now.”

Mr. Able argues that charities are much more efficient than government in providing services, and that the public therefore benefits when nonprofit organizations spend money rather than giving it to government to spend.

Firm measures are required, Mr. Able says. “Nonprofit organizations must be extremely aggressive in resisting and warding off these efforts,” he says. “To do less is to compromise our responsibilities to both our donors and the public we serve. And experience has taught that any acquiescence simply emboldens governments to impose further taxation in the future.”

But some charities lack the money, time, or zeal to defend their tax-exempt status so aggressively.

After spending five years fighting a property-tax bill from the county assessor’s office, the Georgia O’Keefe Museum, in Santa Fe, N.M., agreed to a deal this spring. Instead of paying $15,000 in annual property taxes on the entire museum, as the county had sought, the museum will now pay between $2,000 and $3,000 for its freestanding cafe building and no taxes on its adjacent main building, which houses its collection and offices.

George G. King, the museum’s director, says that while he understands Mr. Able’s view that nonprofit groups should not pay any property taxes, the museum must operate within the realm of political reality and public perception. “He doesn’t understand the nuances,” Mr. King says of Mr. Able. “He doesn’t live down here.”

Tax Assessors

The intensity and success of efforts by local municipalities to tax nonprofit groups vary by state, county, and city, depending not only on differences in applicable laws but on the interests and attitudes of individual assessors and administrations. The result is a patchwork in which some institutions routinely pay some taxes or make large voluntary payments to support city services, others steadfastly refuse to consider such payments, and still others cut the best deals they can at the moment, knowing that the picture might change with a new city election or a judge’s decision.

Politics often play a role. After years of resisting requests from Providence, R.I., for voluntary payments, the city’s four major educational institutions — Brown University, Johnson & Wales University, Providence College, and the Rhode Island School of Design — this spring agreed to donate nearly $50-million to the city over the next 20 years. The agreement is intended to ensure that the institutions “pay a fair share, comparable to what other colleges and universities contribute to their host cities,” says the mayor of Providence, David N. Cicilline, who had threatened to seek legislation requiring such support if it did not come voluntarily.

Harvard University has found it expedient to make so-called payments in lieu of taxes — or PILOTs — since 1928. As it has gradually bought property in Boston, Cambridge, and Watertown, Mass., it has crafted separate deals with all three cities.

Northwestern University, by contrast, makes no voluntary payments to Evanston, Ill., and has been successfully fighting off attempts by the city to tax its property dating back to 1874. The university claims in a current lawsuit, however, that the city’s decision to include a large piece of its campus in a new historic district (a move that restricts the university’s development plans) came in part in retaliation for the university’s refusal to make voluntary payments to the city. The city has denied any such motive.

‘Near Death’ Experience

The ephemeral nature of agreements with local government officials over tax exemptions was driven home to ALSO-Cornerstone, a New Haven, Conn., charity for people with substance-abuse and mental-health problems, when its mortgage holders notified it this spring that the city had placed liens on the buildings where its clients are housed because, according to the city, the organization owed $32,000 in back taxes.

For three decades, ALSO-Cornerstone had never been required to pay property tax. But several years ago the assessor placed its facilities on the tax rolls. The charity protested, and succeeded in securing written confirmation affirming it tax-exempt status. But its relief was short-lived: This year it found itself back on the rolls.

Jerry Ross, the group’s executive director, says he and his board protested once more, and had thought the issue with the city was again resolved. Then he heard from the mortgage holders. The charity was told it would have to come up with $200,000 or so to pay off the mortgages and prevent foreclosure on the properties, which “would have precipitated a financial collapse of the agency,” says Mr. Ross. Only when faced with the prospect of negative news stories and possible litigation by legal-aid groups did city officials back down, once again agreeing to reclassify the group’s tax status and remove the liens. Mr. Ross describes the situation as a “near-death experience.”

Comprehensive Approach

Vast differences in the way local governments apply taxes or voluntary payments to nonprofit institutions have prompted some charity tax experts to call for a more comprehensive approach to ensure that nonprofit groups meet their civic obligations according to their means while also preserving the rights afforded by their tax-exempt status.

“This area is crying out for a systematic overhaul,” says Richard D. Pomp, a professor at the University of Connecticut School of Law who has written on the topic. “You can’t lump everyone together anymore,” he says. “We’re in a very different world than the 19th century. You have needier nonprofits and less-needy nonprofits.”

Among the options he says would promote fairness would be to limit the dollar value or the acreage of property exempted from taxation, Mr. Pomp says. Another approach might be to phase in a tax exemption over time, to ease the sudden strain on a municipality’s budget that results when a large piece of property is removed from the tax rolls. The Providence agreement, for example, provides for such a phasing-in when any of the four institutions purchase taxable property.

Overhauling Laws

Several states, including Maine, New Jersey, and New Mexico, are considering a systematic overhaul of their tax structures, including a reexamination of nonprofit exemptions. One idea being considered in Maine, for example, would allow cities and towns to charge for services that directly benefit tax-exempt properties.

In New Mexico, the Blue Ribbon Tax Reform Commission is considering a proposal to extend the state’s gross receipts tax (its equivalent of a sales tax) to cover purchases by nonprofit groups either at the commercial rate of 5 percent, plus a smaller amount that goes to the county, or at a smaller nonprofit rate of perhaps 2 or 3 percent.

Mr. Mattison, the New Haven alderman, says his state may also need to reexamine its laws governing tax exemption.

“The basic problem is that the rich nonprofits are treated as a matter of law as though they’re the same as some mom-and-pop operation, and ultimately that makes no sense,” he says. “We lack an adequate theory to differentiate the responsibilities of those two kinds of institutions.”