On April 10, the Internal Revenue Service (IRS) released LTR 202015035, a final adverse determination letter for an applicant seeking recognition of exemption under Internal Revenue Code Section 501(c)(3). The IRS denied exemption because the applicant plans to provide health insurance for a fee, which will be a substantial activity in its first several years of operation. One of the two grounds for the IRS denial, application of Section 501(m) of the Code, may give pause to those representing tax-exempt HMOs and other organizations that have been excluded from the reach of Section 501(m). We have not seen many rulings citing Section 501(m) in recent years, after the IRS declared it would not use Section 501(m) to challenge HMO tax exemption in 2003. On balance, this ruling seems consistent with precedent and provides little reason for the tax-exempt health care community to worry. The applicant at issue is an insurance provider, not an HMO, and does not qualify for any of the exceptions from Section 501(m).
There is nothing novel in the analysis the IRS applies in LTR 202015035. They reached an adverse determination on two grounds: applicant’s substantial non-exempt purpose and Section 501(m). Another way to characterize the first ground would be that the applicant lacks a valid charitable purpose. As noted in the analysis, the IRS and the courts have long held that not every activity that promotes health will be considered charitable. IRS cites the example of the sale of pharmaceuticals for a fee, but the sale of health insurance for a fee that is not substantially below cost has been similarly regarded since at least 1986.
The second ground is that providing commercial-type insurance is a substantial part of the applicant’s activities, so that exemption is prohibited by Section 501(m) and this applicant, unlike an HMO, does not benefit from any of the statutory exceptions to section 501(m). The applicant here may have a laudable objective to provide health insurance and, later, it hopes to offer health care services, but, as with all nonprofit insurers not granted a specific exception to section 501(m), the Internal Revenue Code requires them to do so on a taxable basis.