Healthcare tax lawyers hailed last week's field directive from the Internal Revenue Service proposing new regulations to clarify the tax-exempt status of not-for-profit HMOs.
The proposed regulations will define how an IRS code provision applies to not-for-profit HMOs, said former IRS official T.J. Sullivan. The section, 501(m), was added to the federal tax code in 1986 to revoke the tax exemption of Blue Cross and Blue Shield organizations.
Until the regulations are final, the IRS said it would stop using 501(m) to revoke HMOs' tax-exempt status, with few exceptions, the directive said. In addition, the IRS will put on hold HMOs' applications for tax exemption, except for existing 501(c)(3) HMOs seeking to switch to the less-stringent (c)(4) status.
Sullivan, now a Washington healthcare tax lawyer in private practice with the firm Gardner, Carton & Douglas, said the two-page field directive is very significant.
"It suggests that the winds are shifting," Sullivan observed, noting a change in IRS thinking on tax-exempt HMOs.
The 501(m) section denies tax exemption to any organization that provides a substantial part of its activities to commercial-type insurance, Sullivan said. Questions have been raised about the definition of commercial-type insurance and whether there are special exceptions for HMOs.
These issues were raised recently in a federal court ruling that determined several health plans owned by 21-hospital Intermountain Health Care in Salt Lake City were not tax-exempt (April 14, p. 3).
In April, a three-judge panel from the 10th U.S. Circuit Court of Appeals in Denver upheld a 2001 U.S. Tax Court decision that IHC Health Plans did not operate exclusively for charitable purposes. The IRS had revoked the health plans' tax exempt status in 1999.
Doug Mancino, of the Los Angeles office of McDermott, Will & Emery who represented the Intermountain plans, said the field directive won't change the outcome of the IHC case but will allow the 501 (c) (3) organization to change to the less stringent 501(c)(4) status.
"I think this is a very welcome action on the part of the service," Mancino said. "It should unleash the logjam created by the uncertainty of how to interpret 501(m) to HMOs. And I think it will allow administrative process to move forward."
New regulations relating to healthcare tax exemptions are rare, said tax lawyer Gerald Griffith, of Honigman Miller Schwarz and Cohn, Detroit.
Although the directive brings good news in that it promises clearer guidance, the interim could be frustrating for some HMOs, he said. Because of the IRS' hold on applications, HMOs will wait 18 months or longer for an exemption hearing, Griffith said. Also during that interim period until regulations are issued, "unless you're an existing tax-exempt HMO, you won't know how much of your income is subject to tax because of the uncertain definition of commercial-type insurance and the scope of the exceptions," he said.
Griffith said the directive may require HMOs to renegotiate physician and hospital contracts so they can remain exempt or reduce their own tax liability for commercial activities.
The IRS will publish a formal notice of its plan to propose regulations on May 27 and will accept comments on the contents of the regulations to be proposed until Aug. 25.