Tax Exemptions for Charities: New Questions

Exemptions for Charities Face New Challenges
Allen Brisson-Smith for The New York Times

Minnesota’s Supreme Court said Michelle Finholdt’s child care center had to pay property taxes.


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By STEPHANIE STROM
Published: May 26, 2008

RED WING, Minn. — Authorities from the local tax assessor to members of Congress are increasingly challenging the tax-exempt status of nonprofit institutions — ranging from small group homes to wealthy universities — questioning whether they deserve special treatment.

One issue is the growing confusion over what constitutes a charity at a time when nonprofit groups look more like businesses, charging fees and selling products and services to raise money, and state and local governments are under financial pressure because of lower tax revenues.

And there are others: Does a nonprofit hospital give enough charity care to earn a tax exemption? Is a wealthy university providing enough financial aid?

In a ruling last December that sent tremors through the not-for-profit world, the Minnesota Supreme Court said a small nonprofit day care agency here had to pay property taxes because, in essence, it gave nothing away.

The agency, the Under the Rainbow Child Care Center, charges the same price per child regardless of whether their parents are able to pay the full amount themselves or they receive government support to cover the cost.

“We were shocked,” said Michelle Finholdt, who founded the center in 1994 and scraped together the money to buy a building in 2002. “There are a lot of other organizations in our area that we’re similar to, and they are exempt from property taxes.”

The tax-exempt status of charities costs local governments $8 billion to $13 billion annually, according to various rough estimates.

And local assessors are not the only government officials scratching their heads over which groups deserve privileged tax status. Congress has threatened to impose a requirement that wealthy universities make minimum payouts from their endowments and raised questions about whether nonprofit hospitals are really all that different from their for-profit — and tax-paying — competitors.

And, concerned about the way some churches are spending money, the Senate Finance Committee has asked for detailed financial information from six evangelical ministries asking them to justify their tax exemptions.

Others are questioning whether some tax-exempt nonprofits, primarily universities and hospitals, have accumulated so much wealth that they should no longer be considered charities. In Massachusetts, where Harvard’s endowment has reached $35 billion in assets, legislators are weighing whether to impose a 2.5 percent annual assessment on universities with endowments of more than $1 billion.

The idea behind tax exemptions is that the organizations provide a public service or substantially reduce the burdens of government. Standards from property-tax exemptions are set by the states, while the federal exemption means charities are not taxed on their income.

Almost 88 percent of overall nonprofit revenues in 2005, the most recent year for which figures are available, came from fees for services, sales and sources other than charitable contributions, according to the National Center for Charitable Statistics. Nonprofit health care providers, day care centers and retirement homes, among others, are often difficult to distinguish from their tax-paying competitors.

“We’re all seeing the growth of revenue in this area we call earned income,” said Audrey R. Alvarado, executive director of the National Council of Nonprofit Associations, adding that the Minnesota court decision “is saying, ‘Wait a minute, charities are supposed to give things away for free.’ ”

“It goes to the core of how nonprofits are classified and defined,” she said, “and I think it is an example of the confusion in the public, and even among folks in the sector itself, about what a nonprofit is.”

Evelyn Brody, a professor at Chicago-Kent College of Law and an expert on nonprofits and property taxes, said that, in studying the issue in 2002 and revisiting it last year, she had seen an explosion of cases across the country in which charities were challenged to say why they deserve their property tax exemptions.

As universities charge high tuitions, and pay large salaries to administrators, they have become prime targets. For example, New London, Conn., assessed property taxes on a skating rink owned by Connecticut College. Local assessors tried to tax Smith College in Northampton, Mass., arguing that the women’s college engaged in sex discrimination and thus was not charitable.

Smaller organizations that provide services like day care or drug treatment are being challenged, too. The Oregon tax court denied property tax exemption to a residential substance-abuse treatment center because it catered to “addicted professionals” and, like Under the Rainbow, did not give away its services.

The Minnesota Department of Revenue and county tax assessors say the uproar over the court ruling here has surprised them.