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AWPHD Legal Guide

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Section: A | B | C | D | E | F | G | H 

Section Summary

Most issues related to the payment of debts and bills by hospital districts are common to all hospitals and beyond the scope of this manual. However, there are two issue areas which require discussion- the obligation of hospital districts to pay various federal, state, and local taxes and restrictions on the ability of hospital districts to provide "gifts" under the Washington Constitution.

Paying Out Taxes
Taxation In General

In general, public hospital districts are subject to many different taxes, as are private persons, corporations and private not-for-profit hospitals. On a state level, public hospital districts are taxed similarly to private not-for-profit hospitals, although some distinctions are made for governmental status as set forth below. On a federal level, far more uniqueness exists due to the fact that public hospital districts are political subdivisions of the state.

Washington State Taxes

Washington state taxes can be divided into two general categories, excise taxes and property (ad valorem) taxes. Excise taxes are applied to activities and, therefore, are considered voluntary in the sense that they can be avoided by not engaging in the activity taxed. Property taxes are applied to the value of property owned by a taxpayer and are considered involuntary in that they apply to property annually, whether or not the property is used or transferred in any manner.

Further Legal Background

An excellent summary of Washington state excise taxes applicable to all hospitals can be found in WAC 458-20-168 (referred to by the Department of Revenue as "Rule 168"). The Rule discusses the applicability and the exemptions for the Business and Occupations tax and the Retail Sales tax. The discussion below will focus on the uniqueness of the Washington state excise taxes with regard to public hospital districts.

Business And Occupations Tax

The Business and Occupations tax is levied and collected from every person or company who engages in a business activity within the State of Washington. It is clear that the tax is applicable to public hospital districts, as the definition of "person" or "company" to whom the tax is subject includes "municipal corporations and political subdivisions of the State of Washington." [RCW 82.04.030]

The Washington State Supreme Court reviewed the applicability of the tax to a municipal corporation rendering sewer service and held that this was clearly an activity subject to the Business and Occupations tax, even though the payments to the city were for the reimbursement of construction expenses and did not represent a taxable gain or profit to the city. [City of Kennewick v. State, 67 Wn. 2d 589 (1965)]

RCW 82.04.4297 governs business and occupations tax owed by hospital districts. Public hospital districts are required to pay tax on gross income derived as compensation for medical services to patients at a rate of 1.5 percent, unless payment is from a governmental program such as Medicare or Medicaid, in which case no tax is levied. Private not-for profit hospitals are subject to the same tax rate provided that they meet certain not-for-profit criteria.

Other activities by public hospital districts that generate gross revenues from sources other than direct patient care may be subject to the Business and Occupations tax. These non-hospital services are taxed at a rate of two percent. For PHDs that have affiliated non profit organizations however, amounts received for fundraising activities are exempt from both business and occupation tax and sales tax. Fundraising is defined as either accepting contributions of money or other property or activities involving the anticipated exchange of goods or services for money. [RCW 82.04.3651]

Further Legal Background

Rule 189 summarizes the applicability of business and occupations tax to municipal corporations. The Rule makes it clear that municipal corporations are taxable with respect to amounts derived from any "utility or enterprise activity" for which a specific charge is made. An "enterprise activity" is an activity financed and operated similar to a private business activity. This includes activities which generally are in competition with private businesses and are over 50% funded by user fees. The rule states that "the term does not include activities which are exclusively governmental." Examples of enterprise activities are admission fees to special events, user fees (lockers, checkrooms), the granting of a license to use real property, user fees for parking, sales and rental of tangible personal property.

Other miscellaneous exemptions from the Business and Occupations tax for public hospital districts are as follows:

  • Taxes levied. See Washington State Constitution.
  • Amounts received from other political subdivisions. See RCW 82.04.4291 .
  • Interdepartmental charges. See Rule 201.
Sales And Use Tax

Sales taxes generally are levied on each retail sale in the state and are imposed on each successive retail sale of the same property. The sales tax is applicable to the sales of tangible personal property and certain specified services, but not to the provision of medical or healthcare services. The use tax is an equivalent to the sales tax but applies to situations where there is a consumption of goods or services in the state and the sales tax has not been paid. For example, out of state purchasers must pay the use tax when goods are brought into the state and used here. Also, if goods are purchased which are not subject to the sales tax (for example, a wholesaler who purchases goods for resale) but the goods are then converted to a taxable situation (such as the consumption of the goods by the wholesaler), the use tax must be paid. The state's share of the sales and use tax is equal to 6.5% of the selling price. Local jurisdictions may add additional sales tax to which public hospital districts are subject.

As a buyer, public hospital districts are clearly subject to the Sales and Use tax. It is also clear that sales of medical supplies, durable equipment and consumables, with the exception of prosthetic devices and ostomic items to hospitals, are subject to the Retail Sales tax.

Sales of drugs, medicines, prescription lenses, orthotic devices, medical oxygen or other substances prescribed to medical practitioners are exempt from the Retail Sales tax where the written prescription bearing the signature of the issuing medical practitioner and the name of the patient for whom prescribed is retained and such sales are separately accounted for. However, dietary supplements or dietary adjuncts do not qualify for this exemption, even though prescribed by a physician. Exemptions for use taxes are the same as those for sales taxes.

Additionally, there is an exemption to the sales tax for fundraising by nonprofit organizations. This topic is discussed above under "Business and Occupations Tax on Non-Profit Organizations."

Real Estate Excise Taxes

A real estate excise tax is assessed against sales of real property in the State of Washington. [RCW 82.45.060 and WAC 458-61-050]

The payment of the tax is imposed upon the transferor and is payable at the time of sale. The tax is based upon the selling price of the property. The rate imposed is 1 28/100% of the selling price. [RCW 82.45.060]

In addition to the state tax, counties and cities may choose to impose an additional local tax on the transfer. Therefore, the total tax payable may vary from county to county, and from properties in one area of the county to those in another.

The real estate excise tax does not apply to transfers from Washington State municipal corporations. [WAC 458-61A-205]

Leasehold Excise Tax

Starting in 1976, all leases of public property in Washington became subject to an excise tax in lieu of property tax. Leasehold excise tax is intended to replace the annual ad valorem tax on leasehold interests in tax exempt property leased by non-exempt users. RCW 82.29A.030 provides:

There is hereby levied... a leasehold excise tax on the act or privilege of occupying or using publicly owned real or personal property through a leasehold interest...

Like the sales tax, the leasehold excise tax is an obligation of the lessee but must be collected by the lessor and, if not properly collected, becomes the obligation of the lessor. The tax currently is applied at a rate of 12.84% and is based on "contract rent." In other words, with every lease payment to a public entity, the lessee is required to separately calculate and pay an additional 12.84% of the rent. Cities and counties may levy up to 6% of the tax, thereby reducing the state's portion.

The statute contains several exemptions, including temporary leases of one month, leases with taxable rents not exceeding $250 annually. Because the leasehold excise tax is intended to be a tax in lieu of property tax, RCW 82.29A.120 allows a credit for leases executed with an effective date of April 1, 1986 or later computed equal to the amount the tax exceeds the property tax that would apply to the leased property if it were privately owned.

Further Legal Background

In a memo dated May 30, 1986, from the Department of Revenue to a lessor/lessee subject to leasehold excise tax, the Department set forth a procedure for a valuation request in order to qualify for the credit based on the property tax that otherwise would have been paid. The procedure is as follows:

  • It can only be initiated by lessee or Department of Revenue.
  • Requests must be by letter addressed to the lessee's County Assessor and carboned to the lessor and Department of Revenue Leasehold Tax Section. Indicate parcel or parcel numbers, legal description, local levy code, lessor or lessee ownership, structures, improvements, personal property, business name if different.
  • County Assessor's response should be to the lessee, carboned to the lessor and Department of Revenue Leasehold Tax Section, with the valuations, levy rate, and what would the tax be were the property owned in fee.
  • SShould a disparity exist, a Request for Adjustment shall be placed with the lessor subject to review and clearance by the Department of Revenue Leasehold Tax Section.

Where a public hospital district leases real or personal property from a private person or entity, it is entitled to a property tax exemption similar to the exemption enjoyed by private not-for-profit hospitals.

Washington State Property Taxes

As municipal corporations, public hospital districts are constitutionally exempt from the payment of property taxes levied by the state and local governments.

Further Legal Background

This is a significant distinction between public hospital districts and private not-for-profit hospitals which must demonstrate and maintain a charitable status in order to remain tax exempt. For example, a private not-for-profit hospital that leases a large portion of the hospital to a for-profit entity, such as a clinic, may jeopardize the entire tax exemption of the hospital. RCW 84.36.040 states that property must be used exclusively for purposes for which exemption is granted. If a private not-for profit hospital loses its property tax exemption, it will also lose its Business and Occupations tax exemption. See RCW 82.04.4289. However, a public hospital district that does the same merely would be required to collect a leasehold excise tax for the portion of the leased property. See Leasehold Excise Taxes, above.

RCW 84.36.805 states the conditions for obtaining exemptions by non-profit organizations. In general, the property must be used exclusively for the actual operation of a hospital and irrevocably dedicated to the purposes of the hospital; the facilities and services must be available to all regardless of race, color, national origin or ancestry; the hospital must be licensed; the Director of the Department of Revenue must have access to the books and records of the hospital. The exemption should be applied for through the Department of Revenue as soon as a lease is entered into. Exemption for real property does not apply for the first year of the lease.

Federal Income Tax

Public hospital districts are exempt from federal income taxation based on an implied statutory immunity under the provisions of the Internal Revenue Code. The doctrine of implied statutory immunity applies to states, their political subdivisions or enterprises that are integral parts of either states or political subdivisions. An entity is treated as political subdivision of a state if it has at least some of the sovereign powers of taxation, eminent domain or police powers. Because public hospital districts have both the powers of taxation and eminent domain, they qualify as political subdivisions.

Although historically it was thought that states and political subdivisions that engaged in governmental functions (as opposed to proprietary functions) were immune from federal income tax based on constitutional grounds, the governmental function/proprietary function test was abandoned by the United States Supreme Court in State of New York v. United States, 326 U.S. 572 (1946). The existing immunity is simply based on the Internal Revenue Service's ("IRS") interpretation of the Internal Revenue Code as reflected in its administrative rulings. The IRS has interpreted the provisions of the Internal Revenue Code imposing income tax on corporations as not being applicable to states or political subdivisions unless there is an express imposition of tax. One example of an express provision is Section 511(a)(2)(B), which expressly imposes unrelated business income on "any college or university which is an agency or instrumentality of any government or any political subdivision thereof, or by any agency or instrumentality of one or more governments or political subdivisions." There is no comparable provision imposing federal tax on any other types of state agencies or political subdivisions such as public hospital districts.

As result, based on the implied statutory immunity, the income of public hospital districts should not be subject to federal income tax regardless of whatever activities they undertake. Public hospital districts are also not required to file federal income tax returns. Contributions to public hospital districts qualify for the maximum charitable contribution deduction limit of 50 percent under Sections 170(a)(1) and 170(c)(1) of the Internal Revenue Code. Finally, interest paid by public hospital districts on borrowings are excluded, with certain exceptions, from the lender's gross income under section 103(a) of the Internal Revenue Code.

Although all income of public hospital districts is exempt from federal income tax based on the implied statutory immunity, some public hospital districts also may seek to obtain an exemption from federal income taxation under Section 501(c)(3). The principal advantages of a public hospital districts seeking such exemption are as follows:

  • A public hospital district who qualified for Section 501(c)(3) status may establish Section 403(b) tax sheltered annuity programs for its employees.
  • A public hospital districts who qualifies for Section 501(c)(3) status may be able to use special third class bulk mailing permits through the United States Postal Service and mail bulk items at preferential rates. However, several public hospital districts in the State of Washington have been denied these preferential rates because they are political subdivisions of the state.

A public hospital district exempt under Section 501(c)(3) may be taxable on its unrelated business income under Section 511 of the Internal Revenue Code. In Private Letter Ruling 814005, the Internal Revenue Service concluded that the unrelated business income of a local governmental instrumentality that seeks and obtains an exemption under Section 501(c)(3) is subject to taxation under Section 511 of the Code. This ruling would appear to be contrary to implied statutory immunity. In addition, Private Letter Rulings merely are a statement of the Internal Revenue Service's interpretation and are not to be used or cited as precedent by the Internal Revenue Service's own declaration.

Gifting Of Funds And Stock Ownership

While hospital districts are clearly authorized -- like all local governments -- to pay those bills and claims which are related to their purposes and powers, hospital districts also must deal with an over-riding constitutional limit on the ability of governments to make "gifts" or to use funds to own stock in corporations.

The restriction is contained in Article VIII, Section 7 of the State Constitution: "No county, city, town or other municipal corporation shall hereafter ... become directly or indirectly the owner of any stock in or bonds of any association, company or corporation." Hospital districts must recognize the limits created by this provision.

Most of the issues raised by Article VIII have been covered under specific topics in this Manual. See, for example, discussions relating to: