Sec. 501(m) can bar tax-exempt status.

Sec. 501(m) denies a tax exemption to an organization that would otherwise qualify under Sec. 501(c)(3) or (4), if providing commercial-type insurance is a substantial part of its activity. In two recent Tax Court cases, the IRS was successful in denying organizations exempt status, when the organizations were carrying on substantial activities equivalent to providing commercial-type insurance.

In Paratransit Insurance Corp., 102 TC No. 34 (1994), a nonprofit mutual benefit insurance corporation provided automobile liability insurance to its members. The member premiums for the insurance were determined actuarially. The members were tax-exempt social service organizations that furnished transportation to the elderly, handicapped, needy, etc. In addition to providing automo bile insurance, the organization also provided members wit assistance and education on the control and management of losses arising from the operation of their vehicles.

The court held that the organization did not qualify for tax-exempt status under Sec. 501(c)(3), because a substantial part of its activities consisted of providing commercial-type insurance (as defined in Sec. 501(m)). The insurance was not provide at rates substantially below cost and, therefore, was not exclude from commercial-type insurance classification under Sec 501(m)(3)(A). The peripheral provision of education and other forms of assistance did not alter the fact that the organization fundamentally provided a means for spreading the members' individual risks.

Florida Hospital Trust Fund, 103 TC No. 10 (1994), concerned three organizations that desired to be exempt from taxation as Sec. 501(e) cooperative hospital service organizations. Two of the organizations were established under Florida law to serve as medical malpractice risk management funds; the third established itself as a group self-insurer fund under Florida law. The members of each organization were either Sec. 501(c)(3) hospitals or government run hospitals described in Sec. 501(e)(1)(B)(iii). The members used the Organizations to pool member resources on a group basis for the purposes of self-insuring against hospital professional liability, excess hospital professional liability and worker's compensation liability.

The Tax Court held the organizations did not qualify for tax exempt status as cooperative hospital service organizations because a substantial part of their activity was the provision of commercial-type insurance. Thus, the organizations were precluded from tax-exempt status. The organizations also did not qualify as cooperative hospital service organizations under Sec. 501(e) because they were not engaged in purchasing insurance on a group basis, but instead were acting as the actual insurer.

In light of these recent decisions, exempt organizations subject to Sec. 501(m) (i.e., Sec. 501(c)(3) and (c)(4) organizations) should closely examine their activities, especially if the activities could arguably be deemed the provision of commercial-type insurance due to the transfer of risk between parties. Remember, however, that an organization may maintain its exempt status, provided that the provision of commercial-type insurance is an insubstantial part of its activities. In such a situation, the commercial insurance activity is treated as an unrelated trade or business; in lieu of the tax imposed by Sec. 511 on such activity, the organization is treated as an insurance company with respect to that activity and taxed under subchapter L of the Code.