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Posted On: Apr. 20, 1997 12:00 AM CST

ATLANTA-Some self-insuring employers are smiling, despite the tax payment deadline last week.

The Internal Revenue Service essentially "threw in the towel" when it voluntarily asked a federal appeals court to dismiss its appeal of a lower court's finding that Georgia's workers compensation guaranty fund is a tax-exempt, non-profit entity under the IRS code.

The outcome is expected to save millions of dollars for individual self-insurers in Georgia and perhaps elsewhere, attorneys say.

It also resolves a 5-year-old controversy for the Georgia Self-Insurers Guaranty Trust Fund and may help resolve the identical issue for guaranty funds elsewhere, according to Douglas F. Stevenson, a Chicago attorney who is executive director of the National Council of Self-Insurers.

The IRS asked to have the case dismissed "with prejudice," meaning the IRS cannot challenge it again in the northern district of Georgia, according to court records filed last month.

However, the IRS' use of that phrase "really has no independent significance" and cannot be considered indicative of the IRS' position on the tax liability of other funds, according to Curtis Pett, a U.S. Department of Justice attorney who represented the IRS in the case.

The National Council's Mr. Stevenson said the IRS' decision "doesn't necessarily bind other districts but is expected to be persuasive."

As a result, the outcome buoys the refund hopes of similar guaranty funds in several other states, many of which lost earlier challenges to their non-profit status.

A total of 29 states have guaranty funds for individual self-insurers, which are designed to assess financially healthy companies to help pay the workers compensation liabilities of any bankrupt self-insurer, said Mr. Stevenson, an attorney with Stevenson, Rusin & Friedman Ltd. in Chicago.

Last year, Kentucky became the most recent state to approve establishing guaranty funds. Its law calls for establishing three separate self-insurance funds for individual companies, coal operators and groups, respectively, Mr. Stevenson said.

The National Council has recommended since 1987 that states adopt such guaranty funds for individual self-insurers, though it saw no need to prefund them, he added. However, some states require prefunding.

The existence of such funds generally makes state regulators' more comfortable with allowing large companies to self-insure their workers comp liabilities because the funds help ensure that injured workers' claims will be paid even if companies go bankrupt.

The tax liability issue is particularly important in "five 'M' states"-Maine, Minnesota, Missouri, Mississippi and Montana-where the respective guaranty funds previously lost efforts to have the IRS accept them as non-profits under the tax code, said George Wood, executive secretary of both the Montana guaranty fund and the state's self-insurers association. He is also chairman of the National Council of Self-Insurers Guaranty Fund Committee. The federal tax liability of those funds varies, depending on the amount of money accumulated in the funds. For example, Montana's tax bill was about $200 because it had assessed self-insuring employers only for administrative expenses, Mr. Wood said. However, another fund faced a $450,000 federal tax liability, he said.

"Self-insurers have always taken the position that their guaranty funds should enjoy the same exemption from tax that the insurance company guaranty funds do," Mr. Wood said.

Employers prefer that the millions of dollars at stake go to injured workers whose employers have become bankrupt, rather than to pay federal taxes, he said.

But, "the IRS has taken the position that the guaranty fund is of benefit to self-insuring companies," Mr. Wood said.

However, "I don't know how having to pay the workers compensation claims of a bankrupt employer is of any benefit to another self-insuring employer," Mr. Wood said.

The issue of the tax deductibility of individual self-insurers' guaranty funds has been a murky one for several years, especially because the IRS authorities have adopted differing positions.

For example, local or regional IRS offices approved the tax-deductible, non-profit status of similar guaranty funds in California and Florida, self-insurer sources say. However, the national IRS office apparently was responsible for the opposite decision in some other states, including Georgia.

"In Illinois, where the (guaranty trust) funds are held by the state treasury, the IRS has not attempted to tax them," Mr. Stevenson added.

Generally, all monies that most state guaranty funds obtain are at risk of taxation, including assessments for administrative costs and claims payments as well as the investment income the fund earns, Mr. Wood said.

However, most guaranty funds have been filing under protest or paying federal tax only on earned interest income, Mr. Stevenson added.

In Georgia's case, the issue was whether the trust fund was exempt as a "business league" within the definition under Section 501(c)(6) under the IRS tax code.

The Georgia guaranty fund is currently assessing employers to reach a $10 million limit authorized by the state Legislature, said guaranty fund litigation attorney Sonya Ragland in the Atlanta office of Womble Carlyle Sandridge & Rice P.L.L.C. The Legislature had previously approved a $3 million limit, she said.

"The need to get a tax-exempt status was viewed, going forward, as a multimillion-dollar problem," she said.

A few years ago, the guaranty fund filed for 501(c)(6) status, but the IRS denied the request. The fund then paid slightly more than $2,000 in federal taxes but filed for a tax refund in the U.S. District Court for the Northern District of Georgia, which the court approved in September 1996.

The IRS appealed that decision to the 11th U.S. Circuit Court of Appeals. However, it voluntarily asked to dismiss the case "with prejudice" in an order filed last month.

"Setting a precedent for other states is great," said Ellen Brunner, director of risk services for Holiday Inn Worldwide in Atlanta. The self-insurer participates in the Georgia guaranty fund.

The outcome "will be beneficial to all employers in that we don't have to bear the cost that the fund would have borne had it been found to be a taxable entity," she said.

"Perhaps this long and unnecessary IRS burden is over for our guaranty funds," Mr. Stevenson wrote in a recent NCSI newsletter.

An IRS spokeswoman declined to comment on the case or answer other tax-related questions>