Trust funds created by tax-exempt hospitals to cover their medical malpractice and workers' compensation risks are not entitled to favorable tax treatment, a federal appeals court said.
The 11th U.S. Circuit Court of Appeals in Atlanta said that under a 1988 law, trust funds that purchase insurance, but not those that cover risks themselves, can qualify as tax-exempt "cooperative hospital service organizations."
Affirming a U.S. Tax Court ruling, the appeals court said the trust funds were not purchasing insurance but instead were acting as insurers by extending coverage in return for premiums based on the risks involved. That activity, the court said, is not eligible for favorable tax treatment.
While the 1988 law may have created some unfair results-large tax-exempt hospitals can self-insure their own risks, but smaller hospitals that band together and form these trusts could not-the judicial branch cannot undo the "imperfect" work of legislators, the appeals court said.
The ruling in the case of Florida Hospital Trust Fund et al. vs. Commissioner of Internal Revenue is a blow to the trust funds organized by several dozen Florida hospitals. With the trust funds considered taxable organizations, the income earned by them will be taxed.
Nationally, though, the impact will be minor.
For example, the ruling would have no effect on the hundreds of tax-exempt pools organized by public organizations to cover their property/casualty risks. Section 115 of the Tax Code gives favorable treatment to public entity pools, said Tom Jones, a partner with the law firm of McDermott, Will & Emery in Chicago.
Pools formally organized as reciprocals by tax-exempt organizations also receive favorable treatment under Section 832(f) of the Tax Code, he said.
The appeals court ruling involves three Florida trust funds:
The 23-member Florida Hospital Trust Fund, which provides coverage of up to $250,000 per claim with an annual aggregate limit of $1 million.
The Florida Hospital Excess Trust Fund, which has 26 members that provide up to $10 million of coverage with a minimum retention of $250,000 per claim and an annual aggregate retention of $1 million.
The 31-member Florida Hospital Workers' Compensation Fund, which was established to cover workers' compensation claims.
The trust funds receive payments from members based on actuarial projections. Those payments are adjusted later, resulting in other assessments or a refund or credit to reflect the funds' actual experience.
In 1990, the funds applied to the Internal Revenue Service as tax-exempt hospital service organizations. In 1992, the IRS denied the requests, saying the trust funds' activities were not covered by the list of exempt activities of tax-exempt hospital service organizations.