For Nonprofits, State and Local Tax Exemption May Soon Be a Tough Entry

For Nonprofits, State and Local Tax Exemption May Soon Be a Tough Entry

May 26, 2021

NFP_250x383Of the many factors that go into a nonprofit achieving its mission, one of the most important assets sometimes goes overlooked: tax exemption. The benefit provided at the federal, state, and local levels frees essential funds to support operations that otherwise would be paid out in taxes. This can often be the difference between success or failure.

While many nonprofit organizations are familiar with the federal standards for exemption under Internal Revenue Code (IRC) Section 501, it may go unnoticed that several states and localities provide their own, more stringent, requirements. Pennsylvania’s “purely public charity” constitutional standard has been a hot topic, affecting several different taxes at both the state and local levels. The Pennsylvania standard may be a bellwether of an emerging trend, as other jurisdictions have recently enacted or enforced restrictive requirements to limit exemptions traditionally provided to nonprofit organizations and to raise sorely needed funds in the era of post-pandemic budget deficits.

IRC Section 501

Absent application of other, narrower provisions provided in the title,1 many nonprofit organizations claim tax exemption under IRC Section 501(c)(3) for charitable, religious, and educational organizations. To be eligible, organizations must be organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes. Examples of qualifying institutions include museums, tax-exempt hospitals, schools, animal rescues, human service organizations, foundations, and similar businesses.

Generally, an organization must file Form 1023 with the IRS to obtain exemption from federal income tax. Since tax exemption under Section 501(c)(3) is a matter of federal law, state requirements need to be considered separately.

Pennsylvania’s Purely Public Charity Standard

While many states and localities conform to the federal exemption in IRC Section 501 without further stipulation, Article VIII, Section 2, of the Pennsylvania Constitution only allows the state legislature to exempt organizations from tax if they qualify as places of worship, not-for-profit cemeteries, public spaces, properties used for veterans, and institutions of purely public charity. Intended to curb perceived legislative abuse before the state constitution was ratified in 1874, the standard persists to this day and its interpretation continues to make waves.2

The Pennsylvania Supreme Court interpreted the purely public charity standard in its 1984 decision Hospital Utilization Project v. Commonwealth (HUP).3 In HUP, the Pennsylvania Department of Revenue denied a charitable organization’s exemption from Pennsylvania sales and use tax. The court held that any exemption provided by the legislature must first meet the “purely public charity” standard found in the state’s constitution.4 The court reasoned that the sales and use tax statutory exemption originated from Article VIII, Section 2(a)(v), of the Pennsylvania Constitution’s purely public charity standard, as the legislature is only authorized to exempt certain groups of entities, including “institutions of purely public charity.”5 The taxpayer’s exempt status under IRC Section 501(c)(3) was not binding on the state.6

In HUP, the court established a five-prong test to determine whether an organization meets the purely public charity standard (the HUP Test). To qualify, an organization must have the following characteristics:

  • Advances a charitable purpose
  • Donates or renders gratuitously a substantial portion of its services
  • Benefits a substantial and indefinite class of persons who are legitimate subjects of charity
  • Relieves the government of some of its burden
  • Operates entirely free from private profit motive.7

Following the HUP decision, the Pennsylvania legislature enacted the Institutions of Purely Public Charity Act of 1997 (Act 55) to codify the HUP Test and provide guidance.8 Act 55 added statutory requirements organizations must meet for exemption in response to confusion and litigation following the HUP decision. Act 55 lists examples of what an organization can do to meet each prong of the HUP Test and Act 55. For example, to satisfy the first prong requiring charitable purpose, the organization’s primary purpose must fit under one of several designated categorizations, such as relief of poverty, advancement and provision of education, advancement of religion, prevention and treatment of disease or injury, or other purposes beneficial to the public.9

In Mesivtah Eitz Chaim of Bobov Inc. v. Pike County Board of Assessment Appeals,10 the Pennsylvania Supreme Court affirmed applicability of the HUP Test, holding that an organization must meet the requirements of both the HUP Test and Act 55. The court held that the General Assembly may influence the definition of purely public charity, but cannot ignore the court’s interpretation of the exemption set forth in HUP. The court reasoned that though the Pennsylvania Constitution enables the General Assembly to create and flesh out exemptions, it cannot excuse the constitutional minimum set forth in the HUP Test. The court noted in dicta that the General Assembly’s motive behind passing Act 55 was well-intentioned, but it did not excuse noncompliance with the constitution.11

Application of the Purely Public Charity Standard

While Pennsylvania’s legislature and courts have established that the state’s purely public charity standard applies stricter requirements for nonprofit organizations seeking state exemption, it is not always clear to which taxes the standard applies.

Sales and use tax – Pennsylvania and Philadelphia impose a sales tax on the retail sale of tangible personal property and certain enumerated services. The Philadelphia tax is administered by the Pennsylvania Department of Revenue; thus, the state’s sales and use tax administrative provisions, rules, and regulations apply at the city level. An exclusion is provided for a “sale at retail to or use by ... any charitable organization.”12 As HUP addressed sales and use tax, an organization applying for exemption from both Pennsylvania and Philadelphia sales and use tax would need to meet the constitutional and statutory requirements required by the purely public charity standard.13

Property tax – Pennsylvania imposes and creates exemptions for local tax on real estate. The General County Assessment Law sets forth various exemptions for properties owned by charitable organizations or properties used for charitable purposes. As addressed in Mesivtah, case law has established that organizations must meet both the constitutional and statutory requirements to be considered a purely public charity and receive an exemption.14

Other Pennsylvania and local taxes – While application of the purely public charity standard appears to clearly apply to property tax and sales and use tax, it is unclear whether Pennsylvania and its localities could attempt to apply the standard to other taxes. Of specific interest would be Pennsylvania corporate net income tax, Philadelphia business income and receipts tax, Philadelphia use and occupancy tax, local business privilege tax, and other similar taxes.

Litigating the purely public charity standard – Recent litigation has shown the willingness of Pennsylvania and local jurisdictions to challenge exempt status, meaning some businesses would be tax-exempt for federal income tax purposes but taxable at the state and/or local level. Litigation under the HUP Test can be challenging for businesses, as the test requires satisfaction of each prong, and exemption can be defeated if any prong fails. Analysis is fact-specific, and ultimate outcomes can be uncertain. In Good Shepherd Child Care Center v. Pike County Board of Assessment Appeals,15 the court held that the daycare was not a purely public charity under Pennsylvania law because it failed the second prong of the HUP Test: “donates or renders gratuitously a substantial portion of its services.” The daycare did not demonstrate that fundraising and government subsidies lowered the cost of tuition. Similarly, in Rouse Brokenstraw Associates Corporation v. Warren County Board of Appeals,16 the court held that an affordable housing facility was not a purely public charity because it did not donate a substantial portion of its services, failing the second prong of the HUP Test despite providing senior housing at cost or less and funding volunteer work and community events. In Foundation for Eldercare v. Dauphin County Board of Tax Assessment Appeals,17 the court held that a low-income housing foundation failed the HUP Test because it did not benefit an indefinite class of senior citizens where it would screen and turn down potential residents due to inability to pay and risk of damaging the property. In addition, the foundation work did not relieve government of burden because it did not provide any in-home physical, emotional, or moral services.18

The city of Allentown is a party in several cases that seek to invalidate taxpayer exemptions under the purely public charity standard. One case involves Allentown seeking tax collection from a nonprofit hospital for business privilege tax purposes. Good Shepherd Rehabilitation Network (Good Shepherd), a nonprofit corporation recognized as a Section 501(c)(3) organization and an institution of purely public charity for purposes of sales and use tax, challenged in Commonwealth Court the assessment of it being a purely public charity.

Allentown assessed business privilege tax (BPT) on several revenue streams, including the rental of hospital real estate and management services performed for subsidiaries.19 With regard to management operations, the Lehigh County Court of Common Pleas held that Good Shepherd was not engaged in business activities as defined under the city’s BPT ordinance, and tax did not apply to related revenue.20 While Good Shepherd was responsible for oversight over hospitals and facilities, Good Shepherd did not carry on or exercise activity for gain or profit as required for the imposition of Allentown BPT. Good Shepherd’s purpose was not to generate profit, but rather to reduce costs by providing management and administrative personnel for its subsidiaries. It did not matter that Good Shepherd was compensated for services provided to its subsidiaries. On March 19, 2021, Pennsylvania Commonwealth Court affirmed the trial court’s holding that Good Shepherd is not subject to BPT because it is not a “business” under the BPT ordinances.21

Good Shepherd was one of the first nonprofit organizations to fight back against this targeting, but it was not the last. Other large medical networks, and even a gymnastics club, filed suit against Allentown for similar practices. Many other taxpayers may have also been affected.

Other States Show a Broader Trend

Other states have begun drawing distinctions between federal and state tax exemptions, so being exempt under IRC Section 501 may not be enough to claim state tax exemptions in certain instances. For example, New Jersey, California, New York, and Illinois may apply narrower tax exemption.

Effective Feb. 22, 2021, New Jersey enacted Bill A1135, which collects “community service” payments from nonprofit hospitals to help cover municipal and other local services. The bill requires nonprofit hospitals to pay $3 per day per hospital bed and $300 per day for each satellite emergency care facility to the municipality they are located in. The bill is in response to various lawsuits filed by communities against local for-profit hospitals. While not an explicit denial of previously applicable exemptions, this new tax illustrates a willingness to expand the taxation of businesses exempt from federal tax and even other state taxes.

On Nov. 7, 1944, California amended its state constitution to include the Welfare Exemption, which exempts certain organizations from property tax. Organizations must be formed and operated exclusively for qualifying purposes, use their property exclusively for religious, hospital, or charitable purposes, and have a current tax-exempt letter from the IRS or the Franchise Tax Board. As in Pennsylvania, not all organizations exempt under federal law will qualify for the Welfare Exemption, and California has enforced this distinction in certain cases. For example, organizations operated for literary or public purposes will not qualify, as the exemption only applies to businesses that operate for religious, hospital, scientific, or charitable purposes. Affected organizations include chambers of commerce, literary societies, college fraternities and sororities, lodges, and others that do not qualify for the Welfare Exemption but are formed as nonprofit corporations exempt from federal income tax.

New York’s nonprofit exemption from property tax is first based on an organization’s IRS determination of exempt status, but also requires the organization to qualify under one of the approved purposes listed under Section 420-a or Section 420-b, including, but not limited to, religious, charitable, educational, benevolent, patriotic, and historical purposes. Examples of organizations that meet the exemption are hospitals, missionaries, infirmaries, public playgrounds, libraries, and youth sports programs. In addition, the assessor will review the relevant property to ensure it is being used for its qualifying purpose and not to generate profit for the corporation or any individual. For example, a property tax exemption for a nonprofit under Section 401-a(1) was denied because the property was not used “exclusively for educational purposes.”22 While the nonprofit was found to be “beneficial and arguably educational in a broad sense,” it was not affiliated with the Commissioner of Education, had not conducted classes, and did not have faculty.

The Illinois Supreme Court recently resolved uncertainty surrounding application of the state’s own constitutional standard that narrows exemptions for nonprofit organizations.23 The Illinois Constitution allows the legislature to exempt “property used exclusively for ... charitable purposes.” Illinois law then provides a property tax exemption for property that is “actually and exclusively used for charitable or beneficent purposes, and not leased or otherwise used with a view to profit.” The organization must use “the property exclusively for the distribution, sale, or resale of donated goods and related activities and [use] all the income from those activities to support the charitable ... activities of the owner, whether or not such activities occur on the property.”24 In response to adverse case law applying the charitable exemption, Illinois passed Section 15-86 in 2012 to specifically exempt property owned by hospitals that benefit low-income individuals and that provide other services that relieve the burden of the government in an amount that exceeds the value of its property tax exemption.25 Following years of uncertainty surrounding the constitutionality of this law, the Illinois Supreme Court affirmed the hospital property tax exemption in 2018.

Where Do We Go from Here?

During the COVID-19 health crisis, state and local tax collections in many jurisdictions plummeted after stay-at-home orders were declared and unemployment skyrocketed. While federal funding has helped, many states forecasted sharp decreases in revenue, particularly in areas reliant on tourism.

States and localities may seek alternative sources of revenue, and nonprofit businesses may be part of the solution to their economic woes. In states like Pennsylvania, that may mean aggressive enforcement of the purely public charity standard for property tax and sales and use tax purposes, or expansion of the standard. Similarly, local jurisdictions may follow the example set by Allentown in its attempt to impose local business privilege tax on nonprofit organizations. The ultimate success of such assessments is fact-dependent, and outcomes can be highly uncertain for nonprofit organizations.

It is imperative that nonprofit organizations be aware of the larger picture when confronting application of the purely public charity standard in Pennsylvania. While the state or a local jurisdiction may focus on one tax, such as sales and use tax, recent case law and trends suggest other taxes may also be implicated. Charities that are unsure if they qualify for an exemption often enter into payment in lieu of taxes and services in lieu of taxes agreements with the local jurisdictions. Any negotiations or decisions to pursue these options must consider the risk that other taxes may ultimately be applicable. Further, nonprofit organizations should understand the value of tax exemptions to their business, as the degree of potential exposure could be key to decision-making in the current environment. Also, nonprofit organizations should strive to illustrate the value provided by their services to bolster their positions for exemption. Federal precedent requires determination of whether an organization’s activities speak to a relevant burden and that activities do in fact lessen such burden.26 Making the case that significant government burden is relieved by a nonprofit organization’s activities can be an important shield in defense against potential taxation at the state or local level.

The role of the CPA in this analysis is critical. CPAs should assist organizations in identifying, assessing, and quantifying potential exposure associated with any risk to tax exemption, and ensure an organization’s management and board of directors are educated on these issues. Further, any response should be coordinated with an organization’s community relations or media teams for potential publicity. With proper coordination, nonprofit organizations can prepare for the future and ensure they are in the best position to promote their mission for years to come.

1 Corporations that act as instrumentalities of the United States may be exempt under Section 501(c)(1). Corporations organized for the purpose of holding title to property, collecting income, and turning the property over to an exempt organization may be exempt under Section 501(c)(2). Trade associations under Section 501(c)(4) may be exempt from corporate federal income tax, but may be subject to state and local tax, such as real estate, personal property, sales and use, franchise, and others (IRC Section 501).
2 Mesivtah Eitz Chaim of Bobov Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3, 8 (Pa. 2012).
3 487 A.2d 1306, 1317 (Pa. 1985).
4 Mesivtah, 44 A.3d at 1312.
5 Id. at 1311-12.
6 Id.
7 HUP, 487 A.2d at 1317.
8 P.L. 508, No. 55; 10 Pennsylvania Constitution Stat. Sections 371-385.
9 10 Pa. Stat. Ann. Section 375(b).
10 44 A.3d 3 (Pa. 2012).
11 Id. at 8.
12 72 Pennsylvania Constitution Stat. Section 7204(10).
13 Purely public charities exempt from Pennsylvania property or sales taxes are required to file an annual report with a copy of its IRS 990 Return. The annual report must be filed with the Bureau of Corporations and Charitable Organizations within 135 days after the close of its fiscal year.
14 Note that property owned by an organization deemed a purely public charity is not automatically exempt from property tax. Property may not qualify for a real property tax exemption if the property is not actually and regularly used for the purposes of the institution.
15 2018 WL 1997192 (Pa. Commw. Ct., April 30, 2018).
16 2018 WL 2770619 (Pa. Commw. Ct., June 11, 2018).
17 2018 WL 2107230 (Pa. Commw. Ct., May 8, 2018).
18 See Metropolitan Pittsburgh Nonprofit Housing Corp. v. Board of Property Assessment, A.2d 1059 (Pa. 1978) (holding that housing facilities would meet the third prong of the HUP Test if they provided physical, emotional, or moral services).
19 Revenue streams addressed included contributions, gifts, and grants, management fees for administrative services, investment income, gross rent generated by leases on hospital property, expense reimbursement, revenue from a 2% share in a lab company, management services, and insurance reimbursement.
20 Good Shepherd Rehabilitation Network Inc. v. City of Allentown, No. 2018-C-2309 (Oct. 15, 2019).
21 Id., No. 1646 C.D. 20019 (Pa. Commw. Ct. March 19, 2021).
22 Asia Society Inc. v. Tax Commission of City of New York, 459 N.Y.S.2d 620 (N.Y. App. Div. 1983).
23 Oswald v. Hamer, 115 N.E.3d 181 (Ill. 2018).
24 35 Ill. Comp. Stat. 200/15-65.
25 35 Ill. Comp. Stat. at 15-86.
26 Rev. Rul 85-2, 1985-1 C.B. 178.


Michael Beck, JD, is a senior manager with the state and local tax practice of Grant Thornton in Philadelphia. He can be reached at


Alycia Solecki, EA, is a senior manager with the not-for-profit and higher education practice of Grant Thornton in Philadelphia. She can be reached at

The authors wish to acknowledge the contributions of Marielle Montecillo toward this article.

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