Fifth Circuit Cites Loper Bright to Invalidate Social Welfare Reg; Declares Accountable Care Organization Ineligible for (c)(4) Status

The Fifth Circuit Court of Appeals denied social welfare status to an Accountable Care Organization on Monday.  In a quiet but remarkable reversal of at least 40 years of administrative jurisprudence, the Court said that a membership requirement defeats (c)(4) status for a managed care organization.  For good measure along the way the Court relied on Loper Bright to declare Treasury Regulation 1.501(c)(4)-1(a)(2) invalid!  The Court’s action didn’t bother the Government none, because the Government implicitly argued that the regulation is invalid anyway.  No kidding.  

We have followed Memorial Hermann’s efforts to be classified as a 501(c)(4) social welfare organization for about 18 months now.  Last month the Fifth Circuit heard oral argument.  I thought the judges were insufficiently focused on the private benefit issue.  The parties spent time parsing the difference between “substantial” and “primary” purpose.  Whether Memorial Hermann operates for a substantial or primary purpose doesn’t seem to have anything to do with whether Memorial Hermann provided more than incidental private benefit to private parties whose participation and cooperation in the Accountable Health Plan is necessary to achieve the public good.  But the parties and the Fifth Circuit wasted time arguing about it anyway. 

Just to recap, an accountable health care organization operates by incentivizing all health care delivery participants to work more efficiency.  It gathers dues-paying members and manages their health care to achieve cost efficiencies conducive to socialized medicine, such as it is in the United States.  When the private participants achieve a savings benchmark, the accountable health organization sends them a rebate check.  Private parties are rewarded for their participation.  So  the government argued and the Fifth Circuit agreed that Memorial Hermann operated for private benefit. 

The private participants are indispensable to the charitable goal.  There is hardly a charitable purpose that can be accomplished without private participants and they usually don’t work for free.  So just because an activity conveys private benefit doesn’t logically mean that is the organization’s purpose.  If that were the case, no charity could be tax exempt.  And that’s why we distinguish incidental from non-incidental benefit. Incidental is that which is necessary to achieve a charitable purpose.  Non-incidental is unnecessary.   The opinion illogically conflates effect and purpose. 

It is fascinating, first, though to talk about the Court’s post-Chevron jurisprudence.  MH argued that the word “exclusively” in (c)(4) has a different meaning than “exclusively” in (c)(3).  The latter means “substantially,” under Better Business Bureau, and the former means “primarily,” under Treas. Reg. 1.501(c)(4)-1.   But the Court said it would not accept different definitions of the same word in the same subsection of the same statute.  And that Loper Bright says it owes no deference to 1.501(c)(4)-1.  With that, the Court threw out the regulation!  Read the opinion for yourself if you don’t believe me. 

After doing so, the Court determined that MH did not deserve (c)(4) status because it operated for the private benefit of its members and the private health care providers who receive rebates for their successful participation.  Without any analysis at all, except to note its presence, the Court concluded that a membership requirement conveyed non-incidental private benefit.  That conflates effect – private benefit — with intent – operating for a substantial non-exempt purpose.  Because a membership requirement is necessary to spread risks and lower costs.  It must always be present.  That’s why Congress gave its imprimatur to accountable health care organizations when it enacted ObamaCare.   Yes, there is private benefit because the charitable purpose cannot otherwise be achieved. But if the mere presence of private benefit proves a substantial non-exempt purpose, hardly any exempt organization should be exempt. The Court should have inquired whether the charitable goal is attainable without the private benefit. Only when a charitable purpose is attainable without the benefit should the benefit be considered  non-incidental.  

 The Court’s ruling that a membership requirement defeats (c)(4) as well as (c)(3) surprises me for another reason.  I stopped paying attention to managed care organizations in the early 1990’s.  It was around that time, as it turns out, that the Service changed its mind and began denying (c)(4) exemption if managed care organizations relied on paid memberships.  Before that, membership requirements were not fatal to (c)(4) exemption.  The reversal makes no sense to me because a membership requirement is indispensable to holding down costs and thus health care prices.  Holding costs and prices down is the indispensable method by which to better allocate health care as contemplated by ObamaCare.  Clearly, better allocating health care is a public good worthy of the label “charity.”  All this proves a membership requirement is necessary and thus incidental. 

Anyway, that’s my argument.  The Service has heard it all before.  After much internal back and forth, the Service finally rejected the argument I am making. That happened about ten years ago.  This case is probably the first case that the Service’s position has been adopted by a Circuit Court of Appeal.  Prior to this case, only a single district court deemed a membership requirement fatal to (c)(4) status.  To get the whole long history of the membership requirement as it relates to (c)(4) exemption, as well as the Service’s 50-year evolution on the issue, download General Counsel Memorandum 39829 and Private Letter Ruling 201538027.  But be warned:  the GCM is a good long read, about 15 pages single spaced, and the PLR is the longest private letter ruling you will ever read.   It is nearly 130 pages long. 

darryll k. jones