Nonprofits' Tax Exemptions Increasingly Under Fire

Federal, state and local governments are taking an extra hard look at whether exempt organizations deserve their special tax status.

By Peter Blank, Editor, The Kiplinger Tax Letter

Joan Pryde, Senior Tax Editor, the Kiplinger letters

June 17, 2008

Tax breaks for nonprofit groups are facing heightened scrutiny from all levels of government because of concerns that some exempt organizations are primarily moneymaking operations that don't live up to the purposes for which they received their special tax status in the first place.

States and localities are combating the problem by denying property tax exemptions. This is a backdoor approach, since only the feds can yank a nonprofit's tax-exempt status. But it's a weapon that state and municipal governments are using more often when they believe exempt groups aren't toeing the line, especially when it comes to revenue producing outlets such as health clubs and day care centers, for example. Groups not charging customers based on their ability to pay are in the most danger. That is a prime indication that the facility isn't providing sufficient benefits to lower-income community residents.

This trend will continue, particularly as long as the economy stays in the doldrums: Many municipalities and state governments are experiencing significant funding shortfalls, and they are likely to see a clampdown on exempt organizations as a way to help make up those revenue losses.

So far, courts are backing up state and local governments in this area. For example, in Minnesota, the state supreme court recently ruled that Goodhue County's tax assessors acted properly in forcing a nonprofit day care center to pay property taxes. The court noted that families in Goodhue County who were receiving public assistance were charged the same tuition as families that didn't get help from the county. "To qualify for the exemption from property taxes as an institution of purely public charity, an organization must provide its 'charity' to recipients free of charge or at considerably reduced rates," the court said.

Congress is taking a look at this matter, too. Senate taxwriters, for example, are pressing tax-exempt public hospitals to provide more charity care. They are eyeing legislation, in fact, that would require all nonprofit hospitals to have written policies detailing indigent services, and to publicize them. As for universities, lawmakers want schools that have big endowments to use more of their earnings to reduce tuition. Exempt organizations will likely fall in line in order to avoid federal mandates.

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