On April 25, the Pennsylvania Supreme Court issued a potentially explosive decision to any nonprofit organization possessing tax-exempt status or seeking to qualify for tax-exempt status as a “purely public charity” in the commonwealth of Pennsylvania. In Mesitvah Eitz Chaim of Bobov v. Pike County Board of Assessment Appeals , No. 16 MAP 2011, the Pennsylvania Supreme Court held that any nonprofit organization seeking to qualify for tax-exempt status as a purely public charity must, under Article VIII, §2 of the Pennsylvania Constitution, first meet all of the elements of the test announced in Hospital Utilization Project v. Commonwealth , 487 A.2d 1306, 1317 (Pa. 1985).

In so holding, the court rejected the notion that the Pennsylvania General Assembly, through the Institutions of Purely Public Charity Act, 10 P.S. §§371-385 (Act 55), could legislatively relax the minimum constitutional standard for a purely public charity previously set by the Supreme Court in Hospital Utilization Project .

Initially, the authority to exempt any organization from taxation as a purely public charity derives from Article VIII, Section 2(a)(v) of the Pennsylvania Constitution. The section permits the General Assembly to exempt from taxation “institutions of purely public charity.” The section, however, provides no further guidance on what constitutes a purely public charity.

Summarizing the state of constitutional jurisprudence on the definition of a purely public charity, in Hospital Utilization Project , the Pennsylvania Supreme Court established a five-part judicial test, the HUP test, under Article VIII, §2(a)(v). Specifically, under the HUP test, an organization must show all of the following elements to qualify as a purely public charity: (1) It advances a charitable purpose; (2) it donates or renders gratuitously a substantial portion of its services; (3) it benefits a substantial and indefinite class of persons who are legitimate subjects of charity; (4) it relieves the government of some of its burden; and (5) it operates entirely free from profit motive.

In response to the body of case law developed under the HUP test that limited the number and kind of nonprofits that qualified as a purely public charity, in 1997, the Pennsylvania General Assembly enacted Act 55. The stated purpose of Act 55 was to reduce confusion and to eliminate confrontation between taxing jurisdictions and traditional charities by providing uniform standards to determine eligibility for tax-exempt status as a purely public charity. While tracking the HUP test criteria, Act 55 expands on those criteria by adding additional objective standards under each prong of the HUP test to assist taxpayers and taxing jurisdictions in determining whether the organization does in fact qualify for tax-exempt status. For example, 10 P.S. §375(f) of Act 55 expressly finds that the governmental burden is relieved if the organization advances or promotes religion.

Subsequent to enactment of Act 55, in Community Options v. Board of Property Assessment , 813 A.2d 680 (2002), and Alliance Home of Carlisle v. Board of Assessment Appeals , 919 A.2d 206, (Pa. 2007), the Pennsylvania Supreme Court confronted arguments highlighting the potential tension between the HUP test and the legislative interpretation of that test as embodied in Act 55. Community Options involved a question of whether an organization providing group homes for the mentally impaired qualified as a purely public charity, and specifically whether the organization relieved a governmental burden. In addition to arguing that it met the HUP test, the organization also separately argued that even if the HUP test was not met the Pennsylvania Supreme Court should show deference to the criterion of Act 55 that the organization plainly met. By determining that the evidentiary record was sufficient to establish the organization as a purely public charity under the HUP test, the Pennsylvania Supreme Court failed to reach the organization’s argument based on deference to Act 55.

Five years later, the court faced a similar argument in Alliance Home of Carlisle , which involved a question of whether a purely public charity could exempt a portion of its real estate used as a paid independent assisted living facility. Although acknowledging that in theory a dispute could exist over whether an organization could meet Act 55 but not the HUP test, the Supreme Court managed to avoid a decision on the issue because it was undisputed that the nonprofit organization qualified as a purely public charity under the HUP test.

This brings us to April 25 and the decision rendered in Mesitvah Eitz Chaim of Bobov . Mesitvah Eitz Chaim, a 501(c)(3) corporation, owned and operated an Orthodox Jewish summer camp in Pike County. The camp filed a tax exemption appeal for its real estate. The camp conducts lectures and classes on the Orthodox Jewish faith and provides food and recreational activities to campers. The camp charges tuition, but also provides financial assistance to a portion of its campers. Although purporting to be open to the public, the camp apparently failed to introduce any evidence that it relieved a governmental burden in Pike County. Ultimately, the Commonwealth Court found that the evidentiary record was not sufficient to show that the camp relieved a governmental burden — a finding the camp did not challenge on appeal to the Pennsylvania Supreme Court.

The Supreme Court granted allocatur to the camp’s appeal for the sole purpose of determining whether the HUP test occupies the “constitutional field.” As a religious organization, the camp contended it expressly met its obligation to relieve a governmental burden as expressly set forth in 10 P.S. §375(f) of Act 55. The camp argued that the state Supreme Court should show deference to the General Assembly’s decision to relax the HUP test as to the element regarding relieving a governmental burden.

In a 4-3 decision affirming the denial of the tax exemption to the camp, the state Supreme Court found that “to receive an exemption without violating the Constitution, the party must first meet the definition of ‘purely public charity’ as measured by the [ HUP test].” That is, the HUP test occupies the constitutional field. In so doing, the Pennsylvania Supreme Court traced the history of Article VIII, §2 and concluded that it was designed not to grant, but limit, legislative authority to create tax exemptions. The court stated that the “legislature may certainly determine what exemptions it chooses to grant, but only within the boundaries of the Constitution — the constitutional identification of those boundaries remains the unique province of the judiciary.” Because the General Assembly could not expand those boundaries through Act 55, the camp, absent meeting the HUP test, could not show that it relieved a governmental burden merely by establishing compliance with Act 55.

While seemingly innocuous, this decision has potential ramifications for every nonprofit organization, particularly religious organizations like the camp, currently possessing or seeking tax-exempt status in Pennsylvania. Through the HUP test, the courts, not the legislature, now occupy the field in determining the constitutional standards for a “purely public charity” under Article VIII, §2, and the HUP test is the constitutional standard. To the extent the courts determine Act 55 exceeds the constitutional standard under the HUP test (as it does under 10 P.S. §375(f)), Act 55 provides no refuge or even guidance for nonprofit organizations applying for tax-exempt status. In the wake of Mesitvah Eitz Chaim , organizations seeking or possessing tax-exempt status will need to carefully scrutinize case law to ensure that they comply with the HUP test.

Additionally, the decision dictates that Act 55 must be interpreted by the courts only as being either co-extensive with or narrower than the HUP test. This signals a potential narrowing of nonprofit organizations that may qualify for tax-exempt status.

Finally, organizations, including traditional charities, must be prepared for the likelihood of serious challenges by taxing jurisdictions searching for new sources of revenue in light of budgetary constraints. Mesitvah Eitz Chaim highlights one of the potential major battlegrounds between nonprofit organizations and taxing jurisdictions concerning the necessity under the HUP test of an organization to relieve a governmental burden to qualify for tax-exempt status. Under current case law, an organization must show that it “bears a substantial burden that would otherwise fall to the government,” as the court held in Alliance Home of Carlisle .

This prong is not without teeth. In 2009, the Commonwealth Court upheld a denial of tax-exempt status concerning a nonprofit organization engaged in searching for and recovering lost children because there was no showing that the organization relieved a governmental burden in American Assoc. for Lost Children v. Westmoreland County Board of Assessment Appeals , 977 A.2d 595 (2009). Moreover, if the organization receives governmental subsidies, the organization must make a showing separate and apart from the governmental funding that its operation otherwise relieves the government of some burden. Organizations will need to produce competent evidence showing that (1) their operations fulfill a government obligation and (2) the existence of their operations relieves the government of a substantial burden.

Mesitvah Eitz Chaim establishes the supremacy of the HUP test as the constitutional standard for measuring eligibility for tax-exempt status. Mesitvah Eitz Chaim, which rejects any legislative effort to expand tax-exempt status, will likely impact nonprofit organization across Pennsylvania by making it more difficult to achieve tax-exempt status and may result in systematic attacks by taxing jurisdictions to present tax-exempt status. •

Dusty Elias Kirk is the practice group leader of Reed Smith‘s firmwide real estate group. She concentrates her practice on all aspects of real estate development, with an emphasis on real estate litigation, including real estate tax-assessment appeals, land-use and zoning appeals, and eminent domain proceedings.

Jeffrey G. Wilhelm is a senior associate in the firm’s real estate group. He concentrates his practice on litigation with an emphasis on real estate litigation including real estate tax-assessment appeals, property disputes, and land-use and zoning appeals.