Healthcare lawyers and investment bankers said last month's decision by the U.S. Tax Court to revoke the tax-exempt status of a Utah HMO operated by a not-for-profit hospital system shouldn't greatly affect the provider-owned HMO industry.
They said that most provider-owned HMOs, if not originally incorporated as for-profit companies, have converted to for-profit status. And those that chose to remain tax-exempt can convert to a different form of not-for-profit status that will also protect the plan's income from federal corporate taxes. The U.S. Tax Court in Washington affirmed a previous decision by the Internal Revenue Service revoking the tax-exemption of IHC Health Plans, a not-for-profit subsidiary of Salt Lake City-based Intermountain Health Care, which owns 22 hospitals in Utah and Idaho.
IHC Health covers 440,000 members in its HMO, PPO, point-of-service and traditional health insurance plans. Intermountain, the state's largest health system, earned $141 million in 2000 on net revenue of $1.93 billion. IHC Health Plans earned $13.5 million on 2000 revenue of $587 million. IHC Health Plans received its 501(c)(3) designation as a tax-exempt public charity in 1984. Its two federally qualified HMO subsidiaries, IHC Group, a medical group model HMO, and IHC Care, a direct-contract HMO, later applied for, but never received, the same exemptions. They operated as tax-exempt organizations while awaiting a final determination from the IRS.
During a 1991 audit, the IRS questioned whether the plans, which by then had merged into IHC Health Plans, deserved those designations. The designations carry a number of tax benefits, including paying no federal income tax. The IRS revoked IHC Health's exemption and denied the two subsidiaries' requests for the exemptions in 1999 after ruling that IHC Health Plans operates just like a for-profit business. The IRS also said that IHC Health Plans did not provide emergency care or treat nonenrollees and therefore provided no community benefit.
Intermountain had argued that IHC Health Plans was an integral part of the system's charitable mission, and the system should be able to extend its tax-exemption to the managed-care company.
In October 1999 Intermountain appealed the IRS decision to the U.S. Tax Court. No trial and no oral arguments took place. Both IHC Health and the IRS submitted final briefs in December 2000.
In a 48-page decision, U.S. Tax Court Chief Judge Thomas Wells affirmed the IRS decision on IHC Health and similarly upheld the IRS denials for the subsidiaries' requests.
Wells agreed with the IRS that the plans do not provide the community benefit required to qualify for the charitable tax exemption and said their operations weren't essential or substantially related to Intermountain's tax-exempt functions.
"Significantly, (IHC Health Plans) did not own or operate its own medical facilities, did not employ (to any significant extent) its own physicians and did not offer free medical care to the needy," Wells wrote in affirming the IRS revocation. He also said IHC Health's failure to have any program to reduce premiums for low-income members or to provide any free or low-cost healthcare services beyond a few free health screenings contributed to his ruling against the plan's exemption.
The tax court's action may cost the health plan and its parent company millions of dollars in back taxes dating to 1987. Intermountain has until Dec. 19 to appeal the decision to the 9th U.S. Circuit Court of Appeals in San Francisco.
"This case, while widely watched, is of limited significance for most nonprofit HMOs and healthcare organizations because it was nothing more than a straightforward application of existing law," said Washington tax lawyer and former IRS official T. J. Sullivan of Gardner, Carton & Douglas. "Many providers have already spun off their HMOs because they found it difficult to be both a provider and a payer."
Sullivan said Intermountain could convert IHC Health Plans to 501(c)(4) status, which also shields income from corporate federal taxes, but, unlike the 501(c)(3) status, doesn't allow organizations to accept charitable contributions or qualify for tax-exempt bonds. He said that conversion could be done retroactively, minimizing the tax liability. That, along with appealing the ruling, is exactly what Intermountain plans to do, said Douglas Hammer, Intermountain vice president and general counsel.
"While we are disappointed and disagree with the ruling and feel we qualify for an exemption under Section 501(c)(3), we are not surprised," Hammer said.
An Intermountain spokesman would not disclose the amount of its potential tax liability, but sources close to the case said it could amount to millions of dollars.