Understanding the Debate Around Nonprofit Tax-Exempt Status, PA Act 55, and PILOTS

City Council Member Bill Green has proposed two bills that would impact the nonprofit sector. One would require nonprofits to file an annual report outlining their benefit to the community. The other would tax commercial activity by nonprofits that is outside of their stated mission, a classic example being a gift shop located inside a nonprofit museum.

As we reported last month, the bills came on the heels of a Pennsylvania Supreme Court decision that in effect gave municipalities greater leverage to revoke tax-exempt status from nonprofits. Green said the ruling was his motivation for proposing new legislation.

“What I wanted to do was clarify the law, make it clear that the recent Supreme Court decision is the way Philadelphia will be conducting itself, using the standards set forth in the constitution,” Green said. He added that he thinks Philadelphia is far behind other U.S. cities when it comes to getting revenue from the nonprofit sector.

The ruling was pivotal for Green because it reasserted the power of the courts to determine tax-exempt status rather than a state law passed in 1997. The difference is that the specific criteria outlined in the law are now secondary to the court’s opinion. This has made it easier for municipalities to challenge the tax-exempt status of nonprofits, according to legal experts.

And while other PA cities and townships, including Pittsburgh, have made direct challenges to nonprofits, Green said his legislation is designed to encourage nonprofits to enter into payment plans themselves. This is a very different strategy than directly revoking their tax-exempt status, as has been done to local branches of the YMCA and Habitat for Humanity in other parts of the state.

Still, Green’s bills and other initiatives in the state are using the recent Supreme Court decision to redefine how municipalities engage with nonprofits when it comes to seeking revenue.

A Brief History of the Debate
But how has one court decision changed the playing field so drastically? Here is some history:

The PA Constitution states that the General Assembly may exempt from taxes “institutions of purely public charity.” But for years, this qualification was interpreted differently by courts across the state.

Then, in 1985, the PA Supreme Court decided a case that established a five-pronged test, called the HUP test, for judging whether an organization was a “purely public charity.” (We listed the criteria for the test in this prior report). This test clarified the law to an extent, but it also established that the courts had the discretion to determine tax-exempt status.

“Between 1985 and 1997, there was a great deal of confusion about the status of the law,” said Don Kramer, chair of the Nonprofit Law Group at the Philadelphia law firm of Montgomery, McCracken, Walker & Rhoads, LLP.

PILOT programs (payments in lieu of taxes) increased from 1985 to 1997, partially as a result of the uncertainty felt by nonprofits. In Philadelphia, the city collected nearly $60 million in payments and services from large nonprofit institutions like the University of Pennsylvania.

In response to this confusion, the General Assembly passed a law in 1997 called Act 55, or the “The Institutions of Purely Public Charity Act,” which established specific legal criteria for achieving tax-exempt status.

From 1997 to today, PILOT programs and challenges to tax-exempt status have decreased statewide. Revenue from PILOT programs in Philadelphia plummeted in 1999 as deals with over 40 nonprofits expired.

“Act 55 created a great deal more certainty and a great deal more uniformity and avoided a lot of litigation, which is expensive for everybody,” Kramer said. “It also reduced the ability of taxing authorities to threaten litigation in return for payments in lieu of taxes.”

Act 55 held sway for more than a decade, until April 2012, when the PA Supreme Court passed a ruling that weakened the law by again giving the court-issued test precedence. The majority opinion in the case stated that “the General Assembly cannot displace our interpretation of the Constitution because ‘the ultimate power and authority to interpret the Pennsylvania Constitution rests with the Judiciary, and in particular with the court.’”

This means an organization must first pass the court-issued test before being held to the standards of Act 55, in the event that their tax-exempt status is challenged. Since April, a number of nonprofits have been challenged and lost their status because they did not pass the test. Dunwoody Estates in Delaware County and a Jewish Orthodox summer camp in Pike County have both been revoked their status.

Still, Green maintains that placing the criteria for tax-exempt status in the hands of the General Assembly is a recipe for corruption and a barrier to municipalities seeking revenue from the nonprofit sector when it is warranted.

Kramer and organizations like the Pennsylvania Association of Nonprofit Organizations (PANO) think that Act 55 is crucial to safeguarding against the abuse of nonprofits by municipalities, as well creating uniform standards statewide.

Joe Geiger, recently retired executive director of PANO, believes that Green’s bills, in particular, will be burdensome to nonprofits.

“Its an unnecessary burden at a time when charities, like everyone else, are having to do more with less, and having to do more because there are more people needed by charities,” Geiger said.

By May 22nd, the bills will be discussed at a Finance Committee hearing and possibly put up to vote at the next scheduled meeting.

Read our previous coverage, How City Council Might Raise Revenue from Philly Nonprofits and Charities.