The Commonwealth Court of Pennsylvania recently issued a decision that adds to the patchwork of law pertaining to purely public charities. The case involved the Pocono Community Theater in East Stroudsburg, Pennsylvania, which was organized to present “independent and art films offering a unique cinematic experience” and to promote “local visual artists on the stage and in exhibition.” At issue was whether the theater qualified as an institution of purely public charity and should be exempt from paying real estate taxes. Pocono’s application for exemption had been denied by the Monroe County Board of Assessment Appeals and that denial was then upheld by the Court of Common Pleas, which led to Pocono’s appeal to the Commonwealth Court.
While noteworthy on its own, this case is also significant when viewed in the larger historical, political, and legal context of purely public charities. The current law regarding the tax-exempt status of purely public charities is more than a century in the making. The basis for exemption originates in the Pennsylvania Constitution, which states that the General Assembly may exempt from taxation “institutions of purely public charity.” Relying on this authority, the General Assembly enacted the General County Assessment Law, which exempts charitable institutions from county, borough, and school tax. Unfortunately, neither the Pennsylvania Constitution nor state law defines the term “purely public charity.” As a result, the responsibility for interpreting the law and establishing the criteria for eligibility as a purely public charity fell to the courts.
In 1985, the Pennsylvania Supreme Court issued a key decision that identified the various factors that courts had historically relied upon and consolidated them into a five-factor test for qualification as a purely public charity. The case involved the Hospital Utilization Project and the test became known as the HUP test, which provides as follows:
“An entity qualifies as a purely public charity if it possesses the following characteristics:
(a) Advances a charitable purpose;
(b) Donates or renders gratuitously a substantial portion of its services;
(c) Benefits a substantial and indefinite class of persons who are legitimate subjects of charity;
(d) Relieves the government of some of its burden; and
(e) Operates entirely free from private profit motive.”
Despite the Court’s attempt to clarify the definition of a purely public charity, over the next decade there remained a perceived lack of consistency with many lower court decisions involving the HUP test. This perception was based in part on the conflicting interests of nonprofits and local taxing authorities. Nonprofits were aiming to reduce expenses in an era of shrinking charitable contributions and greater competition for every dollar, while struggling municipalities were looking for ways to expand their respective tax bases. As a result, nonprofits grew concerned that their applications for exemption would be denied or their current exemption would be revoked not on the basis of their qualifications as purely public charities but due to local politics and economic pressures, which tended to produce what appeared to be an arbitrary and financially motivated outcome.
Eventually, in 1997, the Pennsylvania House and Senate unanimously passed the Institutions of Purely Public Charity Act (“Act 55”). The main goal of Act 55 was to clarify the requirements for eligibility as a purely public charity. In so doing, Act 55 codified the five components of the HUP test, reciting them almost verbatim, but it also went on to define terms used in the test and to establish criteria that, if met, would be dispositive on the issue of whether an institution would be considered a purely public charity.
The passage of Act 55 created several problems, not least of which was that many courts did not seem to know whether the controlling law was the HUP test or Act 55. This question was answered by the Pennsylvania Supreme Court in 2012, when it ruled in a case named Mesivtah v. Pike County that the first step in considering a nonprofit’s eligibility for tax-exempt status is to determine whether it meets the definition of a purely public charity as measured by the HUP test. If it does, the nonprofit may qualify for exemption if it then meets the requirements of Act 55. Or, as the Court succinctly summarized, “if you do not qualify under the HUP test, you never get to the statute.”
With this legal mélange as the backdrop, the Commonwealth Court heard Pocono’s appeal. The trial court had determined that Pocono failed the HUP test because it did not relieve the government of a burden. It concluded that Pocono’s main business purpose was to operate a movie theater and noted that Pocono’s educational programs were not “a significant portion” of these efforts. Since the government has no obligation to provide entertainment, the trial court held that Pocono failed to relieve a burden that the government would otherwise carry.
Having determined that Pocono failed the HUP test, the trial court could have stopped its analysis there, but instead it chose to continue its analysis under Act 55. The decision to do so perhaps reflects ongoing confusion over how the HUP test and Act 55 are to be applied, or it may have simply been the court’s attempt to buttress its holding to prevent being overturned on appeal. In any event, the trial court went on to explain that Pocono failed two sections of Act 55: the requirement to include appropriate dissolution language as a way to ensure that the institution is operating entirely free from private profit motive; and the requirement that a substantial portion of the institution’s services be donated or rendered gratuitously as a way of ensuring that the institution provides community service.
With respect to whether it relieved a government burden under the HUP test, Pocono relied on a prior Pennsylvania Supreme Court ruling in which the Court stated that the government has long provided support for cultural institutions. In opposition, Monroe County argued that the services provided by Pocono were not sufficiently meaningful or on a scale necessary to relieve the government of its burden of promoting culture. The Commonwealth Court agreed with Pocono, stating that Pocono supports and advances artistic and cultural causes that the state and local government have chosen to support. Implicit in the court’s brief explanation was its recognition that a nonprofit institution should be evaluated based on the scope of the services it actually provides and not held to a loftier, aspirational standard set by larger nonprofits with regional or national influence.
As to the question of whether Pocono included in its organizational document the dissolution language required by Act 55, the Commonwealth Court answered this in the affirmative by simply referring to Pocono’s status as a 501(c)(3) organization and concluding that the IRS would not have granted 501(c)(3) status if this language were absent from Pocono’s articles of incorporation. With regard to the question of whether Pocono donated or rendered gratuitously a substantial portion of its services, the Commonwealth Court held that it did. The test under Act 55 that pertains to community service provides seven different methods by which an institution can show that it donates or renders gratuitously a substantial portion of its services. Providing services by any one of these methods is enough to satisfy the test, and the Commonwealth Court held that Pocono did indeed satisfy the test because it provided uncompensated goods or services having a value of at least five percent of the total cost of providing such good or services.
The result in Pocono Community Theater will likely be seen as one favoring nonprofits, but the 4-3 decision was certainly not a foregone conclusion and it would be erroneous to infer that this decision indicates a trend. To the contrary, the Pocono decision serves to highlight the fact that, after more than 30 years of judicial and legislative effort directed at clarifying the legal requirements for an institution of purely public charity and, by extension, an institution’s eligibility for an exemption from the obligation to pay real estate tax, there remains an absence of clear, objective guidance for both nonprofits and local governments. As the Pocono decision indicates, one unfortunate consequence of this is protracted litigation where the outcome of the case is often unpredictable.
Prepared by GKH attorney Doug Smith. Attorney Smith practices in the areas of Estate Planning and Administration, Business Succession Planning, Nonprofit Organization, Corporate and Commercial Law, and Tax Controversies.