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ATLANTA-Trust funds created by tax-exempt hospitals to cover their medical malpractice and workers compensation risks are not entitled to favorable tax treatment, a federal appeals court says.

The 11th U.S. Circuit Court of Appeals said that under a 1988 law, trust funds that purchase insurance, but not those that cover risks themselves, can qualify as tax-exempt "cooperative hospital service organizations."

Affirming a U.S. Tax Court ruling, the appeals court said the trust funds were not purchasing insurance but instead were acting as insurers by extending coverage in return for premiums based on the risks involved. That activity, the court said, is not eligible for favorable tax treatment.

While the 1988 law may have created some unfair results-large tax-exempt hospitals can self-insure their own risks, but smaller hospitals that band together and form these trusts could not-the judicial branch cannot undo the "imperfect" work of legislators, the appeals court said.

The ruling is a blow to the trust funds organized by several dozen Florida hospitals. With the trust funds considered taxable entities, that will mean that income earned by the trusts will be taxable.

Nationally, though, the impact will be only minor.

For example, the ruling would have no effect on the hundreds of tax-exempt pools organized by public entities to cover their property/casualty risks. Section 115 of the Tax Code gives favorable treatment to public entity pools, noted Tom Jones, a partner with the law firm of McDermott, Will & Emery in Chicago.

Pools formally organized as reciprocals by tax-exempt organizations also receive favorable treatment under Section 832(f) of the Tax Code, he said.

The appeals court ruling involves three Florida trust funds:

The 23-member Florida Hospital Trust Fund, which provides coverage of up to $250,000 per claim with an annual aggregate limit of $1 million.

The Florida Hospital Excess Trust Fund, which has 26 members that provide up to $10 million of coverage with a minimum retention of $250,000 per claim and an annual aggregate retention of $1 million.

The 31-member Florida Hospital Workers' Compensation Fund, which was established to cover workers comp claims.

The trust funds receive payments from members based on actuarial projections. Those payments are adjusted later, resulting in other assessments or a refund or credit to reflect the funds' actual experience.

In 1990, the funds applied to the Internal Revenue Service as tax-exempt hospital service organizations. In 1992, the IRS denied the requests, saying the trust funds' activities were not covered by the list of exempt activities of tax-exempt hospital service organizations.

In appealing to the Tax Court, the trust funds argued that when Congress in 1988 expanded the list of activities allowed by tax-exempt hospital service organizations to cover the purchase of insurance, legislators effectively were interchanging the words "acquisition" or "providing" with the word "purchasing."

The trusts said the 1988 law broadens the scope of insurance activities that hospital service organizations could engage in and still retain their tax-exempt status.

The trusts argued that the 1988 law should be considered amid the backdrop of the 1980s, when insurance for hospitals was in a state of crisis "with no known method of acquiring primary or professional liability insurance."

The court disagreed, though, and declined to view "purchasing" and "providing" as interchangeable.

The meaning of the term "*'purchase of insurance on a group basis' denotes a commercial transaction in which a cooperative hospital service organization negotiates and executes the purchase of insurance for its membership as a group," the Tax Court said, adding that the trusts had taken on the role of insurers.

The 11th Circuit said it empathized with the trust funds, noting that no commercial insurer even wanted the smaller hospitals' business in the late 1980s. "By definition, therefore, there can be no overriding anti-competitive concerns about the trust funds' operation in the insurance marketplace as tax-exempt entity, enjoying an unfair advantage vis-a-vis their for-profit competitors," the court said.

Nonetheless, the Tax Court's interpretation of the 1988 law was correct, the appeals court ruled.

"From a statutory construction standpoint, however, it is clear that included in (the Tax Code's) list of exempt activities is the 'purchasing of insurance on a group basis' and omitted from this list is the 'providing of insurance'*" the court said.

"While we recognize the apparent need expressed in the position of the trust funds, we find the law, as written, does not grant them tax-exempt status. It is not the role or power of the judiciary to remedy a legislative statute by opinion," the court said.

Attorneys for the trust funds did not return calls for comment.

Florida Hospital Trust Fund et al. vs. Commissioner of Internal Revenue, 11th U.S. Circuit Court of Appeals; No. 94-3377.