The Fifth Circuit Court of Appeals has ruled that an Accountable Care Organization providing benefits to private parties as a “substantial” part of its activities is not eligible for exemption as a 501(c)(4) social welfare organization.  The ruling is the first modern appellate court ruling rejecting the claim that an organization can qualify for (c)(4) status so long as its “primary” activity is promoting the public good. 

The Memorial Hermann Accountable Care Organization was formed in Texas in 2012 as a program encouraged under the Affordable Care Act to allow groups of providers to work together to manage and coordinate care for Medicare beneficiaries.  If the organization satisfies cost-savings benchmarks established by the Secretary of Health and Human Services, it can share those savings with its members.  Memorial Hermann had about 10% of its patients in Medicare, 9% in Medicare Advantage plans, and about 81% in employer-sponsored health plans through commercial insurers.

Memorial Hermann applied to the IRS for recognition of (c)(4) status but was denied. The Tax Court affirmed, but declined to decide whether exemption should be denied if non-qualified activity was substantial or was primary.  It held that the non-qualified activity helping commercial insurers was both substantial and primary and avoided the question whether a substantial non-qualifying activity which was not a primary activity would preclude exemption.  (See Nonprofit Issues®, Vol. XXXIII, No. 3.). Congress has in its appropriation acts provided that the IRS may not spend any money coming up with a uniform interpretation.

On the appeal, the Fifth Circuit said it had to determine whether the organization “operated exclusively” for the promotion of social welfare as provided in the statute.  Memorial Hermann argued it merely had to show that its non-qualified activity was not its “primary purpose” as stated in the Treasury Regulations for (c)(4).

The Court said the “substantial” nonexempt purpose rule stemmed from a U.S. Supreme case in 1945 denying educational exemption to the Better Business Bureau of Washington, D.C. under the predecessor of the present section 501(c)(3). There, the Supreme Court said that the term “exclusively” “plainly means that the presence of a single non-educational purpose, if substantial in nature, will destroy the exemption regardless of the number or importance of truly educational purposes.”

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The Court of Appeals in this case said “it makes little sense to treat the same phrase differently in two neighboring paragraphs of the same statute.”  It noted that earlier cases in other circuits had applied the substantial nonexempt purpose test from the Better Business Bureau case in cases involving (c)(4) organizations as well as (c)(3) cases.

Memorial Hermann argued the court should consider what the Court called a “sparse” legislative history of the language, but the Court said the Supreme Court has “repeatedly and emphatically” rejected the use of legislative history where the text is unambiguous.  The Court also noted that it is no longer required to give deference to administrative interpretations because of the Supreme Court case of Loper Bright Enterprises v. Raimondo earlier this year overturning the Chevron doctrine requiring such deference.  (Memorial Hermann Accountable Care Organization v. Commissioner, 5th Cir. Ct. of Apps., No. 23-60608, 10/28/24.)

YOU NEED TO KNOW

People use 501(c)(4) social welfare organizations to intervene in elections not because they are tax exempt entities (political parties and political action committees are tax-exempt entities) but because 501(c)(4) organizations, unlike political parties and PACs, do not have to disclose their donors.  (c)(4)s permit an almost unlimited flow of “dark money” into our politics.  The Brennan Center for Justice has estimated that more than $1 billion was put into our elections by dark money groups between 2008 and 2020.  It has more recently estimated that four (c)(4)s associated with the Republican and Democratic parties alone have put more than $182 million into their related PACS through September 30 of this year, more than twice the amount they had contributed to that point in 2020.

To get this money out of politics will take an announcement by the Internal Revenue Service, which is not known for its political courage, that it will audit (c)(4)s to determine whether they are involved in “too much” electioneering and should lose their exemption.  No one other than the IRS has standing to challenge the exempt status of the organizations. 

Although the law seems to be as clear as the Fifth Circuit Court says it is, the ruling could be overturned by the Supreme Court if this case is appealed or if another similar case is taken up.  It could also be overturned by Congress, which so far has come together repeatedly to prohibit the IRS from making a general rule on the question and might just together again to change the law to remove the “exclusive” requirement. 

If you are hoping that this ruling will spark a change in political financing, don’t hold your breath.