HMO tells Congress of fear of losing tax-exempt status under Clinton plan.

WASHINGTON -- An official from a large nonprofit health maintenance organization testified yesterday that the HMO could lose its tax-exempt status -- and the ability to issue tax-exempt bonds -- if President Clinton's health-care reform bill is enacted.

Marc Wolfert, vice president of the 1.2-million member Health Insurance Plan of Greater New York, told the House Way s and Means Committee's select revenue measures subcommittee that the Clinton plan could force his organization to engage in taxable business activity that would jeopardize its 501(c)(3) tax status.

Currently, the HMO issues tax-exempt bonds that derive their tax exemption largely from the organization's nonprofit activities offering pre-paid group practice services to patients in New York, New Jersey, and Florida.

The Clinton plan would require the organization for the first time to offer a "point of service" option to its members. This "freedom of choice" provision, added at the last minute before the White House announced the plan, would enable patients to go to doctors outside the HMO's group practice at an additional cost.

Wolfert said that providing such services would amount to taxable business activity, however, and could cause the HMO to exceed the Internal Revenue Service's informal 10% limit on such activities for nonprofit organizations.

"The Internal Revenue Service has taken the position that if 'unrelated business' activity becomes a 'substantial' activity of the exempt organization, the organization's overall tax exemption is threatened, in the extreme case, with revocation of that status retroactive to the date of inception," Wolfert testified.

Rep. Charles Rangel, D-N.Y., chairman of the subcommittee, said after the hearing that he had not been aware of the problem raised by Wolfert. He said that the Clinton Administration should address any questions raised about the impact its plan would have on tax-exempt organizations and their borrowings.

"He's right on target in terms of the kinds of complexities we're dealing with" in the health-care legislation, Rangel said.

An IRS official said the HMO's fear of losing its tax-exempt status was based on the belief that the IRS would treat the HMO's payments for services provided outside the organization's group practice as insurance that would be taxable under section 501(m) of the tax code.

With this line of reasoning, the insurance activities would be treated as business unrelated to the HMO's exempt purpose, and would be subject to the unrelated business income tax. IRS memoranda and revenue rulings have suggested that an exempt organization that has more than 10% unrelated business income could lose its tax-exempt status.

But the IRS official said the agency has not determined if HMOs would be providing insurance in such situations. "We're looking at the activities of HMOs to see how they would fit under section 501(m) of the code," which covers insurance, he said.

The IRS official said that Congress is not likely to change the laws governing nonprofit organizations in a way that would immediately threaten their tax-exempt status.

Historically, he said, when Congress changes the tax laws in the health-care area, it provides a transition period for nonprofit organizations to either come into compliance or otherwise adjust to the new laws.

"There's certainly a pattern when you have congressional action ... that Congress or the IRS and Treasury come up with some sort of transition to ease that shift," the IRS official said.

In view of the uncertainty on how the tax law would apply under the Clinton plan, Wolfert called on the subcommittee to "clarify that any HMO which chooses to offer 'point of service' will not thereby lose its tax exemption."

Wolfert said that even if his HMO does not lose its tax-exempt status under the Clinton plan, it could be forced up against a $150 million volume limit on borrowings that the tax law imposes on 501(c)(3) organizations other than hospitals.

Under the Clinton plan's mandate for universal health coverage, he said, the HMO would have to expand rapidly and significantly increase its spending on capital equipment to "avoid overcrowded facilities and demands for care we simply couldn't meet."

The nonprofit volume cap, however, "is a significant barrier to our ability to expand and renovate our health facilities and equipment," he said.

Wolfert urged that a repeal of the nonprofit volume cap be included in any health reform legislation that passes Congress.

On a related issue, two major hospital groups testified that they do not believe most nonprofit hospitals will have much trouble retaining their tax-exempt status under a Clinton reform proposal that requires them to demonstrate that they are serving their communities.

The Catholic Health Association, which represents more than 1,200 nonprofit hospitals, and the Greater New York Hospital Association, which represents 164 hospitals and nursing homes in the New York City area, said they see no immediate danger for their hospitals from the bill's requirements.

"I believe that it will be quite a long time before the tax-exempt status of these not-for-profit institutions may be legitimately challenged," said Kenneth E. Raske of the hospital association.

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