IRS written determination 201538027

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TEGE EO Examinations Mail Stop 4920 DAL
1100 Commerce St.
Dallas, Texas 75242
Date: February 19, 2015
Numbe~ 201538027
Release Date: 9/18/2015
Taxpayer Identification Number:
UIL Code: 501.03-00
CERTIFIED MAIL - RETURN RECEIPT
Dear
Person
to Contact:
Employee Identification Number:
Employee Telephone Number:
(Phone)
(Fax)
This is a final adverse determination regarding your exempt status under section 501 (c)(3) of the
Internal Revenue Code.
Our favorable determination letter to you dated August 5, 19XX is hereby
revoked and you are no
longer exempt under section 501 (c)(3) of the Code effective August 1,
20XX.
As of August 1, 20XX, you are exempt under section 501 (c)(4) of the Code.
The revocation
of your exempt status under section 501 (c)(3) of the Code was made for the
following reason(s):
Organizations described in Code Section
501 (c)(3) and exempt under section 501 (a) must be both
organized and operated
exclusively for exempt purposes. On August 1, 20XX, you merged with
another . Prior to this merger, 100% of your enrollees
were recipients.
After the merger, a substantial portion of your premiums were paid by
commercial enrollees. This income from commercial enrollees caused you to no longer be
operated
exclusively for exempt purposes under Section 501(c)(3) of the Code. You voluntarily
filed Form 1024 and were recognized as exempt under Code Section 501(c)(4) effective on August
1, 20XX.
Contributions to your organization are no longer deductible under IRC §170 after July 31, 20XX.
You are
still required to file information returns on Form 990.
If you decide to contest this determination under the declaratory judgment provisions of section
7428
of the Code, a petition to the United States Tax Court, the United States Claims Court, or the
district court of the United States for the District of Columbia must be filed before the 91
5
t Day
after the date
this determination was mailed to you. Please contact the clerk of the appropriate

court for rules regarding filing petitions for declaratory judgments by referring to the enclosed
Publication 892. You may write
to the United States Tax Court at the following address:
United States Tax Court
400 Second Street, NW
Washington, DC 20217
You also have the right
to contact the Office of the Taxpayer Advocate. Taxpayer Advocate
assistance is
not a substitute for established IRS procedures, such as the formal Appeals process.
The Taxpayer Advocate cannot reverse a legally correct tax determination,
or extend the time fixed
by law
that you have to file a petition in a United States court. The Taxpayer Advocate can,
however, see
that a tax matter that may not have been resolved through normal channels gets
prompt and proper handling. You may call toll-free, 1-877-777-4778, and ask
for Taxpayer
Advocate Assistance.
If you prefer, you may contact your local Taxpayer Advocate at:
Telephone:
We
will notify the appropriate State Officials of this action, as required by Code section 6104(c).
You should contact
your State officials if you have any questions about how this final
determination may affect your State responsibilities and requirements.
If you have any questions, please contact the person whose name and telephone number are
shown in the heading of this letter.
Enclosures:
Publication
892
Sincerely,
Margaret Von Lienen
Director,
EO Examinations

Internal Revenue Service
Tax
Exempt and Government Entities Division
Exempt Organizations: Examinations
11 00 Commerce Street MS 4900 DAL
Dallas,
TX 75242-1100
Certified Mail - Return Receipt Requested
Dear:
Why you are receiving this letter
Department
of the Treasury
Date: March
20, 2014
Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
Person
to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:
Manager's name/ID number:
Manager's
contact number:
Response due date:
We propose to revoke your status as an organization described in section 501 (c)(3) of the
Internal Revenue Code (Code). Enclosed is our report of examination explaining the proposed
action.
What you need to do if you agree
If you agree with our proposal, please sign the enclosed Form 6018, Consent to Proposed
Action-Section 7428, and return it to the contact person at the address listed above (unless
you have already provided us a signed Form 6018). We'll issue a final revocation letter
determining that you aren't an organization described
in section 501 (c)(3).
After we issue the final revocation letter, we'll announce that your organization is no longer
eligible for contributions deductible under section 170 of the Code.
If we don't hear from you
If you don't respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final revocation letter. Failing to respond to this proposal will adversely impact your legal
standing to seek a declaratory judgment because you failed to exhaust your administrative
remedies.
Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

Effect of revocation status
If you receive a final revocation letter, you'll be required to file federal income tax returns for the
tax year(s) shown above as
well as for subsequent tax years.
What you need to do if you disagree with the proposed revocation
If you disagree with our proposed revocation, you may request a meeting or telephone
conference with the supervisor of the
IRS contact identified
in the heading of this letter. You also
may file a protest with the
IRS Appeals office by submitting a written request to the contact
person at the address listed above within 30 calendar days from the date of this letter.
The Appeals office is independent of the Exempt Organizations division and resolves most
disputes informally.
For your protest to be valid, it must contain certain specific information including a statement of
the facts, the applicable law, and arguments
in support of your position. For specific information
needed for a valid protest, please refer to page one of the enclosed Publication 892,
How to
Appeal an IRS Decision on Tax-Exempt Status, and page six of the enclosed Publication 3498,
The Examination Process. Publication 3498 also includes information
on your rights as a
taxpayer and the
IRS collection process. Please note that Fast Track Mediation referred to
in
Publication 3498 generally doesn't apply after we issue this letter.
You also may request that we refer this matter for technical advice as explained
in Publication
892. Please contact the individual identified on the first page of this letter if you are considering
requesting technical advice.
If we issue a determination letter to you based on a technical
advice memorandum issued by the Exempt Organizations Rulings and Agreements office, no
further
IRS administrative appeal will
be available to you.
Contacting the Taxpayer Advocate Office is a taxpayer right
You have the right to contact the office of the Taxpayer Advocate. Their assistance isn't a
substitute for established IRS procedures, such as the formal appeals process. The Taxpayer
Advocate can't reverse a
legally correct tax determination or extend the time you have (fixed by
law) to file a petition
in a United States court. They can, however, see that a tax matter that
hasn't been resolved through normal channels gets prompt and proper handling. You may call
toll-free 1-877-777-4778 and ask for Taxpayer Advocate assistance. If you prefer, you may
contact your local Taxpayer Advocate at:
Internal Revenue Service
Office of the Taxpayer Advocate
For additional information
If you have any questions, please call the contact person at the telephone number shown in the
heading of this letter. If you write, please provide a telephone number and the most convenient
time to call if we need to contact you.
2
Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

Thank you for your cooperation.
Enclosures:
Report of Examination
Form 6018
Publication 892
Publication 3498
3
Sincerely,
Nanette
M. Downing
Director, EO Examinations
Letter 3618 (Rev. 6-2012)
Catalog Number 34809F

A. ISSUE
Should
revoked?
B. FACTS
Federal income tax exemption be
was originally incorporated in 19XX and commenced operations as a for-
profit corporation in 19XX. Effective on May 18, 20XX, the original articles of
incorporation, as amended, were restated with reorganized as a
nonprofit membership corporation and [in
20XX] as tax exempt under
Section 501(c)(4)
of the Internal Revenue Code (Code), whose sole member is
, a nonprofit corporation tax
exempt under Section 501(c)(3)
of the Code, a holding company of various
entities.
is a state licensed health maintenance organization and arranges for the
provision
of comprehensive medical services to persons in specific
counties who subscribe
as recipients of state or federal health benefits. As of
January 1, 20XX, also arranges for the provision of various commercial
healthcare
coverage
to individuals and group subscribers. arranges healthcare
services
to subscribers through contracts with various physician groups, hospitals,
and
other healthcare providers.
1
has not indicated it requested [from the IRS] a
ruling on the tax implications
for its newly instituted commercial line.
1
From the audited financial statements prepared by the accounting firm of
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From promotion material, u covers businesses and
residents in 26 counties throughout northern, southeast, and mid-The
health plan's provider network includes more than 42 hospitals; 8,500 physicians;
and
other health care providers."
On August 1 20XX,
, a
nonprofit
membership organization, entered into a membership interest transfer
agreement
with , whereby
purchased
' a
nonprofit membership
organization
for$ from , which was the sole corporate member
of In accordance with this agreement, became the sole corporate member
of is also an arranger granted tax exempt status as a Section 501(c)(3)
organization in
19XX.
Subsequent to the purchase, and also effective August 1, 20XX, merged into
Effective with this merger, the corporate entity of ceased to exist. Effective
August
1, 20XX, restated its Articles of Incorporation and Bylaws, renaming as
and
as the sole corporate member of the Plan.
2
has not indicated it
requested [from the IRS] a ruling on the affect, if any, as to its former Section
501(c)(4) tax exempt status
or the Section 501(c)(3) tax exempt status of the
entity
it merged into.
In calendar year [CY] 20XX,
had total enrollment [individuals, groups, and
Medicaid]
of
, of which were individuals. In CY 20XX, out of
in total
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enrollment, were individuals. In CY 20XX, out of
in total enrollment,
were individuals.
In CY 20XX, total commercial premiums amounted to % [
] of
overall premiums; % [ . ] of overall expenses; and %
. ] of overall enrollees. In CY 20XX, total commercial
premiums amounted
to % [ . ]; % [ . ] of
expenses; and % [ o ] of enrollees. In CY 20XX, the newly converted
total commercial premiums amounted to %, [$ + $ ];
% [$ + $ ] of expenses, and % [ o of
enrollees.
3
shows the following information for the audited period [CYs 20XX-20XX]:
• Average gross receipts of$
I
• Average net income [almost entirely from the
program]
of$ ,
• Average net
surplus of$
I
• Average compensation, including fringe benefits, paid to officers,
directors, trustees, key employees and highly compensated
employees
of$ ,
• Average commissions paid
to the sales force of$
; and
3
Per State of
Annual Statements.
3IPage

• No contributions received.
4
Excerpts from
Board
of Directors meetings:
February 16, 20XX
stated initiatives include an email blast that went out to
1,200 agents informing them
of joining
commercial network. Sales
staff are receiving quote requests from
larger employer groups (over employees). added he expects
significant membership growth with
SO [State of 1
employees due to the State increasing employee contribution
percentage to
%. Other potential business includes seeking approval
from the
UA W to facilitate opportunities with UA W represented
employer groups.
April 20, 20XX
stated that is financially healthy, has the lowest
administrative cost
of any in the State.
stated the new , Community ,
originally anticipated
[a State of agency] approval by
March 31, 20XX. is still conducting their review of
application. Staff is anxious to receive approval to minimize the
Use Tax being levied on the commercial premium.
4
Filed Forms 990 and filed Annual Statements with the State of
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stated
[
indicated they are impressed with
are interested in a partnership.
June 15, 20XX
] has
performance and
stated initiatives are in place to lower medical and
administrative costs/ as well as increasing membership.
stated the
Sales Department is delighted with the newest
addition to
Sales.
, Business Development Specialist,
was hired May
24/ 20XX to handle general sales and communications
with employer groups.
stated
experience
and
education will have a strong impact on increasing commercial
membership.
August 17, 20XX
stated we are at the final stages of receiving our
Certificate of Authority. However/ new information has come to light
that is resulting in a change of plans. The Federal Reform changes,
effective March
23/
20XX/ will adversely impact the new from being
a "grandfatheredn plan and tax exempt. Additionally, the new
will
have to pay a higher rate of Federal Reform tax. Therefore/ the Board
supported keeping commerciaJ.and
members in the single
current
at this time. An appeal will be made to the
Department
of Treasury for a declarative ruling whether the Use Tax
is applicable on commercial premium. Legal counsel has issued an
5I Page

opinion to and believes it is not taxable. This position varies from
the Depart,ment of Community Health. Staff recommend
finalizing the new commercial application process, but leaving it as
a Nshe/1" company with no membership or premium. This will allow us
the greatest flexibility if the Use Tax appeal is lost or Federal Reform
makes other changes
that would support our activating this second
described the new initiatives being undertaken by
staff
in an effort to expand-business and market growth.
reviewed
and
an analysis of
stated
strategic opportunities
major competitors.
and the Department of Technology,
Management and Budget (DTMB} released
an RFP in June to
participate in the new Federal Reform high risk pool Participants
eligible
for this program must be non-elderly people younger than 65
who are
not insured and who have been rejected for health insurance
because
of a chronic health problem. The policies are to provide
coverage until
20XX, when most major health overhauls, including
state-run insurance exchanges, are to begin.
After careful review,
declined to bid.
The financial risk was deemed to great and
could
not answer many questions because Health and Human
Services had
not yet defined the program parameters. Only two
6IPage

bid, and
.
Our understanding is
has
since rescinded their bid.
October 20, 20XX
stated the Sales department has been restructured to
get more of the staff involved in selling commercial product.
Marketing initiatives include targeting larger employer groups and
doing a media blitz.
stated membership
is growing in
County and new enrollment prospects
for January 1, 20XX
include 3,200 members
of the School Employees Retirement
System ( ) and City
of employees.
August 16, 20XX
reviewed
FY 20XX, budget, highlighting projections
of membership, operating margins, and revenue for
Medicaid, and fully insured products.
February 14, 20XX
commercial,
stated
has the opportunity to lease building space in
SE stated expanding operations in SE
will support its business growth in the SE region.
stated lighted signage will
be atop the building, which
will effectively advertise and be seen clearly from 1-.
71Page

stated prospective business groups include the City of
and County. A follow up meeting with is scheduled this week.
stated he is confident growing reputation, cost-effective
and flexible benefit plans
will begin to attract large employer groups.
Apri/17, 20XX
stated the "Clean Opinion" audit results, by
, are the highest opinions offered. stated
balance sheet
is in terrific shape, has the lowest administrative cost
of any in the State, and has done a terrific job in maintaining
and
controlling operating expenses.
stated 3 new sales executives have been hired, trained,
and
in the field meeting with prospective employer groups. The sales
team
is providing quotes on a daily basis, with many of the requests
coming from large employer groups
in the S.E. region.
stated he is confident the branding of name and its growing
reputation
will begin to attract large employer groups.
stated the City of announced they will continue to offer
but discontinue offering
include
employees), and
with the city
of East
New business prospects
County (including city and school
. A meeting
is scheduled next week
, which has over employees and
approximately
covered lives.
8IPage

June 19, 20XX
reviewed a health plan performance comparison of
. and all other , showing
membership, revenue, expenses, etc.
in both Medicaid and
commercia/lines
of business.
stated the
enterprise branding initiative has
helped increase commercial membership, with
new members
enrolled. stated there are 4 sales representatives currently
out in the field, and with quotes submitted, he expects commercial
membership to exceed by
July. The State of open
enrollment begins
in August. stated the City of and
Public Schools have renewed their contracts. New
business prospects include the (5,000
in the state of
),
I
firm
in , and
October 16, 20XX
reviewed FY XX Draft Budget, highlighting
projections
of membership, operating margins, and revenue for
commercial, Medicaid, and fully insured products.
reviewed
20XX-20XX strategic measurements and
achievements, highlighting plans to increase market growth, network
expansion, financial performance, member and provider satisfaction,
quality/utilization
benchmarks, and employee engagement.
9IPage

December 18, 20XX
stated one of the goals for 20XX is to reinvest a
relationship with
Local to offer commercial product at the
SO [State of ] open enrollment. Local headquarters is in
but the union is statewide with over
members.
In an Information Document Request [IDR] #300, the agents made the following
request:
At our December 18, 20XX meeting, a representative of
stated the following in response to the agent's question
concerning [ ] commercia/line
of business and why would
continue
in this line of business, which so far has resulted in an overall
loss:
started the commercial line
in 20XX. The employers
with 100 or more employees are the
most lucrative
[profitable]
segment of this line, but it is very difficult to
gain a foothold into this segment, which has resulted
in
having a large percentage of their commercial line
consisting
of employers with less than 100 employees,
causing the overall losses. Also,
if the Affordable Care Act
does
not provide some relief, then
commercia/line
of business.
will terminate its
Please indicate
if this is an accurate statement and if not, please
modify accordingly.
10 I Page

gave the following response from
Affairs:
, Vice President,
Regulatory
The description of the challenges experienced by in the commercial
line
of business was not, and was not intended to be, an all-
encompassing explanation of experience in the commercial
line. Additionally, while believes that the Affordable
Care Act
creates some new and significant changes
in how commercial small
group and individual coverage are offered
in the market and is
hopeful that creates new opportunities for , experience
as a result
of will not be the sole factor determining whether or
not continues to offer commercial coverage.
In IDR #304, the agents made the following request:
At our December 18, 20XX meeting, the agents expressed their
concerns with your Medicaid line
of business and the possibility that
said line of business could jeopardize your tax exempt status. While,
at present, we believe neither party is ready to exchange position
papers, nevertheless, the agents believe we should continue
communicating on this matter.
If you concur, then please arrange another meeting to continue our
dialogue on this important topic.
lliPage

gave the following response:
is currently exempt under /RC 501{c}{3}~ and during the
audit years was exempt under
/RC 501{c){4}.
does not concur
that holding a meeting on the issue of Medicaid and exemption
would be useful at this time.
C. LAW
Section SOl(a) of the Internal Revenue Code provides that an organization
described in
§ 501(c) is exempt from income taxation.
Section 501(c)(3) provides
that an organization may be exempted from tax if it is
organized and operated exclusively for religious, charitable, scientific, testing for
public safety, literary, or educational purposes and "no part of the net earnings of
which inures to the benefit of any private shareholder or individual. ... "
Section 1.501(c)(3)-l(a)(l)
of the regulations provides that in order to be exempt
under section 501(c)(3),
an organization must be both organized and operated
exclusively
for one or more of the exempt purposes specified in that section. If an
organization fails to meet either the organizational test or the operational test, it
does not qualify for exemption.
Section 1.501(a)(l)-l(c) defines a "private shareholder
or individuals" as "persons
having a
personal and private interest
in the activities of the organization." Thus,
it is necessary for an organization to establish that it is not organized or operated
for the benefit of private interests, such as designated individuals, the creator or
12 I Page

his family, shareholders of the organization, or persons controlled, directly or
indirectly, by such private interests.
Section 1.501(c)(3}-l(c)(l) provides that
an organization will be regarded as
operated exclusively for one or more exempt purposes only if it engages primarily
in activities which accomplish one
or more of such exempt purposes specified in
section 501(c)(3). An organization will not be so regarded if more than an
insubstantial part of its activities is not in furtherance of an exempt purpose.
Section 1.501(c)(3)-l(c)(2) provides
that "[a]n organization is not operated
exclusively
for one or more exempt purposes if its net earnings inure in whole or
in part to the benefit of private shareholders or individuals .... "
Section 1.501(c)(3)-l(d)(l}(ii) provides
that an organization is not organized or
operated exclusively for one or more exempt purposes unless it serves a public
rather than a private interest.
To meet the requirement of this subsection, the
burden
of proof is on the organization to show that it is not organized or operated
for the benefit of private interests, such as designated individuals, the creator or
his family, shareholders of the organization, or persons controlled, directly or
indirectly, by such private interests.
Section 1.501(c)(3)-l(d)(2) states,
in part, that the term "charitable" in section
501(c)(3) includes relief
of the poor and distressed or of the underprivileged;
advancement
of religion; advancement of education or science; lessening of the
burdens
of government; and promotion of social welfare by organizations
designed
to accomplish any of the above purposes.
13 I Page

Section 1.501(c)(3)-1(e)(1) provides that an organization may meet the
requirements
of section 501(c)(3) although it operates a trade or business as a
substantial part
of its activities, if the operation of such trade or business is in
furtherance
of the organization's exempt purpose or purposes and if the
organization
is not organized or operated for the primary purpose of carrying on
an unrelated trade or business as defined in section 513. In determining the
existence or nonexistence of such primary purpose, all the circumstances must be
considered, including the size and extent of the trade or business and the size and
extent
of the activities which are in furtherance of one or more exempt purposes.
An organization which is organized and operated for the primary purpose of
carrying on an unrelated trade or business is not exempt under section 501(c)(3).
Section 501(c)(4)
of the Code provides exemption from federal income tax for
"[c]ivic leagues or organizations not organized for profit but operated exclusively
for the promotion of social welfare," and whose net earnings do not inure to the
benefit
of any private shareholder or individual.
Section
1.501{c)(4)-1(a)(2){i) of the Income Tax Regulations states that an
organization primarily engaged in promoting the common good and general
welfare
of the people of the community is operated exclusively for the promotion
of social welfare. This includes an organization operated primarily for bringing
about civic betterments
and social improvements.
Section 1.501(c)(4)-1(a){2)(ii) explains
that an organization whose primary activity
is the carrying on of a business in a manner similar to for-profit organizations is
not operated primarily for the promotion of social welfare.
14 I Page

Rev. Rul. 54-394, 1954-2 C.B. 131, stated that a nonprofit organization that
provided antenna services only to its members to enable them to receive
television reception was
not exempt as a social welfare organization because the
benefits were only available to members and not the community in general.
In Rev. Rul. 62-167, 1962-2 C.B. 142, a nonprofit organization whose primary
activity was
to retransmit TV signals, which were available to any television in the
community, qualified
for exemption under § 501{c)(4) because its activities
benefited the community in
general. Distinguishing
Rev. Rul. 54-394, 1954-2 C.B.
131, in which the television services were available only to members of the
organization
who paid membership fees and monthly maintenance charges, this
revenue
ruling described
an organization that operated its system for the benefit
of all television owners in the community and obtained memberships and
contributions on a
voluntary
basis. Therefore, the organization qualified for
exemption under§ 501{c)(4).
Rev. Rul. 71-529, 1971 C. B. 234, describes .a nonprofit organization that provides
assistance in the management
of participating colleges' and universities'
endowment
or investment funds. Because the organization is performing an
essential function for tax-exempt organizations for a charge "substantially below
cost,"
it qualifies for exemption under section 501{c){3).
Rev. Rul. 72-369, 1972-2 C.B. 245, concerns an organization formed to provide
managerial and consulting services
to unrelated section 501{c){3) organizations.
The organization enters
into agreements with unrelated nonprofit organizations
to furnish managerial and consulting services on a cost basis. The ruling states
15 I Page

that providing managerial and consulting services on a regular basis for a fee is a
trade
or business ordinarily carried on for profit. The fact that the services in this
case are provided at cost and solely for exempt organizations is not sufficient to
characterize this activity as charitable within the meaning of section 501(c)(3).
Furnishing the services at cost
lacks the donative element necessary to establish
this activity
as charitable. Accordingly, the ruling holds that the organization's
activities are
not charitable and, consequently, the organizati9n does not qualify
for exemption under section 501(c)(3).
Rev. Rul. 73-349, 1973-2 C.B. 179, noted that an organization formed to purchase
low-cost groceries
for its members was not exempt as a social welfare
organization even though membership was open to all individuals in the
community. The members paid
for the cost of the food and a monthly service
charge
to cover operating costs. It operated primarily for the private benefit of its
members; any benefits
to the community were not sufficient to meet the
requirement
that it operate primarily for the common good and general welfare
of the people of the community.
An organization provided sick benefits to its members and paid death benefits to
member's beneficiaries in Rev. Rul. 75-199, 1975-1 C.B. 160. Only individuals in a
particular ethnic group in a certain geographical area who were of "good moral
character and health" could become members. It was essentially a mutual self-
interest organization, whose income provided direct and economic benefits
to its
members; any benefit
to the larger community was minor and incidental.
Therefore, it did not qualify for exemption under§ 501(c)(4) of the Code. "Where
the benefit
from an organization is limited to that organization's members (except
16 I Page

for some minor and incidental benefit to the community as a whole), the
organization is not operated exclusively for the promotion of social welfare within
the meaning of§ 501(c)(4) of the Code."
Rev. Rul. 75-199, 1975-1 C.B. 160, distinguishes mutual benefit societies from
social welfare organizations by comparing Rev. Rul. 54-394 with Rev. Rul. 62-167.
One organization only benefited its members who paid membership fees and
monthly charges (the mutual benefit society) while the other organization made
their services available to everyone in the community (the social welfare
organization).
Rev. Rul. 76-419, 1976-2 C.B. 146, held that a nonprofit organization that
purchased blighted land in an economically depressed community, converted the
land into
an industrial park, and induced industrial enterprises to locate new
facilities in the park through favorable lease terms that required employment and
training opportunities for unemployed and underemployed residents in the area,
is operated exclusively for charitable purposes.
Rev. Rul. 77-3, 1977-1 C.B. 140, describes an organization formed for the
purposes
of leasing housing to a city at cost and providing all necessary repairs,
adequate winter heating, security guards, and other services normally associated
with providing rental housing. The city uses the housing to accommodate families
whose homes
or apartments have been destroyed by fire and the housing is
furnished on a temporary basis, pending relocation to permanent housing. The
temporary housing
is furnished to families by the city at no charge and without
regard to their ability to pay. The revenue ruling concludes that although the
17 I Page

providing of free temporary housing to distressed persons in need of adequate
housing
is a charitable activity, the organization is not exempt under section
501(c)(3)
of the Code because the city rather than the organization that is
providing free housing; the organization is merely leasing housing property and
providing certain maintenance and
other services in connection therewith to the
city at cost in a manner similar to organizations operated for profit, and is not
itself engaged in charitable activities.
Rev. Rul. 77-111, 1977-1 C.B. 144, held that an organization formed to increase
business patronage
in a deteriorated area by providing information about the
shopping opportunities
is not operated for charitable purposes and is not exempt
under section 501(c)(3}. Increasing business patronage and reviving lagging sales
are
not charitable purposes.
The organization in
Rev. Rul. 78-132, 1978-1 C.B. 157, facilitated the exchange of
personal services among its members, which was open to all individuals in a
particular community. The members received economic benefit even though
they
did not use cash for payment; every service had a corresponding credit hour
amount, which the organization tracked
for each member. The community
realized minimal,
if any, benefit from the organization. The organization was a
private cooperative enterprise
that operated primarily for its member's economic
benefit and was
not exempt as a social welfare organization under§ 501(c)(4).
Rev. Rul. 80-287, 1980-2 C.B. 195, provides that a nonprofit lawyer referral
service does
not qualify for exemption under section 501(c)(3). The organization
aided persons
who did not have an attorney by helping them select one, in
18 I Page

exchange for a nominal service charge. Any attorney who was a member of a local
bar association could apply
for placement on the referral list, in exchange for an
application fee. Because a substantial purpose of the organization was aiding the
legal profession, the organization was
not organized or operated exclusively for
charitable purposes, even though its lawyer referral service did provide some
public benefit.
In Rev. Rul. 98-15, 1998-1 C.B. 718, the IRS noted that "not every activity that
promotes health supports tax exemption under section 501(c)(3). For example,
selling prescription pharmaceuticals certainly promotes health,
but pharmacies
cannot qualify
for recognition of exemption under [section] 501(c)(3) on that
basis alone."
In Better Business Bureau of Washington D.C., Inc. v. U.S., 326 U.S. 279 {1945),
the Supreme Court held
that the presence of a single non-exempt purpose, if
substantial in nature, will destroy the exemption regardless of the number or
importance of truly exempt purposes. The Court found that a trade association
had
an "underlying commercial motive" that distinguished its educational
program from
that carried out by a university, and therefore, the association did
not qualify for exemption.
The tax court found
that an insurance trust organization, created to provide its
members
access to insurance at group rates, was not exempt under §
501(c)(4). New York State Association of Real Estate Boards Group Insurance
Fund v. Commissioner, 54
T.C. 1325 (1954), nonacq. on different grounds, 1974-
2
C.B. 5, action on decision., 1974 AOD 146 {Sept. 6, 1974). The organization
19 I Page

offered benefits only to its employer members and their employees. "[W]here the
primary economic benefit from
an organization is limited to that organization's
members, the organization
is not operated exclusively for the social welfare
within the meaning of the statute." ld. The organization did not have "the
requisite civic concern to constitute 'social welfare,' and therefore ... [did] not
qualify
for tax exemption under§ 501(c)(4)."
Similarly, in
Commissioner v. Lake Forest, Inc., 305 F.2d 814 (4th Cir. 1962), the
Fourth Circuit held
that a membership-based nonprofit corporation involved in
providing housing mainly
for war veterans did not qualify for exemption under
Section 501(c)(4).
In so holding, the court noted that "social welfare" may be
defined as "the well-being of persons as a community" (as opposed to just a
subgroup
of them), and it concluded that the corporation did not meet this
standard. ld. The Court explained
as follows:
[Lake Forest] does not propose to offer a service or program for direct
betterment or improvement of the community as a whole. It is not a
charitable corporation
in law or equity, for its contribution is neither
to the public
at large nor of a public character. Lake Forest does, of
course, furnish housing to a certain group of citizens but it does not
do so on a community basis. It is a public-spirited but privately-
devoted endeavor.
Its work in part incidentally redounds to society
but this is not the 'social welfare' of the tax statute.
"[T]he exemption granted to social welfare . . . organizations is made in
recognition
of the benefit which the public derives from their social welfare
20 I Page

activities and we think it only fair to determine a particular organization's right to
an exemption largely on the basis of the effect its operations have on the public."
People's Educational Camp Society, Inc. v. Commissioner, 331 F.2d 923 (2d Cir.
1964).
In American Women Buyers Club, Inc. v. Commissioner, 338 F.2d 526 (2d Cir.
1964)
the court affirmed denial of exemption to a membership corporation of
female ready-to-wear buyers organized to promote the general good and welfare
of members in the trade, encourage friendly relations, and give aid to members
in distress. Membership, even within the trade, was restrictive as approximately
15% of the applicants were turned down. The services provided by the club (such
as employment facilities, information about sources of supply, lectures, dinners,
installations, publications, and sick and death benefits) were all primarily,
if not
exclusively, for the club membership.
The court in Contracting Plumbers Cooperative Restoration Corporation v.
United States, 488 F.2d 684 (2d
Cir. 1973), held
that an organization did not
promote the common good, even though its activities benefited the community,
because only members could utilize its services. It repaired damage
to city streets
its members caused in the course
of their plumbing activities, performing the
repairs in proportion
to the member's payment for the services. However, it
would not repair damage created by non-member plumbers or other "enterprises
that burrow into the city streets."
In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the Tax Court
considered
an organization that provided consulting services to groups that were
21 I Page

mostly section 501(c)(3) organizations. The organization charged fees for its
services set
at or close to its own cost. The court concluded that there was
nothing
to distinguish these activities from those of an ordinary commercial
consulting enterprise, and affirmed the Service's denial
of exemption under
section 501(c)(3).
In Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687 {1979), aff'd,
625 F.2d 804 {8 Cir. 1980), the court held that, while selling prescription
pharmaceuticals
to elderly persons at a discount promotes health, the pharmacy
did
not qualify for recognition of exemption under section 501 (c)(3) on that basis
alone. Because the pharmacy operated
for a substantial commercial purpose, it
did not qualify for exemption under section 501 (c)(3).
The organization in
Mutual Aid Association of the Church of the Brethren v.
United
States, 759 F.2d 792
(lOth Cir. 1985), provided property and casualty
insurance
to members of the church and their dependents. If a member left the
church, the organization
would cancel their insurance. The court determined
that
the church did not promote social welfare because it sold insurance. The
organization operated
as a mutual insurance company, not as a church. The court
concluded
that the presence of a substantial non-exempt purpose, such as
insurance for its members in return for premiums, precluded the organization's
exempt status under
§ 501 (c)(4) as an organization primarily engaged in the
promotion of social welfare.
In American Association of Christian Schools Voluntary Employees Beneficiary
Association Welfare Plan Trust v. United States, 850 F.2d 1510 {11th Cir. 1988), a
22 I Page

tax-exempt association of schools formed a trust to provide health, hospital,
disability, life, accidental death
and dismemberment, dental, and prescription
drug insurance
to its member schools' employees and their dependents and
beneficiaries.
Citing
Mutual Aid Association of the Church of the Brethren, 759
F.2d 792, the court held that since the Trust had a substantial private purpose of
providing insurance to its members in return for premiums, it was not an
organization exclusively engaged in the promotion of social welfare under §
501 (c)(4).
In Geisinger Health Plan v. Commissioner, 985 F.2d 1210 (3 Cir. 1993}, the court
held
that a pre-paid health care organization that arranged for the provision of
health care services only for its members, benefited its members, not the
community
as a whole and therefore did not further charitable purposes within
the meaning of section 501 (c)(3).
In Airlie Foundation v. Commissioner, 283 F. Supp. 2d 58 (D.D.C. 2003}, the court
concluded
that an organization did not qualify for tax-exemption under section
501 (c)(3) because it was operated for nonexempt commercial purposes rather
than
for exempt purposes. Among the major factors the court considered in
reaching this conclusion was the organization's competition
with for-profit
commercial entities, the extent and degree of below cost services provided, the
pricing policies, and the reasonableness
of financial reserves. Additional factors
included whether the organization
used commercial promotional methods, such
as advertising, and the extent to which the organization received charitable
donations.
23 I Page

IHC Health Plans, Inc. v. Commissioner, 325 F.3d 1188 (10 Cir. 2003), involved an
operator of health maintenance organizations ("HMOs") that served
approximately one-quarter
of Utah's residents and approximately one-half of its
Medicaid population. The court held
that the organization failed to meet the
community benefit standard
to qualify for exemption under section 501 (c)(3)
because its sole activity was arranging for health care services for its members, in
exchange
for a fee. The court said that providing health-care products or services
to all in the community is necessary but not sufficient to meet the community
benefit standard. Rather, the organization must provide some additional benefit
that likely would not be provided in the community but for the tax exemption,
and
that this public benefit must be the primary purpose for which the
organization operates.
The organization in Vision Service Plan v. United States, 2005
U.S. Dist., WL
3406321 (E.D. Cal. Dec. 12, 2005), provided eye care services
to the employees of
its subscriber companies. VSP claimed that it was exempt under § 501 (c)(4)
because it served broad segments of the community through direct services and
charitable activities. The court found
that servicing small employers or rural
subscribers did
not equate to promoting social welfare. Additionally, the services
VSP provided for the Medicaid, Medicare, and Healthy Families contracts were
profitable, its charitable activities were insubstantial compared
to its profits, and
the executive compensation packages, cost-cutting measures, and business
practices
with the public were operated in a manner similar to for-profit
organizations.
24 I Page

D. ANALYSIS
Section 501 (a) exempts from income taxation certain organizations, including
those described in Section
501 (c)(4), i.e., organizations .. not organized for profit
but operated exclusively for the promotion of social welfare ... The word
.. exclusively .. as used in section 501(c)(4) has been interpreted to mean .. primarily ...
See Am. Women Buyers Club, Inc. v. United States, 338 F.2d 526 (2d Cir. 1964).
Likewise, the Treasury Regulations provide
that an organization is operated
exclusively
for the promotion of social welfare
11
if it is primarily engaged in
promoting in some way the common good and general welfare
of the people of
the community .. and is "operated primarily for the purpose of bring about civil
betterments and social improvements
... Treas. Reg. section 1.501 (c)(4)-1 (a)(2)(i).
The Treasury Regulations further provide
that an organization is not operated
primarily
for the promotion of social welfare if its .. primary activity" is "carrying on
a business
with the general public in a manner similar to organizations which are
operated
for profit ... Treas. Reg. section 1.501(c)(4)-1(a)(2)(ii). As a result, in order
to qualify for exemption under Section 501 (c)(4), is required to establish both
that it operates primarily for the promotion of social welfare and that it is not
conducting a business with the general public in a manner similar to that of for-
profit organizations. Treas. Reg. section 1.501 (c)(4)-1 (a)(2)(i) and (ii); with the over-
arching requirement
that if engaged in non-exempt activities, said activities are
only incidental and insubstantial. Manning Association v. Commissioner, 93
T.C.
596, (1989). If the activities are substantial, exemption may be in jeopardy,
irrespective
of the presence of other exempt purposes, and all the facts and
circumstances are
to be considered in each particular case. ld.
25 I Page

Neither the Internal Revenue Code, the regulations, nor the case law provides a
general definition
of "insubstantial". In this regard, organizations may consider
Seasongood v. Commissioner, 227
F.2d 907 (CA-6, 1955}, in which activities to
influence legislation that represented 5% of the organization's activities were held
to be insubstantial for purposes of Section 501(c)(3), and Haswell v. U.S., 500 F.2d
1133
(Ct. Cl., 1974},
cert. den. 419 U.S. 1107 (1975), in which lobbying activities
representing 16.6%
to 20.5% of organization's expenditures were considered to
be substantial.
While
there
is no statutory or regulatory percentage test or other numerical
threshold
or ratio regarding nonexempt purposes, a level of between 5% and 15%
is often used. A 5% to 15% threshold, of sorts, has been mentioned in such cases
as Best Lock Corp., 31 TC 1217 (1959}, and in such (nonprecedential) IRS rulings
as Ltr. Rul. 9237034 and Ltr. Rul. 200501017. The same threshold also has been
discussed in the legislative history
to Section 501{m), regarding the provision of
commercial insurance: "Under the bill, an organization described in sections
501(c)(3) and
(4) of the Code is exempt from tax only if no substantial part of its
activities consists
of providing commercial-type insurance. For this purpose, no
substantial part
has the meaning given to it under present law applicable to such
organizations.
See Haswell v. U.S., 500 F.2d 1133 (Ct. Cl. 1974}; Seasongood v.
Commissioner, 1227 F.2d 907
(6th Cir. 1955} ..• " 1986-3 C.B. Part 2, 1 H.R. Rep.
#99-426.
An exemption from federal tax, being a matter of legislative grace, is a privilege,
not a right. As a result, "a statute creating an exemption must be strictly
construed and any
doubt must be resolved in favor of the taxing power." Harding
26 I Page

Hospital, Inc., 505 F.2d 1068 (CA - 6th). See also IHC Health Plans, Inc., supra,
quoting Singler v. Johnson, 394
U.S. 741 (1969), and recognizing the "principle
that exemptions from taxation are to be construed narrowly." An organization
claiming exempt status bears the burden
of proving that it satisfies all of the
requirements
of the exemption statute. Am. Ass'n of Christian Schs., supra. See
also Welch v. Helvering, 290 U.S. 111 (1933).
A central consideration in determining whether
an organization is operating
primarily
for the promotion of social welfare under Section 501(c)(4) is whether
the organization places barriers upon membership by the public at large. It is well
settled
that an organization operating primarily for the benefit of its members,
rather than
for the benefit of the community as a whole, is not entitled to exempt
status under Section
501 (c)(4). For example, in Am. Women Buyers Club, supra,
the Second Circuit held
that a membership organization consisting of a restricted
group
of women buyers of ready-to-wear-apparel that had the stated purpose of
promoting the welfare of ready-to-wear buyers throughout the country was not
tax exempt, where the majority of the benefits were for members. The court
accordingly
concluded
that the organization was not operated primarily for the
promotion
of social welfare.
In Contracting Plumbers Co-op Restoration Corp. v. United States, supra, the
Second Circuit denied an exemption under Section 501 (c)(4) to a plumbers'
cooperative organized
to repair damages to city streets as the result of plumbing
activities, where the benefits were directly proportional
to the member's financial
involvement in the cooperative. The court found
that the organization provided
"substantial and different benefits
to both the public and its private members,
27 I Page

and that we therefore cannot say that it is 'primarily' devoted to the common
good
as required by even the most liberal reading of section 501(c)(4)." ld. See
also New York State Ass'n of Real Estate Bds. Group Ins. Fund, supra (insurance
trust established to acquire group health and life insurance benefits exclusively
for members of real estate association did not primarily promote social welfare);
Mutual Aid Ass'n of the Church of the Brethren, supra (to the same effect;
association providing property insurance exclusively
to church members was
primarily acting
as an insurance company).
In VSP the District Court observed that VSP does not provide medical services, but
simply arranges for the provision of services to its subscribers; (entity that merely
arranged health care services held
not to be engaged in activities that promote
health care).
Even if VSP is engaged in promoting health care, that activity would
not mandate a finding that VSP is primarily engaged in the promotion of social
welfare. Although
it is true that the promotion of health can be a charitable
purpose,
not every activity that promotes health supports tax exemption. IHC
Health Plans, Inc., supra ("[n]umerous for-profit enterprises offer products or
services that promote health"). What matters for purposes of exempt status
under Section 501(c)(4)
is whether the organization primarily promotes the
common good, rather than merely the welfare
of a private group. The District
Court found
that VSP's services are "most beneficial" to its private paying
members, the subscribers
and enrollees. See Am. Ass'n of Christian Schs.
Voluntary Employees Beneficiary Ass'n Welfare Plan Trust, supra (trust
providing health, dental and other insurance benefits exclusively
to employees of
member schools held not exempt under section 501(c)(4) where the trust's
28 I Page

primary activity was providing insurance to employees in exchange for
premiums).
VSP also argued that its service to small employers and geographically remote
regions promotes social welfare
to a degree that entitles it to exemption. The
District Court rejected this argument. Contrary
to VSP's contentions, small
employers and residents living in rural areas are
not necessarily poor, needy or
medically underserved. For example, a small but lucrative law firm may qualify as
a "small employer," but it scarcely could be considered part of an underserved
population. Moreover, even
if employees of a small employer or rural resident
were considered poor, needy
or medically underserved, they still must be
members of a limited class, i.e., paying subscribers with whom VSP has
contracted, in order for them to obtain VSP's services.
Furthermore, contrary to VSP's contentions, mere participation in Medicaid,
Medicare and Healthy Families does not result in it_primarily benefitting the
public
at large. VSP did not serve any segment of the population that has not
already contracted with it. The criterion for an enrollee to receive VSP's services,
therefore,
is not whether the person is a member of a medically-underserved
population.
It is, instead, whether the enrollee is an employee or member of a
paying subscriber (e.g., the
State of California) that contracts with VSP for a fee.
Therefore,
VSP's activities are not primarily directed toward the medically.
underserved, but are directed toward the members
of paying subscribers, some
of whom may incidentally happen to be medically underserved. The fact that VSP
has a requirement of membership for these groups indicates that VSP is primarily
benefitting itself and its members by having
such a restriction.
29 I Page

Also, the District Court found VSP competitively bid to obtain contracts to arrange
the provision
of vision care services to participants in Medicaid, Medicare and
Healthy Families. Although
VSP contends that this fact shows that it endeavors to
serve all segments of the market, the argument is not well taken. The mere fact
that VSP has entered into such contracts does not necessarily evidence that it
operates primarily for the promotion of social welfare. To the contrary, the
contracts could just
as easily be characterized as being primarily motivated by
VSP's desire to increase the volume of VSP's business and its revenue. Finally, the
District Court noted that the Medicaid, Medicare and Healthy Families programs
appeared
to be profitable for VSP.
VSP contended that Section 501 (c)(4) does not require that an organization lose
money on its functions before
it can qualify as exempt. While this is certainly true,
VSP's argument nevertheless misses the mark. If only a small portion of an
organization's overall activities consist of promoting social welfare, then the
organization cannot
be said to be primarily engaged in that activity as required by
Section
501 (c)(4).
The District Court additionally found
that VSP carried on a business similar to for-
profit organizations. VSP's primary activity is to arrange vision care services by
connecting its subscribers and
their enrollees to VSP's participating providers.
These services are provided
in exchange for fees and claims costs that represent
the majority
of VSP's revenues. Contracting with paying subscribers does not
directly promote the social welfare of the community. Rather, it represents an
ordinary commercial activity. Hence, VSP is clearly a commercial operation similar
30 I Page

to a for-profit business, and no broad community benefit is conferred by VSP's
primary activity as a mere arranger of services.
The record showed
that VSP has been able to accumulate an extraordinarily large
surplus,
over
$ 300 million by the end of 2003, by successfully operating its
business.
On the other hand, VSP's own financial statements showed that it spent
only approximately
$ 8.2 million on charity work during 2003. The sharp contrast
between these
two figures further demonstrates that VSP's activities are
primarily
of a for-profit nature. See People's Educ. Camp Soc., supra, (corporation
that devoted much of its revenues to improving its ability to compete
commercially in resort business through accumulation
of large surpluses and
expansion
of income-producing facilities held not exempt under section 501(c)(4),
even though
it engaged in some social welfare activities): Scripture Press Found.
v. United States, 285
F.2d 800, (Ct. Cl. 1961) (religious publishing house not
exempt under section 501 (c)(3) where large accumulated profits and small
expenditures
for educational programs indicated that its activities were primarily
of a commercial nature).
The more
VSP acts like a for-profit company (e.g., in setting salaries, in cutting
costs, in increasing
sales and clients, in increasing revenues, in worrying about
competition), the
less it focuses on the promotion of social welfare. Indeed, it was
telling
that VSP cites no factors showing that it is operating in the manner of a
non-profit organization. If VSP is going to behave the same way as it's for-profit
competitors, then it should be required to pay taxes as they do. Otherwise, VSP
would enjoy an unfair competitive advantage that thwarts the very purpose of tax
exemption.
IHC Health Plans, supra ("granting a tax exemption to [petitioners]
31 I Page

would necessarily disadvantage other for-profit [entities] with which [petitioners]
compete").
The central principle underlying the commerciality doctrine
is that an organization
that carries on activities of a type, and in a manner, similar to those of for-profit
enterprises as too large a part of its overall activities does not meet the
requirements
for exemption because it has a substantial nonexempt (i.e.,
commercial) purpose. A corollary rule
is that the presence of a substantial
commercial purpose can be reasonably and reliably inferred from the existence of
certain facts about and circumstances surrounding the organization's activities.
Thus, the regulations embody several principles relating
to the conduct of
commercial pursuits by exempt organizations. First, because a commercial
purpose
is not an exempt purpose, an organization will not be found to operate
'exclusively' for exempt purposes if its operation of a trade or business for profit
is a substantial purpose. In that case, the organization's exemption will be lost, no
matter how many important exempt purposes it may have.
Over the years, the courts elaborated and refined the doctrine in cases involving
all manner
of activities, ranging from the operation of farms, Dumaine Farms, 73
TC 650 (1980); pharmacies, Federation Pharmacy Services, Inc., supra;
restaurants,
living Faith, Inc., 950 F.2d 365, (CA-7, 1991); to the provision of
consulting, B.S.W. Group, Inc., supra; and insurance, Nonprofits' Ins. Alliance of
California, 74 AFTR2d 94-6893 (Fed. Cl. Ct., 1994); services to the sale of artwork,
Aid
to Artisans, Inc., 71 TC 202 (1978); testing materials, Edward Orton, Jr.
Ceramic Foundation, 9
TC 533 {1947); and vision services, VSP, supra. A basic
32 I Page

precept emerged from these cases, which is the hallmark of the commerciality
doctrine:
The presence of a disqualifying commercial purpose can be revealed by
an examination of the nature of the organization's activities and, in particular,
from
an analysis of certain facts and circumstances about those activities. The
most frequently cited
1
Commerciality factors' include:
• Competition with for-profits.
• Generation
and accumulation of profits.
• Pricing margins.
• Business
and marketing practices.
• Customer base.
• Highly Compensated Executives.
• Commissions paid to sales force.
• Lack of Contributions
E. DISCUSSION
(1) Commercial Line of Business
does not provide medical services, but rather arranges for third-parties
[physicians, hospitals and other medical facilities]
to supply the medical services
has contracted to provide to its paying subscribers [employers] for their
employees [enrollees]. , like all [for profit or not
for profit] , are required
[by the State
of ] to have a 30-day open enrollment period [August 1-31]
whereby members
of the general public can apply for medical coverage. In
33 I Page

case, out of
enrollees in 20XX, were individuals, in 20XX, out of
enrollees, were individuals, and in 20XX, out of
enrollees,
were
individuals. Therefore, individual enrollees are considered de minimus
[trifling, minimal,
so insignificant that a court may overlook it in deciding an issue
or case], Black's Law Dictionary (9th Ed. 2009). Even if we were to consider
individual enrollees, there
has been no information provided which indicates that
these I I individuals are part of an underserved medical group or were given
relief from
standard fee [premium] structure.
, like
VSP, concentrated its efforts exclusively on fee [premium] paying
subscribers [employers]
and their employees [enrollees]. Every subscriber or
individual needed to pay fees [premiums] to receive
arranged
medical benefits.
It was VSP's membership-based model [like
] which
works
to benefit [primarily] its subscribers and not the general welfare of the
community. The Court's rejection of a membership/subscriber/enrollee model
may have led to VSP's comments in its Supreme Court brief, "That serving
primarily fee-paying users precludes tax exempt status; means the loss
of tax
exempt status
for almost all currently tax exempt HMOs." 2008 TNT 155-53.
Given
our conclusion that commercial line of business does not advance or
promote the common good and general welfare of the people of the community,
so as to be considered achieving a social welfare [Section 501(c)(4)] purpose, we
need
to determine if this line of business is substantial, causing
exemption under Section 501(c)(4)
to be revoked.
tax
34 I Page

The line of business represents between and percent of overall
activities and applying the Haswell percentages, which Congress, courts and the
IRS have used to distinguish between an (insubstantial' or (substantial' activity, we
find commercial line
of business is (substantial' causing tax
exemption
to be revoked.
, during
CY 20XX, did merge into a Section 501(c)(3) arranger
Section 501(c)(3) corporate entity surviving and changing its name
to
with the
causing tax exempt status
to be converted from a Section 501(c)(4) to a
Section 501(c)(3) organization. This conversion situation
has no bearing on our
determination that tax exempt Section 501(c)(4) status should be revoked
except
that
newly converted to Section 501(c)(3) status should also be
revoked. In CY 20XX, the newly converted
total commercial premiums
amounted
to %, [$
+$
]; % [$
+ $ ] of
expenses, and % [
] of enrollees.
While
an organization which does not qualify for tax exemption under Section
501(c)(3)
can be treated as qualifying under Section 501(c)(4) [Rev. Rul. 75-286,
1975-2
C.B. 210], an organization that does not qualify under Section 501(c)(4)
can never qualify as a Section 501(c)(3) organization [2011 TNT 238-34].
Therefore,
newly converted Section 501(c)(3) status still
has a substantial
non-exempt activity causing its converted Section 501(c)(3) status
to also be
revoked.
35 I Page

{2} Medicaid
In recent years, many states have changed from traditional indemnity insurance
to a managed care system for the provision of health care services to their
Medicaid population. Thus, the state Medicaid agencies contract with insurance
companies and HMOs to arrange for the provision of health care services to
eligible Medicaid beneficiaries.
Under fee-for-service [indemnity insurance], state Medicaid agencies paid
providers
for services at the prescribed rates. Under managed care, an HMO
establishes a provider network, enrolls Medicaid recipients, collects capitated
fees from the state, administers claims and disburses fees
to the providers.
However, the state still retails the obligation to provide health care to the poor; it
has not transferred any of this obligation. Nor have these HMOs assumed any of
the obligations. By contracting with HMOs to perform these services, the state is
merely changing the methods of delivery and payment, expecting higher quality
services, greater patient
access and most important, lower costs.
In the managed care environment, where the Medicaid HMO is receiving
substantial government funds and arranging
for health care services, the state has
a substantial interest in ensuring that the Medicaid HMO is delivering quality
services and appropriately using the funds it receives. As a result, states exercise
their right to extensively regulate and supervise the Medicaid HMO's operations.
This involvement by the state is not an objective manifestation by the state that
the HMO is performing a portion of the state's burden. The state is merely
ensuring
that it is obtaining the services it is purchasing.
36 I Page

does not provide the community with more health care services than were
previously available. Instead
of purchasing health care services from physicians
on a fee-for-service basis, the state
is purchasing arranger health care services
from
was granted [in 20XX] exemption under Section 501(c)(4) as [basically] an
arranger Medicaid HMO. The entity merged into [in CY 20XX] was granted [in
19XX] a Section 501(c)(3) exemption
as [basically] an arranger Medicaid HMO. A
lot has happened since
exemption.
and the entity it merged into were granted tax
In 2003, the Tenth Circuit denied the tax exemption, under Section 501(c)(3}, to
an arranger HMO that had half of the State of Utah Medicaid population as
enrollees. IHC, supra.
In 2005, a California District Court denied the tax exempt status, under Section
501(c)(4),
to an arranger vision service HMO [VSP], who had some Medicaid
enrollees. The court noted how profitable the Medicaid program was and
how
the HMO, like others, had to submit a bid to participate in the program. VSP,
supra.
, over a three year period [CYs 20XX, 20XX and 20XX], earned gross income
from the State of Medicaid program of$ , with a net profit
of$ and [like VSP], had to submit a bid, like other non-profit or
for-profit entities, to participate in the program.s
5
Per State of
Annual Statements.
37 I Page

In 2010, an Ohio District Court denied the tax exempt status, under Section
501{c){4),
of various arranger [HMO] subsidiaries of VSP, who had substantial
Medicaid enrollees. The court noted how all
of the participants in the Medicaid
program had to be enrollees in the VSP plans and the "exact percentages are not
what are controlling." VSP Tax Litigation, 105 AFTR2d 2979 2010.
The courts ruled VSP's 'operational model' of arranged health care services to its
members/subscribers/enrollees primarily benefited these individuals and
not the
common good
or general welfare of the community. ld. It was this 'operating
model'
that the courts viewed as objectionable to the principles of tax exemption
under Section 501(c)(3)
or (4).
The court focused on the fact
that an individual who wanted to participate in the
arranger HMO's health care services
had to be a member of a payor group [i.e.,
either their employer
or the state], even if the individual was part of a medically
underserved group, i.e., the fact
that the individual was part of an underserved
group
is irrelevant. No information has been provided by as to how they
treat an individual who no longer qualifies under the state Medicaid program,
other than having their enrollment status terminated.
Therefore,
an HMO [like ], which merely arranges health care services for
its own members/subscribers/enrollees does not translate into promoting the
common good
or general welfare of the community. IHC, supra; VSP, supra.
At the time was granted tax exempt status, including the entity it merged into,
the Service was focused on the enrollees
of an arranger HMO. If those enrollees
38 I Page

came from a medically underserved class, such as participants in a state Medicaid
program, then exemption was granted under either Section 501(c)(3)
or (c)(4).
Subsequently however, the courts focused on the fact
that if, even an
underserved class had to be a member of a payor group such as an individual's
employer
or the state, then the arranger HMO was only benefitting its
members/subscribers/enrollees [even
if many were part of an underserved class]
rather than
for the purpose of benefitting the community as a whole.
In Wisconsin Nipple & Fabricating Corporation v. Commissioner, 581 F.2d 1235
{1978) and again in Basch Engineering, Inc. v. Commissioner, 1990 WL50664, the
tax court observed:
"It is not unreasonable for him [Commissioner] to charge a taxpayer
receiving the benefit
of such an opinion [tax exempt determination
letter] with the responsibility
of keeping abreast of current
developments
in the law to be assured that his plan [organization] is
still in compliance.... Thus, it is incumbent upon petitioner [taxpayer]
to stay abreast
of any change in the law, such as through legislation,
regulations, or rulings that could affect respondent's
[Commissioner's] initial determination."
Accordingly, even though or the entity it merged into were considered [by
the Service]
as tax exempt in 19XX and 20XX, the intervening years and the
subsequent court
cases demonstrate that could no longer rely on the
Service's
initial determination.
39 I Page

(3) Commerciality Doctrine-operating similar to a for-profit organization.
If
an exempt organization is operated in a for-profit [commercial] manner, then
said organization
is not operating to achieve a tax exempt purpose, i.e., a
commercial endeavor never translates into
an exempt endeavor.
In our case, there is little doubt is, in fact, operating in a commercial manner.
earned considerable income [profits]; accumulated considerable
net assets
[surplus]; pays
their executives handsomely [highly compensated]; paid
substantial commissions
to their sales force; concentrates on the most lucrative
clients [large employers]; advertises; and receives no contributions.
board meetings read like any
for-profit [commercial] firm, i.e., concerned
about competitors,
sales volumes, cutting costs, paying the least amount of taxes,
declining new financially risky ventures [not profitable], etc.
started
as a for-profit commercial firm, i.e., this establishes the basis of
formation [to operate a commercial firm]. And formed three wholly-
owned,
for-profit subsidiaries [two insurance companies and a third party
administrator serving large (self-funded)
employersV
business savvy
has even impressed one of its competitors [
] .
There is simply no information to contradict the obvious conclusion that is
operating in a manner similar to for-profit firms and, as such, not operating
primarily
for the promotion of social welfare or charity under either Section
6
40IPage

501(c)(4) or Section 501(c)(3), i.e., the presence of a single non-exempt purpose
[a commercial operation] if substantial [in our case, 100%] will destroy
exemption.
may believe
it is publicly spirited, but its manner of operation [commercial]
negates any consideration of tax exemption.
F. OVERALL COMMENTS
[like VSP] has an operational model whereby they arrange for their
member/subscriber/enrollees to receive health care services supplied by other
independent health care providers, i.e., physicians, hospitals, and others.
The California District Court [in
VSP] found that this operating model [where VSP
arranged for health care services only for its members/subscribers/enrollees]
resulted in
VSP "operating primarily for the benefit of its subscribers, rather than
for the purpose of benefitting the community as a whole." ld.
The Ninth Circuit also rejected VSP's operational model as promoting the general
welfare
of the community. VSP v. U.S., 2008 WL 268075 {CA gth, 2008}.'
In an April conference on tax exempt organizations sponsored by the Georgetown
University
Law School, Service officials expressed support for the Ninth Circuit's
decision [in VSP] and hoped other courts would follow it. Bennett, 'IRS Officials
Outline Emerging
Issues For Tax-Exempt Health Care Organizations,' 13 BNA
Health Care Daily 1 (4/28/08). 20 TXNEXEMPT 44.
7
VSP's request for rehearing en bane: denied 2009 U.S. App. Lexis 3042.
41 I Page

VSP also petitioned the Supreme Court, stating in its brief [as previously noted], if
~~ ... serving primarily fee-paying users precludes tax exempt status; means the loss
of tax exempt status for almost all currently tax exempt HMOs." [VSP's brief to
the Supreme Court, 2008 TNT 155-53; the court declined VSP's request to hear
the
case. 129 S.CT. 898. Also, see Amicus Curiae's briefs to the Supreme Court
that arrived at the same conclusion [loss of tax exempt status for HMOs]. 2008
WL 4217959, 2008 WL 4217960 and 2008
WL 4217961].
Additionally, several years later various
VSP subsidiaries challenged the Service's
revocation
of their tax exempt Section 501(c)(4) status. An Ohio District Court
followed the conclusion reached
by the California District Court and the Ninth
Circuit in rejecting
VSP's operating model of arranging for their
members/subscribers/enrollees to receive health care services [supplied by other
independent health care providers] as operating primarily for the purpose of
benefitting the community as a whole, i.e., the model primarily benefitted only
members/subscribers/enrollees and
not the community. VSP Tax Litigation,
supra.
The courts' rejections
of VSP's 'operating model' occurred even though VSP
arranged for the health care of small employer groups and participants in
Medicaid, Medicare, and
SCHIP programs. As the Ohio District Court noted,
~~ ... the various small employer and Medicaid, Medicare and SCHIP participants
served
by plaintiffs [VSP] are all subscribers. The exact percentages are not what
are controlling." VSP, supra.
42 I Page

In late 2012, the Service denied exemption as an organization described in Section
501(c)(4)
to an organization that operated as a "bundler" [arranger] of health care
services.
The organization entered into marketing agreements with multiple firms
to sell memberships in the organization. These organizations received a fee for
each type of membership they sold. Anyone could purchase a membership.
Members
included employers
of all sizes, self-employed persons, employees, and
retirees. Members received discounts on medical services and
access to limited
medical indemnity benefits, information on health care and health care reform,
and
access to scholarships for certain types of medical related studies. The
organization also offered discounts on travel, pet services, household appliances,
roadside assistance, legal services, and many other products and services.
If the
costs exceeded the maximum indemnity benefits, the member was responsible
for the excess amount. The Service referred extensively to the judicial
determination that Vision Service Plan did not qualify for exemption as a Section
501(c)(4} organization. The Service noted that both Vision Service Plan and this
organization provided benefits only
to members. In addition, the Service found
that the amount devoted to social welfare was a very small share of the total
expenditures.
8
In a recent program manager technical assistance memorandum [PMTA 2013-
005]
from TE/GE Chief Council to the Commissioner of TE/GE, Council stated:
Accordingly~ X would qualify for exemption under section 501(c){4} only
if X are not organized for profit~ and X operate exclusively for the
promotion of social welfare. The determination is based on all the facts
'
8
Private Letter Ruling (PLR) 201319031.
43 I Page

and circumstances of X, applying the statute, regulations and pertinent
court
cases (including Vision Service Plan). As discussed above, the VSP
decisions, based on the particular facts and circumstances of those
cases, held that certain organizations, whose principal activities were
arranging
or administering vision service benefits for their premium-
paying members, were
not exempt under section 50l{c)(4}.
9
The PLR and Technical Assistance Memorandum are not provided as support for
the agents' position, but rather to show the Service is applying the principles set
forth in the VSP case to other organizations.
10
(G) CONCLUSION
Given the dramatic effect of these cases on
tax exempt status and
need
to keep abreast of current developments that could impact their initial
determination, along
with the for-profit [commercial] manner of
operations, the inescapable conclusion is
[starting with the calendar year
ending on December 31,
20XX] no longer should be considered tax exempt under
Section 501{c)(4),
or should the entity
merged
into [during calendar year
ending on December 31,
20XX] be treated as tax exempt under Section 501(c)(3).
(H) COMMENTS
During the course of this examination, the agents brought to
attention,
their concerns regarding the possibility that
tax exemption could be in
9
2013 TNT 206-15, October 24, 2013.
10
Also, CCH advises practitioners they may want to consider whether there is a FIN48 or tax return issue for tax exempt prepaid health plans.
P. 22,611.035.
441Page

jeopardy and requested a meeting to discuss this matter.
11
declined
the agents' request
to meet and discuss exemption concerns.
12
Nevertheless,
has made comments concerning their commercial line of business; the
integral part doctrine; Section 501(m); and uniformity/unfair competition.
(1) Commercial Line
of Business
The
bulk
of comments are in reference to their commercial line of
business. makes a number of arguments to support its conclusion that the
commercial line
of business is related to their tax exempt purpose.
(a) Promotion of Health
is an arranger prepaid health care plan.
does
not provide any direct
health care services,
but rather acts as a facilitator [go between] linking their
paying subscriber groups [employers] and their employees [enrollees] with
participating health care providers.
believes
their facilitator activities should be looked at in the same light the
IRS views tax exempt hospitals [Rev. Rul. 69-545, 1969-2 C.B. 117]; or HMO's that
directly provide medical care [Sound Health Association v. Commissioner, 71 T.C.
158 (1978}].
Tax exempt hospitals or direct medical service providers are granted tax
exemption on the compelling evidence
of substantial public benefit, based on
community-wide
access to health care services, open medical staffing, and the
11
1DR#304.
12
response to IDR #304.
45 I Page

provision of free emergency room care to indigents. None of those characteristics
are present in
facilitator activities.
No non-enrollees can walk into a
physician's office and expect their treatment
to be paid for by
If an
individual wants their treatment to be paid for by , then said individual must
be linked to a paying subscriber, i.e., in most cases, an employee. Naturally, that
was not the case for the hospital granted tax exempt status in Rev. Rul. 69-545 or
for the direct medical care provider in Sound Health.
Also, in the Vision Service Plan
[VSP] case, [another facilitator of medical
services], they
[VSP] cited Rev. Rul. 69-545 and Sound Health as authority for VSP
to be considered tax exempt under Section 501(c}(4).
13
However, the Courts [two
District Courts, twice at the Court of Appeals for the Ninth Circuit; and the
Supreme Court] rejected
VSP's reliance on Rev. Rul. 69-545 and Sound Health.
(b) Public Policy
believes
(with the enactment
of the Patient Protection and Affordable Care
Act [ACA] in March, 2010) that court cases such as VSP, IHC Health Plan, and
Geisinger Health Plan are no longer "good law."
The years involved in this [
case are years in which the ACA was not fully implemented. Nevertheless, ACA
does not provide any relief to
states that Congress, in enacting ACA, recognized the many negative
effects associated with being uninsured for health care. Therefore, in
mind,
if they are providing an arranger/facilitator service of linking paying subscribers
and
their enrollees to participating health care providers, then they [ ] are
13
2005 Wl 3242065; 2006 Wl2984456; 2006 Wl3294958; 2008 Wl 5104792; 2008 Wl2467744; 2008 WL 4217961; 2008 TNT 155·53.
46 I Page

doing the very thing that Congress sought to achieve; namely, more individuals
with health care insurance. even points to a newly enacted Section 501(c)(29}
exemption
as proof of Congressional intent.
In Lake Forest, supra, an organization formed to provide adequate housing for
war veterans, they [Lake Forest]:
u ... offers national policy statements in a number of Acts of Congress
relating to housing
--the most pertinent enacted after the sale of
Lake Forest--to establish that in the sale of the projects the Congress
intended
that the property should thereafter retain and enjoy a
social-welfare status
in the hands of the purchaser. See 42 U.S.C.A. §§
1586~ 1587~ effective 1950; 2 U.S. Code Cong. Service 1950~ p. 2061 et
seq .... While the occupancy preferences may contribute to the
promotion
of social welfare~ they do not overbalance the private
nature
of the project. Government fostering of social welfare by
financing housing construction through private channels or extending
credit
in sales of its surplus properties does not of itself establish that
the recipients' operations should in addition enjoy tax immunity."
Also, a recent Detroit News article noted a Congressional Budget Office (CBO)
report estimating that 31 million Americans will not have health insurance in
2023.
14
Therefore, as praiseworthy the congressional goals are to have every American
insured,
as the Lake Forest Court of Appeals for the Fourth Circuit noted, a
14
Detroit News, February 20, 2014, Section B.
47 I Page

Congressional goal will not overrule the requirements that a Section 501(c)(4) or
(c)(3) organization must be operated for the
11
Well-being of persons as a
community"
as opposed to just a subgroup [subscribers and their enrollees] of
them.
Section 501(c)(29)
is the latest in a long line of insurance organizations Congress
has determined is an appropriate recipient for tax exempt status. Section 501(e)
permits cooperative hospital service organizations
to purchase insurance on a
group
basis. Sectio~ SOl(n) treats charitable risk pools as Section 501(c)(3)
organizations
if they serve only Section 501{c)(3) organizations, are organized
under a state law authorizing charitable risk pools, and do not rely primarily on
premium payments and capital contributions made by participants.
In addition,
small insurance companies are specifically provided tax exemption under Section
SOl(c)(lS), which provides tax-exempt status
for insurance companies {other than
life insurance companies). State-sponsored health insurance pools
for high-risk
individuals who are otherwise unable
to obtain health insurance and state-
sponsored workers' compensation reinsurance organizations are
eligible for tax-
exempt status under Sections 501{c){26) and {27).
The ACA added Qualified Issuers to the list of tax-exempt organizations under
Section SOl(c). New Section 501{c)(29) allows these insurers, which cater
to
individual and small group markets, to obtain federal tax exemption under certain
conditions.
It also requires such organizations to be nonprofit, membership
corporations, substantially all the activities
of which consist of issuing health plans
to individuals and small groups within the state in which it is licensed. A Qualified
Issuer
{or a related entity or predecessor) must not have been a health insurance
481Page

issuer on or before 7/16/09 and must not be sponsored by a state or local
government, any political subdivision,
or any instrumentality of such government
or political subdivision. Qualified Issuers will receive start-up loans and/or
repayable grants, which will allow Qualified Issuers to satisfy regulatory
requirements necessary
for state insurance licensure. A Qualified Issuer must be
governed by the majority vote of its members, implement ethics and conflict of
interest standards protecting against insurance industry involvement and
interference, and operate
with a strong consumer focus, including timeliness,
responsiveness, and accountability
to members. Furthermore its board of
directors may not include representatives of any federal, state, or local
government, nor any representative
of a health insurance issuer (or related
entity). Qualified Issuers must satisfy the following
four conditions to receive tax
exemption. First, Qualified Issuers must notify the Treasury by applying
for tax
exemption. Second, like Section 501(c)(3) organizations, Qualified Issuers must
comply with a private inurement prohibition (with exceptions for using profits to
lower premiums, improve benefits, or for other programs intended to improve
the quality
of health care provided to members). Third, no more than an
insubstantial amount of a Qualified Issuer's activities may consist of lobbying.
Fourth, Qualified Issuers must refrain from engaging
in political activity. Qualified
Issuers
that lose their tax-exempt status, or those that do not apply for tax-
exempt status, must pay federal income tax.
All this points
to the fact that Congressional requirements for a particular tax
exempt code section does not override
Congressional requirements
for another
tax exempt code section.
49 I Page

If wants to be exempt under either Section 501(c)(4) or (c)(3), then they need
to satisfy the Code section requirements and not merely point to another tax
exempt code section [here Section 501(c)(29)]
as justification for its failure to
satisfy the Congressional requirements for continued consideration as an
organization exempt from Federal taxes under Section 501(c)(4) or (c)(3).
points
to provisions in the ACA where certain small employers may apply
for tax credits if they provide health insurance to their employees as a positive
factor. However, also contained in the
ACA is a provision starting in 2018 that
levels a 40% excise tax on employers who offer high-cost health care plans to
their employees. Additionally, the CBO projects the revenue from this excise tax
[through 2019] will be $32 billion, which far exceeds the average costs savings
[$5.4 billion] from other provisions contained within the
ACA.
15
Therefore, the
ACA contains both tax incentives and tax disincentives relating to employers
offering
health care plans
to their employees.
Finally, regarding
speculation that VSP, IHC Health Plan and Geisinger Health
Plan are no longer "good law" due
to the enactment of ACA, the IRS has cited
either
VSP, IHC, or Geisinger as authority in eight Private Letter Rulings and one
PMTA since the enactment of ACA.
16
Accordingly, and contrary to
Geisinger to still be "good law."
speculation, the
IRS does consider VSP, IHC and
15
Wall Street Journal, February 24, 2014, Special Health Care Report.
16
PLRs 201032049; 201128028, 201145025, 201215019, 201315028, 201319031, 201350043, 201409012 and PMTA 2013-005.
50 I Page

(c) Vision care does not support exemption to the extent medical care does.
believes a prepaid arranger/facilitator health care plan
that covers more
than
just vision care should be viewed in a more favorable light than a prepaid,
arranger/facilitator
health care plan
that merely covers vision care.
views the
huge costs on community resources from uninsured individuals
to be far greater
when
all medical conditions are covered
as opposed to just vision care.
Contrary
to
assertion that vision care is not a huge drain on community
resources, one
of the amici curiae briefs to the Supreme Court is support of VSP
continuing to be recognized as tax exempt under Section 501(c)(4) noted:
A vision problem, left uncorrected, can do serious harm to a child's
development and quality
of life. According to the Center for Disease
Control and Prevention, u[i]mpaired vision can affect a child's
cognitive, emotional, neurological and physical development by
possibly limiting the range
of experiences and kinds of information [to
which] the child is exposed. II Center for Disease Control and
Prevention, What
is Vision Impairment? (Oct. 29, 2004).
17
The effect
of an uncorrected vision problem on the ability of a child to succeed in
school can be devastating. Approximately 80 percent of what a child
learns
is learned visually. American Optometric Association, School-
Aged Vision: 6 to 18
Years of Age.
18
Some vision problems, if not
corrected at an early age, can lead to permanent disability and
blindness. For example, amblyopia, or ulazy eye, II is a condition
17
http://www .cdc.gov I ncbddd/ dd/vision2. htm.
18
http:/ /www.aoa.org/x94Sl.xml#l.
51 I Page

affecting N2 to 3 out of every 100 childrenn and results in reduced
vision in an eye that has not received adequate use during early
childhood. National
Eye Institute, Amblyopia (Mar. 2008}.
19
If left
untreated until age six, amblyopia will most often result in some
permanent vision impairment.
If left untreated until age ten, the eye
may become functionally blind.
Uncorrected vision problems are also a significant drain on the
nation's economy. A
2002 study reported that untreated amblyopia
alone costs the United States an estimated $7.4 billion in earning
power each year. Jaime
H. Membreno, Melissa M. Brown, Gary C.
Brown, Sanjay Sharma & George R. Beauchamp, A Cost-utility
Analysis
of Therapy for Amblyopia, 109 Ophthalmology 2265, 2269
(2002}. If a child becomes visually impaired, the additional costs for
medical visits, home modifications and lost productivity are estimated
at $601,000 over the child's lifetime. Center for Disease Control and
Prevention, Economic Costs Associated with Mental Retardation,
Cerebral
Palsy, Hearing Loss, and Vision Impairment -United States,
2003 (Aug. 18, 2006}.
20
2008 WL 42177961.
The Court was not persuaded by this argument.
In PLR 200512023, the IRS denied an organization's application for tax exempt
status under Section 501(c)(4), which arranged
for health insurance to be
19
http:/ I www.nei.nih.gov/health/amblyopia/amblyopia_guide.asp.
20
http:/ /www.cdc.gov/mmwr/preview/mmwrhtml/mm5303a4.htm amended by erratum at
http:/ /www.cdc.gov/mmwr/preview/mmwrhtml/mmSS32aS.htm.
52 I Page

obtained by "small employer groups" for their employees. The IRS also found the
organization did not establish:
" ... that any benefit that the community as a whole may derive from
your health insurance programs for participating employers and their
employees~ such as relieving the community of the financial burden of
providing healthcare services to uninsured members of the
community~ is more than incidental~ remote and tenuous."
Accordingly, the audit team is following the Court's and the IRS's conclusion
that the cost to the community associated with uninsured individuals [as
speculated by ] is not sufficient to recognize as qualifying for tax
exemption under Section 501(c){4) or (c)(3).
(d) Community Rating
Under this topic, we
have three separate areas to consider: (i) redlining; (ii) pre-
existing condition;
and (iii) generally affordable premiums.
The agents pointed out how VSP [with no success] argued that they also did not
redline;
had no restrictions on pre-existing conditions; and believed their
premiums were generally affordable.
21
Nevertheless,
believes
it is more important to offer these items in the
medical field than
in the vision care field.
In the Fact section of this report,
indicated they are
in the small employer
field only
because, "employers with 100
or more employees are the most
21
VSP's brief to the Supreme Court, 2008 TNT 155-53.
53 I Page

lucrative [profitable] segment of this line, but it is very difficult to gain a foothold
into this segment, which
has resulted in having a large percentage of their
commercial line consisting
of employers with less than 100 employees, causing
the
overall
losses. Also, if the Affordable Care Act does not provide some relief,
then will terminate its commercial line
of business."
22
Additionally, there is not one comment [over a three year period] in
Board minutes that touch upon small employers
or individuals. All Board
comments concern the lucrative large employer market, "Marketing initiative
includes targeting larger employer groups
and doing a media blitz;"
23
"
growing reputation, cost-effective and flexible benefit plans will begin to attract
larger employer groups;"
24
"
... many of the requests coming from large employer
groups in the
S.E. Region;"
2
s and " ... to reinvest a relationship with local
... the union is statewide with over members."
26
On the individual side, all we know is over a three year period,
had,
on
average,
total enrollees
of with average total enrollees not connected
with a paying subscriber group [individuals] of .
27
You would think if
is not
redlining; not taking pre-existing conditions into account; and their premiums are
generally affordable, then far more than individuals would
have signed up over
those years
in one of
prepaid [arranger] health care plans. Also, has failed
to indicate they have any subsidized programs to assist individuals or small
22
IDR #304 and response.
23
10/20/20XX meeting.
24
2/14/20XX meeting.
25
4/17 /20XX meeting.
26
12/18/20XX meeting.
27
annual statements to the State of
54 I Page

employees [due to their financial conditions] to secure one of
[arranger] health care plans.
Additionally, the
IRS noted, in its brief to the Court:
prepaid
VSP argues that its arrangement for the provision of discounted
services to Enrollees
of "small employers" and Enrollees who reside in
rural areas supports its claim for tax-exempt status. There is no legal
authority
for this argument. Indeed, small employers and rural
residents are
not necessarily poor, needy, or medically-underserved
populations. For example, a small
but lucrative law firm may qualify
as a "small employer" but certainly could not be considered part of
an underserved population. Certainly, even if an employee of a small
employer
or rural resident was considered poor, needy, or medically
underserved,
in order for them to obtain VSP's vision benefit, they
would still
be required to become an Enrollee of a paid Subscriber.
Because it limited the vision benefit to its members' Enrollees, VSP's
arrangement for the provision of these services does not promote
social welfare.
28
Lastly, VSP states that its rates are "generally affordable. " This bald
assertion
is not supported by any evidence. Instead, it is based on
VSP's attorney's own statement made without personal knowledge,
should
not be considered, and should be stricken from the record.
And, the term
is too vague to support VSP's claim. The plan might be
28
2005 Wl 3242063.
55 I Page

affordable as that term is used by VSP to an Enrollee who earns
$50~000 per year~ but may not be affordable to an unemployed
person.
29
In Geisinger, supra, the Court stated an organization must "primarily benefit the
community,
not its subscribers plus a few people ... " and in IHC Health Plans,
supra, the Court stated "An organization cannot satisfy the community benefit
requirement based solely on the fact
that it offers health care services to all in the
community in exchange
for a fee."
In PLR 200512023, the IRS denied an organization a Section 501(c)(4) tax exempt
status even though
said organization was operating for the purpose of enabling
employees
of small employer groups to obtain health insurance they would
otherwise
be unable to afford; thereby reducing the number of uninsured
workers and helping small businesses gain
access to quality health insurance for
their employees.
In PLR 201409012, the IRS ruled that an organization established to arrange
quality health care plans
for senior members of the community was not operating
for a Section 501(c}{3)_purpose, but rather primarily for the benefit of the
organization's members. The
PLR went on to note, "For example, a health
maintenance organization
that is operated primarily for the purpose of benefiting
its paying subscribers does
not qualify for exemption solely because the
community also derives health benefits from its activities. See Geisinger Health
Plan, supra; and
IHC Health Plans, Inc., supra."
29
2005 Wl3242063.
56 I Page

In PLR 201409013, the IRS ruled an organization formed to assist members of a
particular faith
with medical expenses was not operating for a Section 501(c)(4}
purpose. The
IRS found the organization "primarily .. .is reimbursing the medical
expense claims of your members in exchange for their regular payment of fees,
which precludes exempt status
as promoting social welfare." Mutual Aid
Association, 759
F.2d 792 {lOth Cir.).
30
Therefore,
tax exempt status, under Section 501(c}(4)
or (c)(3) is not assured
simply because it is offering a prepaid [arranger] health care plan to anyone
willing
to pay their fees.
(e) Incidental Benefit
raises the possibility
that even if paying subscribers and their enrollees are
receiving a direct [private] benefit from
prepaid [arranger] health care plans,
said benefit
is both qualitatively and quantitatively incidental compared to the
benefits the public in general received.
The agents have previously demonstrated
that the Courts [in VSP] found to the
contrary and determined the public benefit was incidental
to the private benefits
received by paying subscribers
and their enrollees. Also, see PLR 200512023
where the
IRS [like the VSP courts] ruled in a like fashion.
Furthermore, the
IRS's expert witness [in the VSP case] found the public benefit
was incidental
to the private benefits received by paying subscribers and their
enrollees:
30
The agents are citing these PLRs not for support of their position, but rather to show how the IRS treated situations similar to .
57 I Page

Mr. Marcus S. Owens is a member of the law firm Caplin & Drysdale,
Chartered,
of Washington D. C. and worked in the Internal Revenue
Service's Exempt Organizations Division
from 1975 to 2000. During
his roughly 25 years with the IRS' Exempt Organizations Division, Mr.
Owens served
in many supervisory capacities ultimately serving in the
Government's Senior Executive Service and specifically serving
as
Director from January 1990 to February 2000. In the decade that he
served as Director of the Exempt Organizations Division, Mr. Owens
was the highest-ranking official within the
IRS with exclusive line
responsibility
for federal tax administration matters relating to tax-
exempt organizations.
His responsibilities included overseeing the
issuance
of all private letter rulings and technical advice memoranda
on complex
issues of federal tax law applicable to tax-exempt
organizations.
In addition, Mr. Owens was responsible for the
development
of the annual IRS audit plan for tax-exempt
organizations and the development of official guidance, including
revenue rulings, revenue procedures, explanatory publications, and
the Internal Revenue Manual and
IRS training materials, relating to
tax-exempt organizations. For example, Mr. Owens supervised the
development, and reviewed
draft versions, of the IRS Training Text on
Healthcare, "Introduction to the Health Care Industry." In conjunction
with the Treasury Department and the
IRS Office of Chief Counsel, Mr.
Owens participated
in the drafting of regulations interpreting
sections
of the Code relevant to tax-exempt organizations.
58 I Page

Mr. Owens reviewed relevant guidance and research materials,
various
VSP internal documents, and Mr. Mancino's [VSP's expert
witness] report and concluded
that "VSP does not qualify for federal
income tax exemption under Section 501(c)(4) as it
is operated,
qualitatively and quantitatively, primarily to further the interests
of
its subscribers, enrollees, and providers rather than a community
beyond its members."
Mr. Owen's also concluded that "VSP does not
qualify for federal income tax exemption under Section 501{c)(4)
because its primary activity consists
of carrying on a business with the
general public
in a manner like that of for-profit organizations ....
[and]
is not operated exclusively for the promotion of social welfare
as described
in Section 501(c)(4)."
Therefore, contrary to assertions, the Courts and IRS have concluded both
qualitatively and quantitatively
that paying subscribers and their enrollees are the
primary beneficiaries
of a prepaid [arranger] health care plan as opposed to the
public
at large; thereby causing said plan to be treated as other than tax exempt
under Section 501(c)(4)
or (c)(3).
(f) Benefits to all.
notes how anyone
can participate in its prepaid [arranger] health care
plans provided they pay the required fees.
In mind, this ability for all to
become participants [so long as they paid the fee] constitutes a benefit to the
community justifying a tax exempt status under Section 501(c)(4)
or (c)(3).
59 I Page

VSP [without success] made the same argument:
VSP's provision of vision care services primarily to its enrollees does
not preclude exempt status. It is the breadth of the community that
VSP serves in this manner that forms the basis for VSP's exemption/
1
VSP served over 5,500 small businesses representing over 70% of its
subscriber groups.
32
VSP promoted health by arranging high quality
vision services for
6. 7 million enrollees.
33
Also, in Lake Forest, supra, the Court noted:
Size of membership in ratio to local population is not controlling on
whether an organization
is 'civic' or 'social'. The number affected is
not the criterion. A private project may touch an appreciable segment
of the people or a large physical area and yet, for want of the
considerations mentioned,
not be converted into a civic or social
undertaking. Classification as 'civic' or 'social' depends upon the
character-as public or private-
of the benefits bestowed, of the
beneficiary, and
of the benefactor.
Finally, as previously noted, the Court, in IHC Health Plan, supra, found uan
organization cannot satisfy the community benefit requirement based solely on
the fact
that it offers health care services to all in the community in exchange for
a fee."
31
2006 Wl 2984456.
32
2005 Wl 3242065.
33
2006 Wl3294958.
GO I Page

Therefore, merely because anyone [for a fee] can participate in one of
prepaid [arranger] health care plans, does not translate into recognizing
tax exempt organization under Section 501(c)(4)
or (c)(3).
(g) Quality Initiatives
as a
feels its quality initiative concerning their contracted physicians will cause
those physicians
to treat all of their patients in a like manner, resulting in benefits
for both enrollees and non-enrollees. The same argument was advanced
[without success] by VSP.
VSP also promotes health through its comprehensive and rigorous
quality
of care programs. The government terms these quality of care
programs
"irrelevanto
because~ it alleges~ they confer a benefit only
on
VSP's enrollees or its participating providers and do not benefit the
community.
First~ to the extent these programs benefit VSP enrollees~
that benefit extended to over 6. 7 million California enrollees in 2003~
including over 2.8 million patients who were Medicare~ Medicaid~ and
Healthy Families
enrollees~ as well as to the over 10
1
000 children who
received free care under
VSP's Sight for Students program. But the
community benefit provided by
VSP's quality of care programs is not
limited to VSP enrollees. By raising the standard of care for doctors on
the
VSP panel~ through the development and continual updating of
clinical algorithms and its rigorous quality management practices
(credentialing~ recredentialing~ peer review and audits)~ VSP
promotes health for all patients of those doctors.
61 I Page

Therefore, as in VSP,
quality initiatives argument does not support a claim for
tax exemption under Section 501(c)(4) or (c)(3).
(h) Section 501(c)(3)
vs. {c)(4}
is of the belief that more private benefit is allowable under Section
501(c)(4) than under Section 501(c)(3).
As we know, in August, 20XX, merged into an existing Section 501(c)(3)
organization and
took over that organization's Section 501(c)(3) status. Prior to
August, 20XX,
was exempt under Section 501(c)(4).
Again,
VSP [without success] made the same argument:
The government acknowledges that the IRS had granted the Sound
Health HMO Section 501{c)(4)
statusJ and then asserts that there is
nothing in the decision that explains why the health plan petitioned
the court for a determination of Section 501{c}(3) statusJ Nor whether
the standard under Section 501(c)(3)
is more or less stringent than
that under Section 501(c)(4). u As to the respective standardsJ surely it
is self-evident that if the IRS granted Section 501{c)(4) status but
refused to grant Section 501(c}(3) statusJ then the standard under
Section 501{c}(3) must
be more stringent. With respect to why the
Sound Health organization sought Section 501{c}(3} status rather
than being content with a Section 501{c}(4) designationJ its reasons
were presumably the same
as those of virtually every other
organization
that applies for exemption under Section 501(c}(3)
rather than under Section 501{c)(4):
as set out in VSP's motion for
62 I Page

summary judgment~ Section 501(c)(3) organizations are eligible for a
host of tax benefits that are not available to Section 501(c)(4)
organizations These include eligibility to receive deductible charitable
contributions under
I.R.C. Section 170
1
and to receive grants from
private foundations under
I. R. C. Section 4945 without expenditure
responsibility
requirements~ to borrow at low interest rates in tax-
exempt bond financings under I.R.C. Section 145~ preferential postal
rates~ and potential access to additional benefits such as real
property tax exemption under state law.
Indeed~ it is because of this
higher level
of associated benefits that the standards under Section
501(c)(3) are more stringent.
What fails to recognize is its subscriber/member/enrollee structure
precludes tax exemption under either Section 501(c)(4)
or (c)(3) no matter what
the differences are between these two tax exempt code sections. Here is how
VSP stated it to the Court:
The Government's primary argument in support of the District Court
decision
is that VSP's membership-based structure precludes exempt
status under Section 501(c)(4). The Government relies on this
membership structure argument to
dismiss~ or at least devalue~
virtually all of the social welfare that VSP provides.
The Government's argument~ adopted virtually wholesale by the
District Court...that a membership organization such as
VSP is per se
outside
of Section 501(c)(4) ....
63 I Page

Throughout this report, the agents have repeatedly referred to
subscriber/member/enrollee operational structure as what the Courts [two
District Courts, twice at the Ninth Circuit Court of Appeals and the Supreme
Court] found objectionable
in granting [VSP] a Section 501(c)(4) or (c)(3) tax
exempt status. Several tax exempt practitioners have found the Court's
determination [in
VSP] damaging to all HMOs. Jedrey & Buck: Vision Service Plan
and the HMO Guidelines, Taxation of Exempts, May/June 2006. "The
decision
... suggesting that most HMOs should not qualify for tax exempt status."
Jedrey
& Fine: Vision Service Plan, Part Two; Taxation of Exempts, July/August
2008, "The District Court's decision
... suggested that most health maintenance
organizations (HMOs) would not qualify
for tax exempt status." Flynn: Does
Vision Service Signal Death Knell for 501(c)(4) HMOs, The Exempt Organization
Tax Review, June 2008, "If the Vision Service standard is imposed in the future on
HMOs seeking
to qualify (or that are currently qualified) for section 501(c)(4)
status,
it is unlikely they will be able to qualify (or continue to qualify) under these
"new" requirements."
Additionally, the
IRS, in PLR 200512023 ruled a facilitator health care organization
was
not entitled to a Section 501(c)(4) tax exemption [even though it acted as a
facilitator
for small employer groups who were unable to afford adequate health
care coverage
for their employees] because their activities only benefited the
participating employers and their employees rather than the community
as a
whole.
641Page

Accordingly, the agents [like the Courts and IRS] reject
subscriber/member/enrollee operating model
as advancing a Section 501(c)(4) or
(c)(3) purpose.
(i)
Even though is not a direct provider of health care services, that [fact] is of
no importance in determining if
commercial line of business promotes
community health.
As the agents previously stated, the hospital in Rev. Rul. 69-545, supra and the
medical clinic in Sound Health, supra, were both direct medical care providers
who attended
to the medical needs of anyone in the community regardless of
their ability to pay.
34
is a facilitator, linking those willing to pay their fees [subscribers and their
employees] with those willing to accept
fees
for providing health care
services. This
is a straight business transaction, i.e., fees charged for arranged
services. There
is simply no community benefit being served by this operating
model; which the Courts, along with the
IRS, rejected said model as advancing a
Section 501(c)(4)
or (c)(3) purpose. Merely offering to arrange health care
services
to all in the community in exchange for a fee cannot satisfy the
community benefit requirement
of Section 501(c)(4} or (c)(3).
35
, in essence, is arguing the two District Courts, twice the Court of Appeals
for the Ninth Circuit, and once the Supreme Court got it wrong in the VSP case.
Namely, an organization, like , with an operational model that primarily
34
As the government's brief in VSP found, a key fact for the Court [in Sound Health] was that an emergency patient cannot be refused aid. In
contrast, VSP doctors are not required to treat non-VSP enrollees and VSP does not reimburse doctors for treatment of non-VSP enrollees.
Thus, one of the key facts for the Sound Health court is not present in VSPs case. 2005 WL3242063.
35
IHC Health Plan, supra.
65 I Page

arranges medical care services to its subscribers/members/enrollees is precluded
from claiming tax exempt status under Section 501(c)(4) or (c)(3). The IRS's
position is clear: an organization [like ], with the noted operational model, is
precluded from claiming tax exempt status under Section 501(c)(4) or (c)(3).
Therefore, sole avenue
for it to retain tax exempt status under Section
501{c)(4)
or (c)(3) is to secure concurrence from another court that
operating model does not preclude from continuing to claim tax exempt
status under Section 501(c)(4)
or (c)(3).
The
IRS examination agents are enforcing the IRS's position and, as such,
commercial line
of business does not achieve a Section 501{c)(4) or (c)(3) purpose
and because this line
of business constitutes a substantial activity [see previous
portion
of this report for additional details], tax exempt status should be
revoked under both Section 501(c)(4)
or (c)(3) effective as of the beginning of the
first tax year [January 1, 20XX] included within the audited period.
(2) Integral Part Doctrine
believes this doctrine applies to their situation. The integral part
doctrine/theory is not codified, but its genesis may be found in Section 1.502-l(b)
of the Income Tax Regulations, which states that a subsidiary may qualify for tax
exempt status "on the ground
that its activities are an integral part of the exempt
activities
of the parent organization."
66 I Page

The court in Geisinger Health Plan [GHP]
36
covered the integral part doctrine and
found
GHP [like ] was part of a large healthcare system, yet it still did not
qualify
for exemption under this doctrine.
As our examination of the manner in which GHP interacts with other
entities
in the System makes clear, its association with those entities
does nothing to increase the portion
of the community for which GHP
promotes health -it serves no more people as a part of the System than
it would serve otherwise.
It may contribute to the System by providing
more patients than the System might otherwise have served, thus
arguably allowing the System to promote health among a broader
segment
of the community than could be served without it, but its
provision
of patients to the System does not enhance its own promotion
of health; the patients it provides -its subscribers -are the same
patients it serves without its association with the System.
To the extent
it promotes health among non-GHP-subscriber patients
of the System, it
does so only because
GHP subscribers' payments to the System help
finance the provision
of health care to others. An entity's mere financing
of the exempt purposes of a related organization does not constitute
furtherance
of that organization's purpose so as to justify exemption.
Thus, it is apparent that GHP merely seeks to "piggyback" off of the
other entities
in the System, taking on their charitable characteristics in
an effort to gain exemption without demonstrating that it is rendered
"more charitable" by virtue
of its association with them.
36
30 F.3d 494 (CA-3, 1994).
67 I Page

In the IHC -Health Plan case/
7
again we had an arranger of medical services
which
was part of a large healthcare system [Health Services] claiming, but
rejected by the court,
it qualifies for exemption under the integral part doctrine.
Nevertheless, to the extent the integral-part doctrine recognizes that we
should consider the totality
of the circumstances in determining an
organization's purpose, the doctrine
is in accord with our section
501(c)(3} jurisprudence.
One of the myriad factors we may consider in
determining an organization's purpose is whether an essential nexus
exists between an organization seeking tax exemption and a tax-exempt
affiliate.
The example cited in the Treasury Regulations aptly illustrates
the point:
"a subsidiary organization which is operated for the sole
purpose
of furnishing electric power used by its parent organization, a
tax-exempt educational organization,
in carrying on its educational
activities." 26
C.F.R. § 1.502-l(b). In other words, as we interpret the
integral-part doctrine, it simply recognizes that "[t]he performance
of a
particular activity that
is not inherently charitable may nonetheless
further a charitable purpose."
Rev. Rul. 69-572.
Using the example cited in Treasury Regulation 1.502-l(b), if we were to
consider the nature
of the subsidiary's activity in isolation -furnishing
electricity -we would have no indication that the subsidiary serves an
exempt purpose. On the other hand, when we look at the totality of the
circumstances, it becomes clear that the subsidiary's activity furthers
the
exempt purpose of education: the product provided is essential; the
37
325 F.3d 1188 (CA-10, 2003).
68 I Page

subsidiary furnishes its product solely to the tax-exempt affiliate and the
tax-exempt parent exercises control over the subsidiary. These facts,
considered
in conjunction with the exempt purpose for which the tax-
exempt parent operates, support a strong inference that the subsidiary
operates for the same
exempt purpose as does the parent.
In this case, we need not decide whether petitioners provide a service
necessary to Health Services
in conducting its exempt activities. The
required nexus between the activities of petitioners and Health Services
is lacking. As the Tax Court noted, "petitioner[s]' enrollees received
approximately 20 percent
of their physician services from physicians
employed by or contracting with Health Services, while petitioner
contracted for the remaining 80 percent
of such physician services
directly with independent physicians." Health
Plans, 82 T.C.M. at 606.
Thus, unlike the subsidiary furnishing electricity in Treasury Regulation §
1.502-l(b}, petitioners do not function solely to further Health Services'
performance
of its exempt activities. Rather, a substantial portion
(eighty percentps
of petitioners' enrollees received physician services
38
The following table, taken from petitioners' brief, presents a percentage breakdown of petitioners' total billings for physician services:
Year
Employed
Not employed/
Panel Not employed/ Non-panel
1997
23.4%
64.3% 12.3%
1998
22.1%
65.8% 12.1%
1999
20.5%
69.2% 10.3%
"Employed" includes those physicians employed by Health Services' Physician Division. "Not employed/Panel" includes independent
contractors who
had medical staff privileges at a Health Services hospital. "Not employed/Non-panel" includes all other physicians.
69 I Page

from "physicians with no direct link to [Health Services]." Health Plans,
82 T.C.M. at 606.
While
has not supplied a breakdown of its physicians' claim payments, we
assume a similar
[IHC-Health Plan] result.
39
Accordingly,
is not afforded tax exemption [under Section 501(c)(3) or
501(c)(4)] through the application of the integral part doctrine.
(3) Section SOl(m)
Section 501(m)(1)
of the Code provides that an organization described in section
501(c)(3)
or 501(c)(4) shall be exempt "only if no substantial part of its activities
consists
of providing commercial-type insurance." The legislative history indicates
that this provision was intended, in part, to bar continued section 501(c)(4)
exemption
for Blue Cross/Blue Shield organizations, which had enjoyed such
status for many years despite being in many respects indistinguishable from
commercial health insurers. See H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 662-
6 (1986}; 1986-3
C. B •. (Vol. 2) 662-6. Consequently, where an organization's
activities
resemble those of commercial insurers, generally, section SOl(m) would
serve to deny exemption under section 501(c)(4).
Section
501(m)(3)(B)
of the Code provides that the term "commercial-type"
insurance does
not include "incidental health insurance provided by a health
maintenance organization
of a kind customarily provided by such organizations."
39
Mancino, Taxation of Hospitals and Health Care Organizations (Matthew Bender, 2005), Chapter 6 (it is very difficult for an HMO to qualify
for tax
exempt status
as an integral part of a health care system).
70 I Page

The legislative history of section 501(m) provides:
For this purpose [section 501{m) of the Code], commercial-type
insurance generally
is any insurance of a type provided by commercial
insurance companies.
[C]ommercial-type insurance
does not include arrangements that are
not treated as insurance (i.e., in the absence of sufficient risk shifting
and risk distribution
for the arrangement to constitute insurance).
See Helve ring v. LeGierse. 312 U.S. 531 {1941).
40
In reporting on technical corrections to Section 501(m) of the Code that were
made in the Technical and Miscellaneous Revenue Act
of 1988 ("TAMRA"), the
Conference Committee stated:
[T]he provision relating to organizations engaged in commercial-type
insurance activities did
not alter the tax-exempt status of health
maintenance organizations
(HMOs}. HMOs provide physician services
in a variety
of practice settings primarily through physicians who are
either employees or partners of the HMO or through contracts with
individual physicians
or one or more groups of physicians (organized
on a group practice
or individual practice basis). The conference
committee clarifies that, in addition to the general exemption
for
health maintenance organizations, organizations that provide
supplemental health maintenance organization-type services (such
as
dental or vision services) are not treated as providing commercial-
40
Staff of Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986. at 58 5 (Comm. Print 1987). See also. H.R. Rep. No.
99-426,
99th Cong., 1st Sess. 663-4 (1986); 1986-3 C.B. (Vol. 2) 663 -4.
711Page

type insurance if they operate in the same manner as a health
maintenance organization.
41
In any event, Section 501(m) does not grant tax-exempt status to any
organization.
Instead,
it disqualifies an organization that otherwise meets the
requirements
for exempt status under Section 501(c}(3} or (4) if the organization
provides "commercial-type insurance."
See Nonprofits' Ins. Alliance of Calif. v.
United States, 32
Fed. Cl. 277, 292 (1994).
As the Service stated in PMTA 2013-005, supra:
Provision of the Tax Reform Act of 1986 states specific circumstances
in which "[t]he amendments made by this section shall not apply." As
noted above~ the amendments section 1012 made were to add
section 501{m) to the
Code.
Section 501{c)(4) enumerates a number of specific requirements. The
organization must not be organized for profit. The organization must
be "operated exclusively for the promotion of social welfare." The
regulations add further explication. The organization must be
"primarily engaged in promoting in some way the common good and
general welfare
of the people of the community." Treas. Reg. section
1.501{c)(4}-l{a)(2)(i). "[J]t's primary activity" must
not be "carrying on
a business with the general public
in a manner similar to
organizations which are operated
for profit." Treas. Reg. section
1.501{c)(4)-l{a){2){ii).
Each of these requirements are distinctive~ and
41
H.R. Conf. Rep. No. 100-1104, 100th Cong., 2d Sess. 11-9 (1988).
721Page

absent, from section 501(m). Moreover, Provision only describes the
activities
of X * * *. It does not cite section 501(c)(4), and it does not
address whether these activities promote social welfare.
The statutory language itself contains no statement or indication
that, by enacting section
1012
of the Tax Reform Act of 1986,
Congress did
(or intended) anything more than to provide an
exception for X from the specific requirements
of section 501(m).
Provision did
not amend section 501(c)(4). It does not state that X
met the general requirements of section 501(c)(4), nor does it provide
an exception for them from section 501(c)(4)'s requirements.
Both the legislative history to the
Tax Reform Act of 1986 and to the
1988 technical corrections act describe Provision as an exception to
section 501(m),
not as an exception to section 501(c)(4). H.R. Rep. No.
99-841, a***; H.R. Rep. No. 100-795, * * *; 5. Rep. No. 100-445, * *
*
We therefore conclude Provision of the Tax Reform Act of 1986 did
not create an exception for X from the requirements for federal tax
exemption under section 501(c)(4). Provision only provides
that
section 501(m) does not apply to X. Ruling A and * * *interpreted
Provision too broadly. Neither the express statutory language nor the
legislative history supports a conclusion that the provision
of Y by X
per se promotes social welfare, or otherwise grants X automatic
exemption under section 501(c)(4).
73 I Page

Also, briefs to the courts in support of VSP's continued tax exemption under
Section 501(c}(4) noted how any revocation
of VSP's exemption would nullify
Congressional intent
as stated in Section SOl(m) causing that section to be
superfluous [meaning less].
42
Nevertheless, the courts approved the IRS's
revocation of VSP's tax exempt status under Section 501(c)(4).
Therefore, Section SOl{m) affords no exception
to the basic requirements needed
to be satisfied in order for
to be considered tax exempt under Section
501(c)(4)
or (c)(3).
{4) Uniformity/Unfair Competition
believes a May 7, 2003 memorandum
43
issued by the IRS National Office-
Tax Exempt Division, requires the IRS to resolve HMO cases on a uniform basis
and
not through the audit process. It would be unfair to challenge
taxation
on audit without dealing with the issue at other entities which competes
against and are
not currently being audited.
The May
7, 2003 memorandum instituted an eighteen-month moratorium on
revoking tax exempt statuses
of HMOs using, as the basis, Section SOl(m) unless
you received approval from the Director, Exempt Organization Examination and
the Director, Rulings and Agreements.
As noted, this moratorium was for an
eighteen-month period, which has long since expired.
Also, the memorandum clearly stated the moratorium on revoking
an HMO's tax
exempt status under Section
501(c}(3)
or (c)(4) applies [only] if the basis for the
42
2008 WL 510479; 2008 WL 4217959; 2008 WL 4217961; 2008 TNT 155-53.
43
2003 TNT 89-22.
74 I Page

revocation is Section SOl(m). ["If a health maintenance organization no longer
meets
the requirements for exemption under IRC 501{c)(3) or {c)(4), without
considering IRC SOl(m), exemption may be revoked."]
The proposed revocation
of tax exempt status under Section 501(c)(3) or
(c)(4) is not based on the application of Section SOl(m), but rather on the basis
that no longer meets the requirements under Section 501(c)(3) or (c)(4}.
Therefore, this May
7, 2003 IRS memorandum has no application to our case.
Furthermore, VSP made the same arguments in their petition to the Court for
continued recognition of their Section 501(c)(4) tax exempt status to no avail:
VSP's nonprofit structure fundamentally distinguishes it from its for-
profit competitors
in another way as well. For-profit companies have
numerous ways
that they can access capital to fund their growth,
issuing stock through public or private placements, accessing public
and private debt, obtaining venture capital, etc. Nonprofit
corporations,
in contrast, have limited access to capital markets, and
typically must build capital through retained earnings, particularly if
they are not exempt under Section 501{c}{3}, which can issue tax
exempt bonds and receive charitable contributions, gifts and grants.
Given the financial advantages that for-profit companies have over
nonprofit companies, "some legal scholars see a nonprofits' tax
exemption as compensating them for the restrictions they face
in
raising capital." The IRS decision to deny exempt status to the VSP
75 I Page

affiliates leaves them nonprofit but not tax exempt, placing them in
the worst of all worlds.
44
The IRS found, which the Court accepted:
"If VSP is going to behave like its competitors, then it should be
required to pay taxes like its competitors. Otherwise, VSP enjoys an
unfair competitive advantage
that thwarts the very purpose of tax
exemption."
See IHC Health Plans Inc. v. Commissioner, 325 F. 3d
1188, 1199 (lOth Cir. 2003} ("granting a tax exemption to
[petitioners] would necessarily disadvantage other
for-profit [entities]
with which [petitioners] compete"), quoting Federation Pharmacy
Servs. Inc. v. C.I.R., 625 F.2d 804, 808 (8th Cir. 1980}, citing Abbott
Labs. V. Portland Retail Druggists Ass'n, Inc., 425 U.S. 1, 17-18
(1976}.
45
Accordingly, there are no restrictions on the agents proposing to revoke tax
exempt status under Section 501(c)(3)
or (c)(4) and subjecting their net income to
Federal taxes.
44
2008 Wl2467744.
45
2005 WL 3242064; In the United States, two-thirds of all HMOs are for profit taxable organizations. John P. Geyman, The Corporate
Transformation
of Medicine and Its Impact on Costs and Access to Care, 16 J. Am. Bd. Of Family Prac. 443; David U. Himmelstein, Quality of
Care in Investor-Owned vs. Not-For-Profit HMOs, 282 J.A.M.A. 159.
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