Accessibility Skip to Top Navigation Skip to Main Content Home  |  Change Text Size  |  Contact IRS  |  About IRS  |  Site Map  |  Español  |  Help  

Part 4. Examining Process

Chapter 76. Exempt Organizations Examination Guidelines

Section 31. Health Maintenance Organizations

4.76.31  Health Maintenance Organizations

4.76.31.1  (08-01-2008)
Introduction

  1. This chapter provides descriptions and guidelines for examiners of health maintenance organizations (HMOs).

  2. The examination of HMOs has the following objectives to:

    1. Determine whether the organization qualifies for exemption under either IRC 501(c)(3) or IRC 501(c)(4);

    2. Determine whether the organization is precluded from qualifying for exemption by IRC 501(m)(1); and

    3. Determine whether any part of the organization’s activities is subject to tax under IRC 501(m)(2).

4.76.31.2  (08-01-2008)
HMO Activities

  1. HMOs directly provide or arrange for the provision of health care services to enrollees on a prepaid basis typically through a managed care arrangement. A managed care arrangement describes an HMO that uses its employed and/or contracted primary care providers as "gatekeepers." Enrollees choose or are assigned a primary care provider and must obtain a referral from the primary care provider to utilize inpatient or outpatient hospital services, specialist physician services, and ancillary health care services. The following are typical of these arrangements:

    1. Direct Provider. A direct provider HMO provides health care services to its enrollees principally by its employed health care providers at facilities that the HMO either owns or leases. (This arrangement is sometimes referred to as a "staff model" HMO.) An HMO’s services may consist of only primary care or may also include specialist care, inpatient and outpatient hospital care, mental health care, vision care, and dental care.

    2. Arranger. An arranger HMO arranges for the provision of health care services to its enrollees principally through a network of contracted health care providers at the providers’ own facilities. An arranger HMO’s services may consist of arranging for only primary care or may also include arranging for specialist care, inpatient and outpatient hospital care, mental health care, vision care, and dental care.

  2. An HMO may permit enrollees to obtain health care services from providers who are not employed or contracted by the HMO. These benefits, referred to as "point-of-service benefits," may be available to enrollees within the HMO’s service area or may be limited to emergency situations where the enrollee is out of the HMO’s service area.

  3. An HMO may also engage in other activities, such as:

    1. Providing whole or partial subsidies of premiums for persons who cannot afford to pay the established premiums,

    2. Health care education programs, or

    3. Health research programs.

  4. To reduce its risk of loss associated with providing or arranging for the provision of health care services to its enrollees, an HMO may purchase insurance from an insurance company, a state or local government agency, or from another organization in the HMO’s health care system. This is referred to as "stop loss insurance."

4.76.31.3  (08-01-2008)
Providers

  1. An HMO employs or contracts with physicians, other health care professionals, hospitals, or clinics. Under these contracts, the providers agree to provide health care services to the HMO’s enrollees.

4.76.31.3.1  (08-01-2008)
Physicians

  1. An HMO’s physician may be employed by the HMO, or the HMO may utilize independent physicians in private practice who contract with the HMO, or both. The following is a description of various physician arrangements:

    1. Contracts with physicians in private practice are typically on a non-exclusive basis.

    2. Contracted physicians may practice individually, in a group of several physicians, or as an individual practice association (IPA).

    3. An HMO may employ or contract with primary care physicians, specialists, or both.

    4. An HMO may employ or contract with other health care professionals, such as osteopaths, registered nurses, nurse practitioners, physician assistants, psychologists, or social workers.

4.76.31.3.2  (08-01-2008)
Hospitals

  1. An HMO may contract with hospitals and clinics to provide enrollees with inpatient and/or outpatient health care services. The contracted hospitals and clinics may be related to the HMO or may be independent organizations.

4.76.31.4  (08-01-2008)
Enrollment

  1. An HMO may offer enrollment to certain groups, such as commercial employer groups, state or local government employer groups, insurance companies, other HMOs, Medicaid beneficiaries, Medicare beneficiaries, or individuals unaffiliated with any group.

  2. Generally, individuals are not rejected for enrollment based on pre-existing conditions or excessive utilization of the HMO’s services. HMOs commonly impose a reasonable waiting period, such as six months to one year, before an enrollee is eligible to receive treatment for a pre-existing condition.

4.76.31.5  (08-01-2008)
Premiums

  1. An HMO determines its premiums using various methods, such as a community rating method or an experience rating method. In the case of HMOs that enroll Medicaid and Medicare beneficiaries, the government program generally sets the premiums.

    1. Community Rating. Premiums are determined without regard to the enrollee’s utilization of services. All enrollees pay the same premium regardless of the extent of health care services they require. An HMO may use an adjusted community rating method under which the premiums are the same for all enrollees in a particular class.

    2. Experience Rating. Premiums vary based on utilization of services. Enrollees who require more health care services pay higher premiums.

    3. Medicaid and Medicare. State Medicaid agencies generally establish the premiums for enrolled Medicaid beneficiaries. The Centers for Medicare & Medicaid Services (CMS) determine the premiums they pay for enrolled Medicare beneficiaries.

4.76.31.6  (08-01-2008)
Control

  1. An HMO’s governing body, such as its board of directors, may consist of independent members of the community. In addition, an HMO may be controlled by:

    1. One or more IRC 501(c)(3) organizations, such as hospitals, which may be related to each other or may be unrelated;

    2. One or more HMOs, which may be exempt under IRC 501(c)(3) or IRC 501(c)(4), or may be non-exempt;

    3. Physicians, either individually or as part of a group or IPA; or

    4. Enrollees in the HMO.

4.76.31.7  (08-01-2008)
IRC 501(c)(3)

  1. To qualify for exemption as an organization described in IRC 501(c)(3), an HMO must be organized and operated exclusively for one or more exempt purposes.

  2. An HMO is organized exclusively for one or more exempt purposes if it satisfies the organizational test in Treas. Reg. 1.501(c)(3)-1(b).

  3. An HMO is operated exclusively for one or more exempt purposes if it satisfies the operational test in Treas. Reg. 1.501(c)(3)-1(c).

  4. The promotion of health is considered an exempt purpose. See IRM 7.25.3.11 (Exempt Organizations Determinations Manual). However, not every activity that promotes health supports tax exemption. See, for example, Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687 (1979), aff’d, 625 F.2d 804 (8th Cir. 1980).

  5. No part of net earnings may inure to the benefit of private shareholders or individuals. See Treas. Reg. 1.501(c)(3)–1(c)(2).

4.76.31.7.1  (08-01-2008)
Direct Provider

  1. The promotion of health in a charitable manner may be accomplished by the direct provision of health care services.

  2. An HMO that operates exclusively as a direct provider of health care services accomplishes the charitable promotion of health if it operates in a manner comparable to the hospital described in Situation 1 in Rev. Rul. 69-545, 1969-2 C.B. 117, or to the HMO described in Sound Health Association v. Commissioner, 71 T.C. 158 (1978), acq . 1981-2 C.B. 2.

4.76.31.7.2  (08-01-2008)
Arranger

  1. Under certain circumstances, the promotion of health in a charitable manner may be accomplished by arranging for the provision of health care services.

  2. In determining whether an arranger HMO qualifies for tax-exempt status under IRC 501(c)(3), the totality of the circumstances must be examined, with an eye toward discerning whether the HMO benefits the community as a whole in addition to its subscribers. Geisinger Health Plan v. Commissioner , 985 F.2d 1210 (3d Cir. 1993), rev’g 62 T.C.M. (CCH) 1656 (1991). The court found that arranging for the provision of medical services only to the HMO’s enrollees is not necessarily charitable, particularly where the HMO subsidized only a small number of enrollees.

  3. An HMO must make its services available to all in the community plus provide additional community or public benefits. The additional public benefit must be sufficient to give rise to a strong inference that the public benefit is the primary purpose for which the organization operates. In conducting this inquiry, the totality of the circumstances should be considered. IHC Health Plan, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003). Some of the factors the court considered were whether free or below cost products or services were provided, the existence of research or educational programs, the size of the class eligible to benefit, and the composition of the board of trustees.

4.76.31.7.2.1  (08-01-2008)
Medicaid HMO

  1. An HMO that arranges for the provision of health care services to its enrollees, consisting exclusively of persons eligible under Medicaid, a comparable state program, or persons having special health care needs, promotes the health of the community if it also actively engages in the following programs that provide related health care services to its enrollees:

    1. Educational programs regarding the benefits available;

    2. Counseling and assistance in making the transition to managed care;

    3. Preventive health care programs;

    4. Coordinating health care services among providers; and

    5. Facilitating access to the plan’s providers.

4.76.31.7.2.2  (08-01-2008)
Integral Part of a Health Care System

  1. An HMO that arranges for the provision of health care services and is part of an IRC 501(c)(3) health care system may qualify for exemption under IRC 501(c)(3) as an integral part of the health care system. See Treas. Reg. 1.502–1(b) and Rev. Rul. 78-41, 1978-1 C.B. 148.

  2. To be considered as an integral part, an HMO must be financially and structurally controlled by either:

    1. One organization in the health care system that is exempt under IRC 501(c)(3), or

    2. Two or more organizations in the health care system that are exempt under IRC 501(c)(3) and related to each other through common control.

  3. An HMO must perform an essential function of one or more related IRC 501(c)(3) organizations in the health care system of which it is a part. For related organizations that are hospitals, the HMO must serve only the patients of these hospitals. Thus, the HMO’s enrollees must also be patients of the related exempt hospitals. Geisinger Health Plan v. Commissioner , 100 T.C. 394 (1993), aff’d on other grounds , 30 F.3d 494 (3d Cir. 1994);IHC Health Plan, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003); Rev. Rul. 68–374, 1968–2 C.B. 242; Rev. Rul. 68–375, 1968–2 C.B. 245; Rev. Rul. 68–376, 1968–2 C.B. 246.

4.76.31.8  (08-01-2008)
IRC 501(c)(4)

  1. To qualify for exemption as an organization described in IRC 501(c)(4), an HMO must not be organized for profit and must be operated exclusively for the promotion of social welfare.

  2. An HMO is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. Treas. Reg. 1.501(c)(4)-1(a)(2).

  3. If an HMO does not qualify for exemption under IRC 501(c)(3), it may qualify for exemption under IRC 501(c)(4).

  4. An organization that arranges to provide limited vision care services for its enrollees for a fee did not qualify for exemption under IRC 501(c)(4) as a social welfare organization. In upholding the District Court’s decision, the Court of Appeals found that the organization’s activities primarily benefited its subscribers and their enrollees rather than the community as a whole. Vision Service Plan, Inc. v. U.S., 2005 U.S. Dist. LEXIS 38812 (E.D. Calif.), aff’d mem., 2008 U.S. App. LEXIS 2388 (9th Cir. 2008).

4.76.31.8.1  (08-01-2008)
Integral Part of a Health Care System

  1. An HMO that arranges for the provision of health care services to its enrollees and is part of a health care system may qualify for exemption under IRC 501(c)(4) as an integral part of the health care system. See Treas. Reg. 1.502-1(b) and Rev. Rul. 78–41, 1978–1 C.B. 148.

  2. To be considered an integral part, an HMO must be financially and structurally controlled by either:

    1. One organization in the health care system that is exempt under IRC 501(c)(3) or IRC 501(c)(4), or

    2. Two or more organizations in the health care system that are exempt under IRC 501(c)(3) or IRC 501(c)(4) and are related to each other through common control.

  3. An HMO must perform an essential function of one or more related IRC 501(c)(3) or IRC 501(c)(4) organizations in the health care system of which it is a part. For related organizations that are hospitals, the HMO must serve only the patients of these hospitals. Thus, the HMO’s enrollees must also be patients of the related exempt hospitals. Geisinger Health Plan v. Commissioner, 100 T.C. 394 (1993), aff’d on other grounds, 30 F.3d 494 (3d Cir. 1994); IHC Health Plan, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003); Rev. Rul. 68-374, 1968-2 C.B. 242; Rev. Rul. 68-375, 1968-2 C.B. 245; Rev. Rul. 68-376, 1968-2 C.B. 246.

4.76.31.9  (08-01-2008)
Exemption Precluded by IRC 501(m)

  1. An HMO that satisfies the requirements for exemption under IRC 501(c)(3) or IRC 501(c)(4) is precluded from qualifying for exemption if a substantial part of its activities consists of providing commercial-type insurance. IRC 501(m)(1).

4.76.31.9.1  (08-01-2008)
Statutory Exceptions to Commercial-Type Insurance

  1. Certain activities of an HMO should not be considered as providing commercial-type insurance:

    1. An HMO that provides insurance at substantially below cost to a class of charitable recipients. See IRC 501(m)(3)(A).

    2. An HMO that provides incidental health insurance of a kind that is customarily provided by HMOs. See IRC 501(m)(3)(B).

4.76.31.10  (08-01-2008)
Unrelated Trade or Business

  1. If an HMO that satisfies the requirements for exemption under IRC 501(c)(3) or IRC 501(c)(4) is not precluded by IRC 501(m) from qualifying for exemption, any commercial-type insurance activities of the HMO should be considered as an unrelated trade or business and the HMO should be considered as an insurance company for applying Subchapter L to such activity. See IRC 501(m)(2).


More Internal Revenue Manual