In a case closely watched by health care and other nonprofits, the Pennsylvania Supreme Court issued a landmark decision concerning qualification for nonprofit property tax exemption in Pottstown School District v. Montgomery County Board of Assessment Appeals, 335 A.3d 1125 (Pa. 2025) on May 30.  The decision clarifies permissible compensation arrangements under the HUP test for property tax exemption and provides much needed guidance for nonprofits concerning executive compensation arrangements.

This is the first time in more than 20 years that the Supreme Court considered the HUP test which was developed in 1985 to assess whether a nonprofit qualifies for tax exempt status.  Local taxing authorities argued in the case that Pottstown Hospital, a subsidiary of Tower Health, was not entitled to exemption because it offered its executives bonuses tied to the hospital’s financial performance and paid management fees to its corporate parent.

In a 5-2 decision, the Supreme Court disagreed with the taxing authorities on both points.

Writing for the majority, Chief Justice Debra Todd held that a subsidiary’s “independent corporate form and structure will be honored by courts unless there is evidence stablishing a reason to pierce its corporate veil” under established caselaw.   Based on the absence of such evidence, the Supreme Court ruled that compensation earned by Tower Health’s executives and management fees paid by Pottstown Hospital to Tower Health do not render Pottstown Hospital ineligible for tax exemption.

With regard to compensation paid to Pottstown Hospital’s executive employees, the Supreme Court held that nonprofits are not disqualified from tax exemption because they offer incentive compensation to executives based on financial performance.  Rather, the test is whether the executive compensation was reasonable and, to facilitate this analysis, the Court identified factors to be considered in determining reasonableness.  These factors include, among other things, the level of compensation paid by similar organizations, the need for the individual’s services, the size and complexity of the organization, and the individual’s background, education, experience, and work performance. The Court made clear that evaluation of these factors is “fact-intensive” and that weight should also be given to the type of charitable services provided by the entity, the geographic location in which it provides those services, and the particular skills, duties and competencies required of the executive to fulfill the entity’s charitable mission.  The Court emphasized that exemption does not turn on a particular compensation formula but rather “the question of whether the compensation is reasonable will depend on the total percentage of the executive’s salary derived from financial performance which the bonus represents, when considered in conjunction with the . . . enumerated factors.”

Applying these considerations to the compensation structure at Pottstown Hospital, the Supreme Court found that the executives’ total compensation was reasonable and within fair market value and therefore Pottstown Hospital was entitled to tax exemption under HUP.

Myers, Brier & Kelly, LLP partners Daniel T. Brier and Donna A. Walsh represented Pottstown Hospital in the appeal before the Supreme Court, together with Thomas I. Vanaskie, Karl S. Myers, Thomas A. Bowen and Peter J. Adonizio, Jr. of Stevens & Lee, PC.

The Myers, Brier & Kelly LLP Healthcare and Nonprofit practice groups regularly advise nonprofits on issues relating to tax exemption and executive compensation.