Court upholds IRS’s denial of college insurance fund’s application for tax exemption

An association of tax-exempt secondary schools and universities in Florida formed to pool insurance risk and obtain insurance for its members did not qualify for federal tax-exempt status because it fell under the prohibition against exemption for commercial-type of insurance companies in Sec. 501(m) (Florida Indep. Colleges & Universities Risk Mgmt. Ass’n, No. 09-1930 (RCL) (D.D.C. 3/22/12).

The U.S. District Court for the District of Columbia granted the IRS’s motion for summary judgment, rejecting the declaratory judgment the association sought that it qualified as tax-exempt. The court explained that, to be tax-exempt, the association had to establish that it was tax-exempt under Sec. 501(c)(3) and that the denial of exempt status under Sec. 501(m)(1) was appropriate when a “substantial part” of an organization’s activities consist of providing “commercial-type insurance.” The association failed to qualify for the various exceptions from “commercial-type insurance” in Sec. 501(m)(3), which include insurance provided at below cost for charitable recipients and insurance provided by churches.

The association argued that it did not provide insurance for its members, but only purchased it for them, and that the insurance it provided was not “commercial-type insurance” because it only provided it to the small group of members, not the general public. But the court cited a Tax Court case, Paratransit Insurance Corp., 102 T.C. 745 (1994), in which an association formed to provide insurance to Sec. 501(c)(3) organizations was found to be a prohibited insurance company. In Paratransit, the Tax Court cited the legislative history behind Sec. 501(m), which had an example of the type of organization that would be prohibited: “two or more unrelated tax-exempt organizations pooling funds in a separate entity to be used to satisfy malpractice claims against the organizations.”
 
The association also argued it could qualify for tax-exemption under Sec. 501(n), which contains an exception from the prohibition against providing insurance for organizations that qualify as a “charitable risk pool.” The association met all of the requirements under Sec. 501(n) except for the requirement to raise $1 million in startup capital from nonmember charitable organizations. The IRS argued that compliance with Sec. 501(n) was the only way to avoid the Sec. 501(m) restriction, while the association made a convoluted argument that, if it did not qualify under Sec. 501(n) and was not within the scope of Sec. 501(m), it still would be exempt. The court described this as a “tortured reading of the tax code” and rejected it.

Because the association does not meet the exceptions in Secs. 501(m)(3) and (n) and because it provides “commercial-type  insurance,” the court held that it is not eligible for tax exemption.

—Sally P. Schreiber (sschreiber@aicpa.org) is a JofA senior editor.

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