On May 30, 2025, the Pennsylvania Supreme Court reversed a Commonwealth Court decision that Pottstown Hospital, LLC (“Hospital”) did not qualify as an institution of purely public charity entitled to real property tax exemption.
In 2023, the Commonwealth Court had held in a group of four related decisions — Pottstown School District v. Montgomery County Board of Assessment Appeals, 289 A.3d 1142 (Pa.Cmwlth. 2023); Brandywine Hospital, LLC v. County of Chester Board of Assessment Appeals, 291 A.3d 467 (Pa.Cmwlth. 2023); Phoenixville Hospital, LLC v. County of Chester Board of Assessment Appeals, 293 A.3d 1248 (Pa.Cmwlth. 2023); and Jennersville Hospital, LLC v. County of Chester Board of Assessment Appeals, 293 A.3d 1248 (Pa.Cmwlth. 2023) — that four Tower Health hospitals were operating with a private profit motive and therefore were not considered charitable institutions.
In 2017, Tower Health’s predecessor bought several for-profit hospital facilities and related properties. Tower Health, which is a nonprofit under 26 U.S.C. § 501(c)(3), formed four non-profit limited liability companies, of which it was the sole member, to run each of the four hospitals. Tower Health generated income solely through charges it imposed on the LLCs in the form of management fees. The trial court in Montgomery County granted a tax exemption for the Pottstown hospital, but the Chester County trial court denied the exemptions for the other three hospitals. On appeal, the Commonwealth Court denied all four exemptions, holding that the hospitals did not operate entirely fee from private profit motive, as required by the test set forth in Hospital Utilization Project v. Commonwealth (“HUP”) 487 A.2d 1306 (Pa. 1985), because: (1) Tower Health’s management fees were exorbitant, essentially draining hospital finances; and (2) the executive compensation tied to the hospitals’ financial performance was substantial.
The Supreme Court granted permission to appeal in the Pottstown case, to determine: (1) whether the operation of Tower Health was relevant to a determination of whether the Hospital qualified as a purely public charity; and (2) whether substantial executive compensation based upon financial performance precluded the Hospital from establishing that it was operating entirely free from private profit motive.
The Supreme Court first addressed the relevance of Tower Health’s executive compensation and the relationship between Tower Health and the Hospital.
The Supreme Court noted that the Commonwealth Court had consistently held that, when a corporate entity seeking a charitable tax exemption is a subsidiary or affiliate of another corporation, it will ordinarily be regarded as its own separate entity unless there is evidence establishing a reason to pierce its corporate veil, including: its gross undercapitalization; a failure to adhere to corporate formalities; a substantial intermingling of personal and corporate affairs; the use of the corporate form to perpetrate a fraud; or where a parent or affiliate corporation dominates the non-profit corporation to the degree that it can be regarded as a sham corporation, or a mere instrumentality or alter ego of the parent or affiliate. The Court held that, absent such evidence, only the salaries of the executives of a corporation seeking the tax exemption, and the net impact the payment of fees by that organization to a parent or affiliate corporation has on its own ability to fulfill its charitable mission, are relevant under the HUP test.
In Pottstown, the School District had not argued that the separate existence of Tower Health and the Hospital should be disregarded. The School District had only argued that the degree of control exerted by Tower Health and the size of the management fee justified consideration of Tower Health’s executive compensation package, and the alleged excessiveness of the management fees. But the Court held that no facts had been established showing that the Hospital was not acting as an independent entity from Tower Health when it entered into the agreement to pay the management fees, or that Tower Health had improperly used its parent relationship. The mere dollar size of Tower Health’s executive compensation and the amount of the management fees the Hospital paid, standing alone, were insufficient to show a private profit motive.
The Court then addressed the Hospital’s executive compensation. Case law established a requirement that such salaries and any fringe benefits be reasonable — i.e., equal to or less than executive salaries of comparable institutions that provide comparable services. The Court had never elaborated on the criteria for determining reasonable compensation. But, in Pottstown, the Court finally adopted the following set of factors, set forth in federal tax law for determining if executive compensation is reasonable:
- the levels of compensation paid by similar organizations . . . for functionally comparable positions, with emphasis on comparable entities in the same community or region;
- the need of the organization for the services of the individual whose compensation is being evaluated;
- the individual’s background, education, training, experience, and responsibilities;
- whether the compensation resulted from arm’s-length bargaining, such as whether it was approved by an independent board of directors;
- the size and complexity of the organization, in terms of . . . assets, income, and number of employees;
- the individual’s prior compensation arrangement;
- the individual’s performance;
- the relationship of the individual’s compensation to that paid to other employees of the same organization;
- whether there has been a sharp increase in the individual’s compensation . . . from one year to the next; and
- the amount of time the individual devotes to the position.
The Court noted that particular weight should be given to the type of charitable services provided by the entity, the geographic location, and the skills, duties, and competencies required of the executive to fulfill the entity’s charitable mission.
The Court stated that, with respect to compensation dependent on financial performance, as a general rule, the greater the percentage of an executive’s total compensation which is based on financial performance, the more likely it will be that the executive compensation package as a whole is unreasonable. The Court, however, stated that there was no fixed percentage of performance-based compensation that would render a compensation structure unreasonable, and that it must be considered with all the enumerated factors.
In Pottstown, the trial court had found the compensation of the Hospital’s executives was reasonable. The compensation package was determined by an Executive Compensation Committee of the Hospital at arm’s length as part of an annual review process, and that it had developed the incentive pay structure and base salary levels to retain its employees, given the added responsibilities the employees would take on. The ultimate compensation package offered to the Hospital’s employees was based on the analysis of its consulting firm comparing the salaries at other similar institutions, and on the firm’s recommendations. Furthermore, an expert in the field of compensation of healthcare executives had testified at trial that, even if the executives had received the maximum total compensation their bonus compensation package allowed (which they did not), it would have been within fair market value. The School District did not present an expert witness, and no other evidence rebutted the Hospital’s expert’s conclusion. Thus, based on its review of the record, the Supreme Court concluded that substantial evidence showed that the percentage of the overall compensation of the Hospital’s executives based on its financial performance, and their total compensation, was reasonable.
Accordingly, the Supreme held that the Hospital functioned free from private profit motive, upholding the trial court’s determination, and reversing the Commonwealth Court.
This case is welcome to the extent it recognizes that, although monetary transfers may occur between related entities, those transfers do not necessarily undermine an entity’s status as a charitable institution. It also rightly recognizes that charitable institutions are free to set compensation comparable to for-profit institutions to compete for the talent necessary to run them effectively. But, given that the burden is usually placed on the entity seeking the exemption, it is unclear to what evidence will be sufficient to satisfy the multiple factors set forth for determining whether compensation is reasonable. These additional factors will also apply in determining whether that entity is entitled to a Pennsylvania sales tax exemption. As always, non-profits should consult an attorney when seeking any tax exemption in Pennsylvania.
Please contact Adam Koelsch, Esq. at 717-237-5305 or Paul Morcom, Esq. at 717-237-5364 if you have any questions regarding the “purely public charity” exemption in Pennsylvania.