Opinion ID: 163334
Heading Depth: 2
Heading Rank: 3

Heading: Whether Health Plans, Care, and Group Operated for a Charitable Purpose.

Text: 24 This inquiry requires us to address two basic questions. First, we must consider whether the purpose proffered by petitioners qualifies as a charitable purpose under section 501(c)(3). The term `charitable' is used in section 501(c)(3) in its generally accepted legal sense and is ... not to be construed as limited by the separate enumeration in section 501(c)(3). 26 C.F.R. § 1.501(c)(3)-1(d)(2). An organization will not be considered charitable, however, unless it serves a public rather than a private interest. 26 C.F.R. § 1.501(c)(3)-1(d)(1)(ii) (emphasis added). 11 25 Second, we must determine whether petitioners in fact operated primarily for this purpose. Geisinger Health Plan v. C.I.R., 985 F.2d 1210, 1219 (3d Cir.1993) ( Geisinger I ). Under the operational test set forth in the IRS regulations, [a]n 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. 12 26 C.F.R. § 1.501(c)(3)-1(c)(1). 26 In this case, the Tax Court concluded that the promotion of health for the benefit of the community is a charitable purpose, Health Plans, 82 T.C.M. at 602, but found that neither Health Plans, Care, nor Group operated primarily to benefit the community. Health Plans, 82 T.C.M. at 605; Care, 82 T.C.M. at 625; Group, 82 T.C.M. at 615. For the reasons set forth below, we agree.
27 In defining charitable, our analysis must focus on whether petitioners' activities conferred a public benefit. 26 C.F.R. § 1.501(c)(3)-1(d)(1)(ii) (An organization is not organized or operated exclusively for [an exempt purpose] ... unless it serves a public rather than a private interest.). The public-benefit requirement highlights the quid pro quo nature of tax exemptions: the public is willing to relieve an organization from the burden of taxation in exchange for the public benefit it provides. Geisinger I, 985 F.2d at 1215; cf. Flat Top Lake Ass'n v. United States, 868 F.2d 108, 112 (4th Cir.1989) (In many ways, exemption from taxation may be seen as a democratic commonwealth's method of acknowledging the conferral of a universal benefit.). As the Supreme Court has recognized, [c]haritable exemptions are justified on the basis that the exempt entity confers a public benefit — a benefit which the society or the community may not itself choose or be able to provide, or which supplements and advances the work of public institutions already supported by tax revenues. Bob Jones Univ. v. United States, 461 U.S. 574, 591, 103 S.Ct. 2017, 76 L.Ed.2d 157 (1983) (emphasis added). 28
29 The IRS has long recognized that nonprofit hospitals may be exempt as charitable entities under section 501(c)(3). See generally John D. Colombo, Health Care Reform and Federal Tax Exemption: Rethinking the Issues, 29 WAKE FOREST L.REV. 215, 218 (1994). Exemption for hospitals, in fact, is so ingrained in the lore of taxation that today about half the states specifically enumerate hospitals as exempt entities, alongside such traditional exemption bulwarks as churches and educational institutions. Id. at 215. Early on, the touchstone for exemption was the provision of free or below-cost care. Id. at 217. In 1956, the IRS published Rev. Rul. 56-185, 1956 WL 11273, which provided that a hospital must be operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay. 30 By the last part of the twentieth century, however, with the advent of Medicare and Medicaid and the increased prevalence of private insurance, nonprofit hospitals moved away from this relief of poverty function. Colombo, supra, at 218. The financing of their services evolved in parallel, from primary dependence on the generosity of religious orders and charitable donors, to almost exclusive reliance on payments for services rendered. M. Gregg Bloche, Health Policy Below the Waterline: Medical Care and the Charitable Exemption, 80 MINN. L.REV. 299, 300 (1995). 31 In 1969, in response to the nonprofit hospital's changing function, the IRS modified its position regarding charity care. In Rev. Rul. 69-545, 1969 WL 19168, which modified 56-185, the IRS removed the requirement[ ] relating to caring for patients without charge or at rates below cost. In its discussion, the IRS stated: 32 The promotion of health, like the relief of poverty and the advancement of education and religion, is one of the purposes in the general law of charity that is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community, provided that the class is not so small that its relief is not of benefit to the community. 33 Rev. Rul. 69-545. The hospital in question provided hospital care for all persons in the community able to pay either directly or through third-party insurers. The IRS also noted, however, that the hospital operated an emergency room open to all persons regardless of ability to pay. 13 In addition, the hospital used surplus funds to improve patient care and finance medical training, education, and research. Based on these factors, 14 the IRS concluded that the hospital was promoting the health of a class of persons ... broad enough to benefit the community. Id. 34 Finally, in Revenue Ruling 83-157, 1983 WL 190185, the IRS amplified its prior ruling in 69-545. The hospital in 83-157 was identical to the hospital in 69-545, 15 except that it did not operate an emergency room open to all regardless of ability to pay. In eschewing any rigid test under section 501(c)(3), the IRS made clear that although [g]enerally, operation of a full time emergency room providing emergency medical services to all members of the public regardless of their ability to pay for such services is strong evidence that a hospital is operating to benefit the community ... other significant factors ... may be considered. Rev. Rul. 83-157. The IRS went on to conclude that the hospital did in fact operate for the benefit of the community, noting that the hospital treated patients participating in Medicare and Medicaid and applied any surplus funds to improve facilities, equipment, and patient care, and advance its medical training, education, and research. 35 Thus, under the IRS's interpretation of section 501(c)(3), in the context of health-care providers, we must determine whether the taxpayer operates primarily for the benefit of the community. 16 And while the concept of community benefit is somewhat amorphous, we agree with the IRS, the Tax Court, and the Third Circuit that it provides a workable standard for determining tax exemption under section 501(c)(3). 36
37 In giving form to the community-benefit standard, we stress that not every activity that promotes health supports tax exemption under § 501(c)(3). For example, selling prescription pharmaceuticals certainly promotes health, but pharmacies cannot qualify for ... exemption under § 501(c)(3) on that basis alone. Rev. Rul. 98-15, 1998 WL 89783. In other words, engaging in an activity that promotes health, standing alone, offers an insufficient indicium of an organization's purpose. Numerous for-profit enterprises offer products or services that promote health. 38 Similarly, the IRS rulings in 69-545 and 83-157 demonstrate that an organization cannot satisfy the community-benefit requirement based solely on the fact that it offers health-care services to all in the community 17 in exchange for a fee. 18 Although providing health-care products or services to all in the community is necessary under those rulings, it is insufficient, standing alone, to qualify for tax exemption under section 501(c)(3). Rather, the organization must provide some additional plus. 39 This plus is perhaps best characterized as a benefit which the society or the community may not itself choose or be able to provide, or which supplements and advances the work of public institutions already supported by tax revenues. Bob Jones Univ., 461 U.S. at 591, 103 S.Ct. 2017. Concerning the former, the IRS rulings provide a number of examples: providing free or below-cost services, see Rev. Rul. 56-185; maintaining an emergency room open to all, regardless of ability to pay, see Rev. Rul. 69-545; and devoting surpluses to research, education, and medical training, see Rev. Rul. 83-157. These services fall under the general umbrella of positive externalities or public goods. Bloche, supra, at 312. 19 Concerning the latter, the primary way in which health-care providers advance government-funded endeavors is the servicing of the Medicaid and Medicare populations. 40
41 Difficulties will inevitably arise in quantifying the required community benefit. The governing statutory language, however, provides some guidance. Under section 501(c)(3), an organization is not entitled to tax exemption unless it operates for a charitable purpose. Thus, the existence of some incidental community benefit is insufficient. Rather, the magnitude of the community benefit conferred must be sufficient to give rise to a strong inference that the organization operates primarily for the purpose of benefitting the community. Geisinger I, 985 F.2d at 1219. 42 Thus, our inquiry turns not [on] the nature of the activity, but [on] the purpose accomplished thereby. 20 Bethel Conservative Mennonite Church v. C.I.R., 746 F.2d 388, 391 (7th Cir.1984) (emphasis added). Of course, because of the inherent difficulty in determining a corporate entity's subjective purpose, we necessarily rely on objective indicia in conducting our analysis. Geisinger I, 985 F.2d at 1215 (citation omitted). In determining an organization's purpose, we primarily consider the manner in which the entity carries on its activities. Living Faith, 950 F.2d at 372 (citing cases). 43
44 In summary, under section 501(c)(3), a health-care provider must make its services available to all in the community plus provide additional community or public benefits. The benefit must either further the function of government-funded institutions or provide a service that would not likely be provided within the community but for the subsidy. Further, the additional public benefit conferred must be sufficient to give rise to a strong inference that the public benefit is the primary purpose for which the organization operates. In conducting this inquiry, we consider the totality of the circumstances. Geisinger I, 985 F.2d at 1219. With these principles in mind, we proceed to review the Tax Court's decision in the present case. 2. The Tax Court correctly defined charitable and applied the appropriate legal test under 501(c)(3). 45 Petitioners first contend that the Tax Court erred in its conclusion regarding the applicable law. Based upon our discussion supra, we disagree. The Tax Court correctly recognized the promotion of health for the benefit of the community as a charitable purpose. Health Plans, 82 T.C.M. at 602 ([I]t is now well settled that the promotion of health for the benefit of the community is a charitable purpose.). Further, the Tax Court considered the community-benefit requirement based on the totality of the circumstances. 21 Id. at 604 (The community benefit test requires consideration of a variety of factors that indicate whether an organization is involved in the charitable activity of promoting health on a community-wide basis.... Considering all the facts and circumstances ... we conclude that petitioner did not provide a meaningful community benefit.). Thus, the Tax Court did not err in determining the applicable law. 46 3. The Tax Court correctly concluded that petitioners do not operate primarily to promote health for the benefit of the community. 47 Petitioners next argue that the Tax Court erred in concluding that petitioners did not operate primarily for the benefit of the community. We disagree. 48 a. Nature of the product or service and the character of the transaction 49 In this case, we deal with organizations that do not provide health-care services directly. Rather, petitioners furnish group insurance entitling enrollees to services of participating hospitals and physicians. Petitioners determine premiums using two methods: (1) an adjusted community rating for individuals and small employers; and (2) past-claims experience for large employers. Thus, as in Church of the Brethren, petitioners sell[ ] insurance coverage ... extend[ing] benefits in return for a premium based generally on the risk assumed. 759 F.2d at 795. In other words, petitioners primarily perform a risk-bearing function. Cf. Bloche, supra, at 399. In Church of the Brethren, as in the instant case, the commercial nature of this activity inspired doubt as to the entity's charitable purpose. 759 F.2d at 795; cf. Federation Pharmacy Servs., Inc. v. C.I.R., 72 T.C. 687, 691-92, 1979 WL 3712 (1979), aff'd 625 F.2d 804 (8th Cir.1980) (noting that selling pharmaceuticals is an activity that is normally carried on by a commercial profitmaking enterprise[]). Where, as here, [i]t is difficult to distinguish the plaintiff corporation from a mutual insurance company, Hassett v. Assoc. Hosp. Serv. Corp. of Mass., 125 F.2d 611, 614 (1st Cir.1942), we must carefully scrutinize the organization's operation. 22 Cf. Church of the Brethren, 759 F.2d at 795; Am. Ass'n of Christian Schools Voluntary Employees Beneficiary Ass'n Welfare Plan Trust by Janney v. United States, 850 F.2d 1510, 1516 (11th Cir.1988) (Since the Trust has a substantial private purpose to provide insurance in return for premiums, it is not an organization exclusively engaged in the promotion of the social welfare.). 23 b. Free or below-cost products or services 50 The fact that an activity is normally undertaken by commercial for-profit entities does not necessarily preclude tax exemption, particularly where the entity offers its services at or below-cost. Cf. Bloche, supra, at 311 n. 31. But petitioners provide virtually no free or below-cost health-care services. 24 All enrollees must pay a premium in order to receive benefits. 25 As the Eighth Circuit has recognized, [a]n organization which does not extend some of its benefits to individuals financially unable to make the required payments [generally] reflects a commercial activity rather than a charitable one. Federation Pharmacy Servs., Inc. v. C.I.R., 625 F.2d 804, 807 (8th Cir.1980). Further, the fact that petitioners in no way subsidize dues for those who cannot afford subscribership distinguishes this case from the HMOs in Sound Health Ass'n v. C.I.R., 71 T.C. 158, 1978 WL 3393 (1979), and Geisinger I, 985 F.2d at 1219. 51 We acknowledge, as did the Tax Court, that petitioners' adjusted community rating system[] likely allowed its enrollees to obtain medical care at a lower cost than might otherwise have been available. Care, 82 T.C.M. at 625; Group, 82 T.C.M. at 615. Again, however, selling services at a discount tells us little about the petitioners' purpose. Many profitmaking organizations sell at a discount. Federation Pharmacy, 72 T.C. at 692, 1979 WL 3712, aff'd 625 F.2d 804 (8th Cir.1980). In considering price as it relates to an organization's purpose, there is a qualitative difference between selling at a discount and selling below cost. 26 52 In sum, petitioners sole activity is arranging for health-care services in exchange for a fee. To elevate the attendant health benefit over the character of the transaction would pervert Congress' intent in providing for charitable tax exemptions under section 501(c)(3). Contrary to petitioners' insinuation, the Tax Court did not accord dispositive weight to the absence of free care. Neither do we. Rather, it is yet another factor that belies petitioners' professions of a charitable purpose. 27 53 c. Research and educational programs 54 Nothing in the record indicates that petitioners conducted research or offered free educational programs to the public. 28 This bolsters our conclusion that petitioners did not operate for the purpose of promoting health for the benefit of the community. 55 d. The class eligible to benefit 56
57 As the Tax Court noted, [Health Plans] offered its [coverage] to a broad cross-section of the community including individuals, the employees of both large and small employers, and individuals eligible for Medicaid benefits. Health Plans, 82 T.C.M. at 604. In fact, in 1999, Health Plans' enrollees represented twenty percent of Utah's total population and fifty percent of Utah residents eligible for Medicaid benefits. 29 58 Nevertheless, even though almost all Utahans were potentially eligible to enroll for Health Plans coverage, the self-imposed requirement of membership tells us something about Health Plans' operation. As the Third Circuit noted in Geisinger I: 59 The community benefitted is, in fact, limited to those who belong to [the HMO] since the requirement of subscribership remains a condition precedent to any service. Absent any additional indicia of a charitable purpose, this self-imposed precondition suggests that [the HMO] is primarily benefitting itself (and, perhaps, secondarily benefitting the community) by promoting subscribership throughout the areas it serves. 60 985 F.2d at 1219. Further, while the absence of a large class of potential beneficiaries may preclude tax-exempt status, its presence standing alone provides little insight into the organization's purpose. Offering products and services to a broad segment of the population is as consistent with self promotion and profit maximization as it is with any charitable purpose. 61
62 Neither Care nor Group offered their health plans to the general public. Rather, both Care and Group limited their enrollment to employees of large employers (employers with 100 or more employees). Thus, as the Tax Court found, [Care and Group] operate[d] in a manner that substantially limit[ed][the] universe of potential enrollees. Care, 82 T.C.M. at 625; Group, 82 T.C.M. at 615. Based on this finding, the Tax Court correctly concluded that neither Care nor Group promoted health for the benefit of the community. 63
64 Finally, we consider petitioners' board composition. Prior to 1996, Health Plans' bylaws provided that [a] plurality of Board members shall represent the buyer-employer community and an approximately equal number of physicians and hospitals representatives shall be appointed. As the IRS noted, Health Plans' pre-1996 bylaws skewed control towards subscribers, rather than the community at large. In 1996, however, Health Plans amended its bylaws to require that a majority of board members be disinterested and broadly representative of the community. 65 It makes little difference whether we consider petitioners' board prior to 1996 or following the amendments. Even if we were to conclude petitioners' board broadly represents the community, the dearth of any actual community benefit in this case rebuts any inference we might otherwise draw. 4. Conclusion 66 For the above reasons, we agree with the Tax Court's conclusion that petitioners, standing alone, do not qualify for tax exemption under section 501(c)(3). 67