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Tuesday, March 31, 2015

A Lesson in Status: Learn from Insurer’s Tax Woes

Posted by John Panetta

The Los Angeles Times reports that the nonprofit Blue Shield of California—the state’s third-largest health insurer—has been stripped of its state tax-exempt status, and may be on the hook for tens of millions in state taxes each year moving forward. The insurer’s California status was revoked in August of last year (it’s just now becoming public) and it lost its federal exempt status in the 1990s.

Trouble for the California “Blue” started with a state audit investigating the insurer’s justification for its tax-exempt status. In the past, Blue Shield has been criticized for rate increases, executive compensation and large financial reserves.

And it’s not just the Golden State.

Community advocates, state and municipal tax commissions, and state attorneys general across the country are crying foul, saying that modern not-for-profit hospitals and health systems have violated their “explicit or implicit contract” to serve uninsured patients in return for significant tax breaks.

A number of hospitals and health systems have received letters from the IRS requesting documentation on executive compensation and benefits, deferred compensation plans and charitable care. In some circumstances, these soft audits have led to full-blown IRS scrutiny.

Could Your Organization be Next?

The battle being waged over the legal status of not-for-profit hospitals and health systems underscores just how important it is for nonprofits of every stripe to actively maintain their tax-exempt status. Here are a few things to watch:

  • Compensation: If executive compensation is too high relative to the job performed, an organization can find itself caught up in the web of “intermediate sanctions”—special punitive taxes created by Congress.
  • Inurement: The area that poses the greatest risk of inadvertent noncompliance is what the IRS calls “private inurement.” Here, regulations prohibit any part of the organization’s net earnings (or operations) from accruing to the benefit of private shareholders or individuals.
  • Political activities: While 501(c)(3) organizations are legally entitled to lobby and advocate for the causes and constituents they represent, they are prohibited from participating in partisan politics—working directly for a political party or candidate, for example. In addition to revoking nonprofit status, the IRS can assess a special excise tax against the organization and its managers, which includes board members.
  • Mission: To ensure adherence to your organization’s mission, board members should regularly review the mission statement, organizing documents and programs. If your 501(c)(3) organization decides it wants to change its mission, you must make sure that your new activities are, in fact, a permitted purpose under your home state’s nonprofit corporation statute and, if so, amend your articles of incorporation. You would also need to amend the registration(s) you have on file with state charitable solicitations officials as well as notify the Internal Revenue Service through a letter specifying the changes from your original application, Form 1023.

In this era of increased scrutiny, nonprofits must take steps every day to protect their tax-exempt status. Start by reviewing the IRS’ informative online training tools at


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