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Tax Court Declines Chance to Define Boundary of 501(c)(4) Exemption

Tax Court Declines Chance to Define Boundary of 501(c)(4) Exemption

Group denied exemption because primary and substantial purpose is to benefit commercial insurers and health care providers

The Tax Court has declined to take the opportunity to decide whether a “substantial” non-qualifying purpose is sufficient to deny exemption as a 501(c)(4) social welfare organization or whether the non-qualifying activity must be the “primary” activity of the organization. 

In affirming an Internal Revenue Service denial of exemption to an Accountable Care Organization in Texas, the Court said that its activities “primarily benefit commercial [health insurance] payors and healthcare providers and thereby constitute a substantial nonexempt purpose precluding [the organization] from qualifying as an organization described by section 501(c)(4).”

Memorial Hermann Accountable Care Organization (MHACO) was originally formed in 2012 as an accountable care organization controlled by its sole member Memorial Hermann Health System. ACOs were promoted by the Affordable Care Act as a means of reducing health care costs.

MHACO described itself as “a group of doctors, hospitals, and other health care providers, who come together voluntarily to give coordinated high-quality care to Medicare and other patients.”  Its primary source of revenue came from its participation in shared savings plans under which it receives a portion of the savings it creates by providing coordinated and high-quality services that reduce overall health care costs for patients as measured by benchmarks established by the federal Centers for Medicare & Medicaid Services.

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MHACO was responsible for more than 450,000 patients.  About 18% of the patients were Medicare beneficiaries.  The other 82% were covered by private insurance payors, who received more than $70 million in benefits from the work of MHACO in the years from 2014 through 2019.  The IRS denied the exemption on the basis that its activities primarily benefit the insurance companies and healthcare providers with which it contracts.  The organization appealed.

The Court noted that the Tax Code requires a 501(c)(4) organization to be “operated exclusively for the promotion of social welfare.”  The Regulations provide that it will be found to operate exclusively for promotion of social welfare if it is “primarily engaged” in promoting social welfare.   The U.S. Supreme Court has held, in connection with an application for 501(c)(3) charitable exemption based on similar statutory and regulatory language, that ‘the presence of a single, substantial nonexempt purpose will preclude exempt status, regardless of the number or importance of exempt purposes.”

The Tax Court noted that the Supreme Court standard had been applied in several cases dealing with (c)(4) applications.  But it did not determine whether the case could be decided solely on the basis of a substantial nonexempt purpose.  Instead, it decided that the organization did not act primarily for a social welfare purpose, which therefore constitutes a substantial nonexempt purpose.  It did not opine on whether the organization would have been exempt if 82% of its patients were Medicare patients and only 18% were privately covered.  It did not have to decide — and did not decide — whether a substantial, but not primary, purpose would have precluded exemption.  (Memorial Hermann Accountable Care Organization v. Commissioner, T.C. Memo.2023-62, 5/16/23.)


This case could have been a defining case for the general controversy over the amount of political activity permitted by 501(c)(4) organizations.  The issue is important because of the increasing expenditures by 501(c)(4) organizations in political campaigns.  Political donors don’t use 501(c)(4) organizations because they are tax-exempt.  They use 501(c)(4)s because they don’t have to disclose their donors.  Section 527 political organizations are also tax-exempt, but they have to disclose their donors under campaign finance laws.  (c)(4)s don’t.  As a result of the U.S. Supreme Court’s decision in the Citizens United case in 2010 that permitted corporations to participate in election campaigns in unlimited amounts if it is not coordinated with a candidate, the amount of “dark money” in politics has expanded exponentially.

The regulatory language for the purpose of 501(c)(3) charities (which are not permitted to participate in election campaigns) and for 501(c)(4) social welfare organizations (which are permitted to participate in election campaigns) is almost identical.  (See Ready Reference Page: “IRS Tea Party ‘Scandal’ Shows Need for (c)(4) Definition”)  Each type organization must operate exclusively, defined as primarily, for its stated purpose.  But political donors to (c)(4) groups seem to rely on “primarily” in the ordinary English language definition to permit electioneering so long as it doesn’t exceed half of the activity of the organization.  They disregard the “substantial” language applied to (c)(3) charities, even though several courts have applied the standard to (c)(4) organizations, as cited by the Tax Court in this case.  The IRS has not taken steps to stop it and ordinary citizens don’t have standing to go to court to challenge the status of a (c)(4) organization.

To make matters worse, Congress has specifically prohibited the IRS from defining (c)(4) status generally.  It has prohibited the IRS from spending money on anything but individual cases, so it is unlikely that we will get a standard definition at any time soon if the courts don’t do it.  And it appears as though the Tax Court is not inclined to jump into the fray if it doesn’t have to.

U.S. Tax Court

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