Justices Unsure If CEO Pay Sinks Hospital Tax Exemption

Pointing to a health network CEO’s “eye-popping” salary and financial performance-based bonuses as reason to revoke a Pennsylvania hospital’s nonprofit tax exemptions runs the risk of undermining competition for qualified executives, several justices of the Pennsylvania Supreme Court said Tuesday.

The high court seemed skeptical as counsel for the Pottstown School District in Montgomery County, Pennsylvania, argued that tying a portion of the Tower Health CEO’s pay to its hospitals’ bottom line meant Tower’s hospital subsidiaries — particularly Pottstown Hospital — were not operating without a private profit motive and thus, could not qualify as a “purely public charity” under state law and should pay taxes to the school district.

The hospital’s lawyer had argued that the CEO’s pay seemed high to laymen and even the justices, but was on par with what executives made at other multihospital networks. Some of the justices seemed to agree.

“If we’re trying to validate a nonprofit based on ... having ‘no private profit motive,’ why does that turn on whether there’s incentives for executives?” said Justice David N. Wecht. “I don’t understand ‘nonprofit’ to mean ‘noncompetitive,’ because that’s also a synonym for failure.”

Pottstown Hospital and Tower Health came to the state Supreme Court on Tuesday seeking to overturn a lower appellate court’s ruling that, because the Tower executives’ pay was significantly tied to the hospital’s financial performance, the hospital failed one prong of the test established in the court’s 1985 Hospital Utilization Project v. Commonwealth case. 

The “HUP test” is how challenges to a nonprofit’s “purely public charity” status are weighed, and changes to the test could affect other major nonprofits – such as the University of Pittsburgh Medical Center, which reported taking in $100 million less than the $22.7 billion it spent in fiscal year 2023. UPMC also paid former CEO Jeffrey Romoff $17.9 million that year, while current CEO Leslie C. Davis made $10.7 million in 2023, according to its Form 990 filed with the IRS in May.

Tower Health, which is incorporated as a 501(c)3 nonprofit, purchased several Pennsylvania hospitals in 2017. Multiple taxing bodies had challenged the hospitals’ tax exemptions on the basis that they were not being operated as “purely public charities,” and after trial courts initially upheld the exemptions, the Commonwealth Court overturned them and said the hospitals, including Pottstown, should pay taxes.

Daniel Brier of Myers Brier & Kelly, representing Pottstown Hospital LLC, argued that nonprofits should be able to pay their employees competitive rates and incentives, and should also be able to operate with a positive balance sheet without risking their tax exemptions. Tower’s CEO at the time of Pottstown’s acquisition made between $1 million and $1.4 million a year in base compensation, with incentive payments of about $500,000 available if the hospitals hit their financial goals, the lower court opinion had noted.

“Purely public charities are permitted to have compensation plans that pay employees reasonably and at market rates,” Brier told the top court Tuesday. “Purely public charities should not be penalized for attempting to operate with a positive bottom line.”

Brier said Pottstown Hospital still donated a significant amount of healthcare services to the community at a free or discounted rate, and its revenues were used to enhance and support the hospital’s services. This includes the money that went to Tower Health, since it was providing centralized administrative services that the hospital had been unable to run on its own. When patients who receive care are unable to pay, the hospital’s collection efforts do not include suing patients for unpaid debts, he said.

When Justice Christine Donohue questioned whether Tower Health made a profit off providing those services to Pottstown Hospital and others, Brier emphasized that Tower was also incorporated as a nonprofit and that Pottstown would be unable to find administrative services for less than it was paying Tower in fees.

“It’s not marked up, it’s at cost, and it’s not available from a third party at a lower rate,” Brier said. “Pottstown couldn’t have afforded these services elsewhere.”

Justice Daniel McCaffery noted that the trial court, despite ruling in the hospital’s favor, had acknowledged the executive pay was “eye-popping,” and that same pay led the Commonwealth Court to reverse the tax exemption. But Brier said the pay was not out of line with other health systems around the state.

“If the compensation at Tower is eye-popping, it’s eye-popping at Tower’s peer organizations around the commonwealth,” he said. 

Brier added that if the court were to allow executive pay as a factor in the HUP test, “In this highly competitive market, for-profit entities will have a massive advantage... They could induce employees to leave not-for-profit hospitals.”

Justice Sallie Updyke Mundy’s questioning focused on the financial performance-based bonuses, and Randall Schauer of Fox Rothschild, representing the Pottstown School District, said that if CEO pay was not tied to the hospital making certain profits, the case likely would not have gone in the district’s favor.

“The utilization of revenue needs to support the nature of the charitable entity,” Schauer told the justices. “Courts for 39 years have seen the HUP test say that compensation for executives can’t be tied to or reflect a profit motive.”

Schauer said accepting the hospital’s arguments would effectively cut out one of the prongs of the HUP test. But Justice Wecht questioned whether that would restrict a hospital system in the market, and how to apply the test to the market for hospital executives’ pay.

“What’s the test we should apply to see if it’s too much, if it smells like profit?” Justice Wecht said. “What is there, besides something seat-of-the-pants? It smells like jealousy.”

Schauer said the courts could look to whether that money could instead be getting pumped back into the hospital to support its charitable work.

The court took Tuesday’s arguments under advisement.

Pottstown Hospital LLC is represented by Daniel T. Brier and Donna Ann Walsh of Myers Brier & Kelly LLP, and Donald E. Wieand Jr., Peter J. Adonizio, Thomas A. Bowen, Karl S. Myers and Thomas I. Vanaskie of Stevens & Lee.

The Pottstown School District is represented by Randall C. Schauer, Gina M. Lombardo and Stephen H. Kalis of Fox Rothschild LLP.

The case is Pottstown School District v. Pottstown Hospital LLC et al., case number 95 MAP 2023, in the Supreme Court of Pennsylvania.

—Editing by Vaqas Asghar and Orlando Lorenzo.