provided that the insurance primarily INSURANCE REFORM BILL INCLUDES covers risks associated with the individual’s EXEMPT ORGANIZATIONS PROVISIONS

he health insurance reform bill (H.R. 3 103) T that was signed into law on August 21 (P.L. 104-191) does more than make health

performance of services in connection with the tax-exempt organization (or exempt affiliates).

Associate Member Dues insurance portable, eliminate coverage deni-

If a tax-exempt agricultural or horticul- tural organization (an IRC Cj 501(c)(5) entity) requires annual dues not exceeding $100 to be paid in order to be a member of the organization, no portion of the dues may be considered unrelated business income be- cause of any benefits or privileges to which these members are entitled (IRC 5 512(d)). For years beginning after 1995, this $100 threshold will be indexed for inflation.

The term dues is defined as “any payment required to be made in order to be recognized by the organization as a member of the orga- nization.” If a person makes a single payment that entitles the person to be recognized as a member of the organization for more than 12 months, the payment can be prorated for purposes of applying the $100 cap.

There is transitional relief for these tax- exempt organizations that had a reasonable basis for not treating membership dues re- ceived prior to January 1 , 1987, as unrelated business income.

als based on pre-existing conditions, and create a new medical savings account (albeit a four-year experiment and a cap of 750,000 of these accounts).

The legislation-the Health Insurance Port- ability and Accountability Act of 1996-also makes the following additions to the law of tax-exempt organizations:

Tax-exempt status (IRC 5 50 1 (cI(26)) for a membership organization established by a state exclusively to provide coverage for medical care on a nonprofit basis to high-risk individuals through insurance issued by the organization or a health maintenance organization (HMO) under an arrangement with the organization (Act Cj 341).

The individuals must be unable to acquire medical care coverage for a medical condition through insurance or from an HMO, or are able to acquire the coverage only at a rate that is substantially in excess of the rate for

S Corporation Shareholders the coverage through the membership

An S corporation is a corporation that is treated for tax purposes as a partnership. Under prior law (IRC 1361(b)(l)(B)), a tax- exempt organization could not be a share- holder in one of these corporations. This rule has been altered, as noted (IRC Cj 136 1 (c) (7)).

Items of income and loss of an S corpora- tion will flow through to exempt Organization shareholders as unrelated business income (IRC Cj 5 12(e)). This is the case irrespective of the source or the nature of the income (for example, passive income of an S corporation will flow through to exempt shareholders as unrelated income). Also, gain or loss on the sale or other disposition of stock of an S corporation by a tax-exempt shareholder will be treated as unrelated business income (id.).

organization. The private inurement doctrine applies with respect to this entity.

Tax-exempt status (IRC § 501(c)(27)) for a membership organization established before June 1, 1996, by a state exclusively to reimburse its members for losses arising under workmen’s compensation acts (Act Cj 342).

The state must require that the membership of the organization consist of all persons who issue insurance covering workmen’s com- pensation losses in the state, and all persons and governmental entities who self-insure against these losses. The organization must operate as a nonprofit organization by returning

The Nonprofit Counsel/3

surplus income to its members or workmen’s compensation policy- holders on a periodic basis and reducing initial premiums in antici- pation of investment income.

GROUP INSURANCE PLANS SPONSORSHIP REVENUE HELD NOT TAXABLE AS UBI

n one of the rare instances when a tax- I exempt organization prevails on the argu- ment that an activity is not a business for tax purposes, the U.S. Court of Appeals for the Eighth Circuit has held that an association is not taxable on certain payments it received through its sponsorship of group insurance plans (American Academy of Family Physi- cians u. United States). This is an affirmance of an opinion by the federal district court in Missouri (see the June 1995 issue).

This organization is a national tax-exempt (IRC 3 50 1 (c)(6)) association representing family physicians and promoting quality health care. I t has a related tax-exempt (IRC 5 50 1 (c)(3)) scientific and educational foundation.

The association owns and sponsors group disability, medical, and life insurance plans that are available to its members and their employees. An insurance company under- writes the policies. The business of adminis- tering the policies was bequeathed to the foundation, which created a wholly owned for-profit corporation to administer the insur- ance plans. This company pays dividends to the foundation.

The association provides its membership lists to the company for fair market value. This company reports twice a year to an association committee and must obtain the committee’s approval before making any changes to the policies.

The members of the association who elect coverage under the group policies pay premi- ums to the insurance company. The company sets aside part of the premium payments as reserves to pay claims. The group policies require the insurance company to turn over to the association any reserve funds remaining

after the policies have terminated and all of the claims have been paid. In the meantime, irrespective of the profitability of the plans for the insurance company, the policies require the insurance company to make annual pay- ments to the association for the company’s use of the reserves, based on a fixed percent- age of the insurance reserves.

The IRS was of the view that the payments by the insurance company to the association were compensation for the association’s spon- sorship of the group insurance plans, and thus were taxable as unrelated business in- come. In response, the association asserted that its participation in the insurance plans was not a business and that the payments were in any event nontaxable interest.

This appellate court adopted the prevailing view of other courts these days, which is that-in addition to applying the statutory definition of “business” (IRC 3 5 13(c))-for the revenue to be taxable, the exempt organim- tion must have had a profrt motive. Also, the court agreed with other courts of appeal that an exempt organization must carry out exten- sive business activities over a substantial period of time to be engaged in a business.

The court concluded that the association did not have the requisite profit motive. The payments were held not to be compensation for services rendered and were not “profit in a commercial sense.” These payments were based on a specified, annual fixed percentage of the insurance reserves and were generated by the insurance company’s investment of the reserves. This interest was payable without regard to the profitability of the group insur- ance plans. Thus, the court wrote that the annual payments “were neither brokerage fees nor other compensation for commercial services, but were the way the parties decided to acknowledge the . . . [association’s] even- tual claim to the excess reserves while. . . [the insurance company] was still holding and using the reserves.”

The court also found that this activity did not constitute a business because the asso- ciation’s involvement in the insurance plans was not extensive and did not possess the general characteristics of a trade or business.

4 / T k Nonprofit Counsel October 1996