VSP exempt case may impact larger HMO sector

A case currently on appeal to the Supreme Court could affect the tax-exempt status of thousands of nonprofit health maintenance organizations.Vision Service Plan, the largest not-for-profit vision benefits and services company, was initially granted a tax exemption in 1960 as a social welfare organization under Section 501(c)(4).

The roots of the case began in 2003, when the Internal Revenue Service revoked the tax-exempt status for VSP's California corporation, whereupon VSP California filed and subsequently paid income taxes for 2003 and then filed in federal district court for a refund.

Two years later, a district court granted summary judgment for the government, deciding that, "VSP is not operated 'exclusively for the promotion of social welfare' as provided for in 501(c)(4)," a ruling which the Ninth Circuit affirmed earlier this year.

The circuit court stated that while VSP offers some public benefits, "They are not enough for us to conclude that VSP is primarily engaged in promoting the common good and general welfare of the community."

"This case is really about determining what guidelines the IRS uses to define what constitutes a tax exempt not-for-profit organization," said former U.S. independent counsel Kenneth W. Starr, lead counsel for VSP on its appeal to the Supreme Court.

"VSP had a tax exemption for more than 40 years, has not changed their business philosophy or focus on the community, and yet lost their tax-exempt status. In the end, we are simply asking the Supreme Court to recognize the significant community benefit VSP offers to more than 55 million Americans," said Starr.

THE RIPPLES WIDEN

"This could be a case of major importance," predicted Larry Perlman, editor of CCH's Tax-Exempt Advisor newsletter. "It will affect the status of many other tax exempts with similar membership structures. Their tax-exempt status may now be in doubt."

"There are many different types of social welfare organizations under Section 501(c)(4)," noted Mary Rauschenberg, a director with Deloitte Tax LLP. "Some organizations that don't qualify for 501(c)(3) status because of lobbying activities, nevertheless qualify under 501(c)(4)."

As an example, the typical church is a Section 501(c)(3) organization. Other examples of 501(c)4 organizations include Amnesty International, AARP, Greenpeace, MoveOn.org, and the National Rifle Association.

Although both 501(c)(4) and 501(c)(3) organizations are tax-exempt, 501(c)(4) organizations have broader ability to engage in lobbying and political campaign activity. Moreover, while contributions to 501(c)(3) organizations are deductible, contributions to 501(c)(4) organizations are not, with the exception of a volunteer fire department or a veteran's organization with at least 90 percent of its membership made up of war veterans.

"Because we are a not-for-profit, surplus revenues are re-invested into our charity programs designed to help less- fortunate American receive eye care," said VSP CEO Rob Lynch. "Funds are also used to deploy new technologies that reduce administrative costs, expand access to eye care in the communities we serve and offer continuing education to the patients and doctors in our national network. We're hopeful that the Supreme Court will recognize the importance of this case, not only to VSP, but to the delivery of health care in America."

The Ninth Circuit's decision turns on the premise that an HMO providing health care to a broad but limited class of patients does not qualify for an exemption, according to VSP.

"This is directly contrary to the common law of charitable trusts, which the Supreme Court has held guides the interpretation of the code's charitable exemptions, and which provides that health care is a charitable purpose," said Starr in his petition. "If allowed to stand, the Ninth Circuit's decision will allow the IRS to proceed on an uncertain and unprecedented course, stripping HMOs of a tax-exempt status that enables these organizations to fulfill their basic, 'charitable' mission of providing health care."

Although the entire public does not participate in VSP's prepaid vision service plans, under the common law of charitable trusts, this is not a necessary element, according to VSP's argument. "If the rule were otherwise, well-known and highly respected nonprofit HMOs could lose their tax exemptions, as could many nonprofit hospitals," it observed.

"'Community benefit' has been a huge issue for a long time," said Barnaby Zall, of counsel at the Rockville, Md.-based firm of Weinberg & Jacobs. "It's hot politically, particularly for hospitals."

"It's not unusual for the IRS to say, 'You've done wrong,' but not tell you what to do to make it right," he said. "They want to avoid setting a standard that can be abused. The community benefit standard is already in the law, so the question is, what is a community benefit? Hospitals are required by federal law to treat illegal immigrants. They provide hundreds of millions of dollars of care, and there's no one they can turn to for compensation. Should that count as a community benefit? The IRS hasn't answered this."

"The problem is that a lot of hospitals are under such financial pressure that they can't go out beyond the emergency room and do community clinics that the IRS would count as a community benefit," said Zall.

"The question is how you define a community," said Jane Searing, shareholder in Bellevue, Wash.-based CPA firm Clark Nuber and chair of the American Institute of CPAs' Exempt Organization Tax Technical Resource Panel.

"It seems the IRS position is that an organization that only provides benefits to members is not a community benefit organization because it doesn't affect the community as a whole," she said. "But it's not an exclusive group. Anyone can be a member - you just have to elect. Why can't that be a 'community?'

"There's a whole new paradigm developing," she continued. "For example, people think they are friends with people they only know online. A community doesn't have to be confined to a geographic area anymore."

The results of the decision could have wide implications for other 501(c)(4) organizations, according to Searing. "If it's successful, I can see the IRS targeting other community benefit organizations with similar membership patterns for revocation," she said. "There are currently over 128,000 of these groups that filed Form 990s last year."

"It's more likely that the Supreme Court will take a case when there's been a split in the various circuits," Perlman observed. "That's not the case here, so VSP is trying to show the potentially extreme negative affect of the Ninth Circuit ruling."

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