IRS revokes a prepaid vision plan's social-welfare exemption

Plain-English summary

A nonprofit subsidiary providing prepaid vision-care plans had long been recognized as exempt under IRC § 501(c)(4). The IRS concluded that its operations primarily benefited subscribers and enrollees rather than the community as a whole, and that it conducted business with the public in a manner similar to for-profit vision service organizations. The subsidiary operated under the same control, fee structure, and business model as its parent, whose exemption had already been revoked and whose challenge had failed in federal court. The IRS therefore revoked the subsidiary's social-welfare exemption effective on the same redacted date as the parent's revocation. Through a technical advice memorandum, the IRS used its § 7805(b) discretion to limit retroactivity and granted relief from corporate income taxes for two redacted examination years. The organization was required to file income-tax returns for periods beginning on the revocation date.

Ruling snapshot

• Question: Did the prepaid vision plan continue to qualify as a social-welfare organization under IRC § 501(c)(4)?
• Outcome: Revocation
• Key authorities: IRC §§ 501(a), 501(c)(4), and 7805(b); Treas. Reg. § 1.501(c)(4)-1(a)(2); Rev. Rul. 55-311; Rev. Rul. 73-349; Vision Service Plan v. United States, 956 A.F.T.R.2d 2005-7440 (E.D. Cal. 2005)

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street, MS 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND

GOVERNMENT ENTITIES Date: 7/12/12

DIVISION UIL: 501.04-01
Release Number: 201443020 Employer Identification Number:
Release Date: 10/24/2014
Legend:

Org= Name of Organization
Address — Address of Org

ORG
Address Contact Person/ID Number
Telephone Number:
Dear

This letter is a final adverse determination regarding your exempt status under
Section 501(c)(4) of the Internal Revenue Code.

By a determination letter dated March 19xx, we recognized your exemption from
Federal income tax under Section 501(a) of the Internal Revenue Code as an
organization described in Section 501(c)(4).

We examined your activities in 20xx and 20xx and proposed revocation of your
Section 501(c)(4) exempt status. You submitted a request for relief to limit the
retroactive effect of the proposed revocation pursuant to Section 7805(b) of the
Code.

By issuance of a technical advice memorandum, the Commissioner of TEGE has

exercised Section 7805(b) discretionary authority to limit the retroactive effect of
this revocation. The TEGE Commissioner granted relief from corporate income

taxes for taxable years 20xx and 20xx and concluded that January 1, 20xx would

be the effective date of revocation of your Section 501(c)(4) filing status.

You are not operated primarily for the purpose of bringing about civic betterments

and social improvements. Moreover, you carry on a business with the general
public in a manner similar to organizations which are operated for profit.
Consequently, you do not qualify for exemption under 501(a) of the Code as an
organization described in section 501(c)(4).

The effective date of revocation of your section 501(c)(4) status is January 1,
20xx. Since you are not exempt from Federal income tax for periods beginning
January 1, 20xx, you are required to file the requisite income tax returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer
Advocate assistance is not a substitute for established IRS procedures, such as the
formal appeals process. The Taxpayer Advocate cannot reverse a legally correct
tax determination. The Taxpayer Advocate can, however, see that a tax matter
that may not have been resolved through normal channels gets prompt and proper
handling. You may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate
Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

If you have any questions about this letter, please contact the person whose name and telephone
number are shown in the heading of this letter. If you have any questions about your Federal
income tax status and responsibilities, please contact IRS Customer Service for businesses at 1-
800-829-4933. The IRS Customer Service number for people with hearing impairments is 1-
800-829-4059.

Sincerely,
Nanette M. Downing
Director, Exempt Organizations

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
' Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

LEGEND:

ORG = Name of Organization
EIN = Identifying Number
Date = xx

State = Name of State

Issue:

Does ORG, EIN, continue to qualify as an organization described in §501(c)(4) of the Internal
Revenue Code?

Facts:

ORG, Inc. was incorporated in State on April 27, 19xx. ORG, Inc. amended its Articles of
Incorporation in 19xx, 19xx, 19xx and 19xx. The Amended Articles of Incorporation filed in
19xx, which were in effect at the time that the IRS issued ORG, Inc.’s determination letter in
19xx, provided at Article Three that the principal purposes of ORG, Inc. are as follows:

To provide prepaid vision services to individuals residing and working in the
State and to have and to exercise all power necessary and convenient to effect
the purpose for which the corporation is organized and to exercise all powers
prescribed by Law.

ORG, Inc.’s current Amended Articles of Incorporation, dated June 9, 19xx, provide at Article
Three that the principal purposes of ORG, Inc. are as follows:

In addition to all statutory purposes granted nonprofit corporations, the purposes
of this corporation are to provide prepaid vision services to individuals residing
and working in the State and to have and to exercise all power necessary and
convenient to effect the purpose for which the corporation is organized and to
exercise all powers prescribed by law. More specifically, to educate the public to
advantages of broad availability of vision care on a free choice bases for the
patient; to provide programs by which the public may obtain quality vision care
within their means on a free choice basis; to arrange vision testing of occupational
and other groups; and to cover the costs of vision services by establishing funds
from periodic payments by subscribers or beneficiaries from which said payments
may be made to practitioners providing such services...

The Articles of Incorporation of ORG, Inc provide at Article Thirteen that:

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

Upon dissolution of this corporation, after making adequate provision for debts
and obligations, the balance remaining shall be distributed to a charitable,
educational research, scientific, or health institution, organization or association,
to be expended in the advancement of optometry.

Accordingly, the primary purposes of ORG, Inc., i.e., to provide prepaid vision services to
individuals residing and working in the State, and its articulation of those purposes in its
organizing documents, have not materially changed since it obtained recognition of qualification
under Section 501(c)(4).

ORG, Inc.’s Form 1024 Application for Recognition of Exemption provides a description of
its specific purposes and activities under Part II, Question 3. Specifically, its Form 1024
application dated December 6, 19xx, states that:

ORG, Inc. was formed to enable citizens of the state to obtain prepaid and/or
group vision care of high quality within their means; to assume the costs of such
vision care by the establishment of a fund from which these costs can be paid; to
engage in visual testing of occupational groups; and to educate the public
concerning benefits available through the optometric profession.

Furthermore, ORG, Inc.’s Form 990 for the 19xx tax year, the earliest Form 990 available,
under the Statement of Program Service Accomplishments, at page 2, part III, states: “Provide
prepaid vision care.”

ORG, Inc. is a subsidiary of Parent . In 1960, Parent was granted exemption, pursuant to
Internal Revenue Code §501(c)(4). To comply with requirements of the various State
Departments of Insurance, subsidiaries needed to be organized as a non-profit corporation under
the laws of the state where VSP performed its activities. They offered insurance coverage for
vision care under group plans, contracted with a network of eye care providers and shared in
benefits of related eye wear laboratories in the same manner as their parent and their related
corporations. The Parent and its subsidiaries contract with employers, insurance companies,
health maintenance organization and political subdivisions (“subscribers”) to arrange for the
provision of vision care services and supplies to the subscribers’ employees or members. The
services and supplies are provided by the independent vision care professionals with whom
Parent contracts.

Following an examination conducted in 19xx, the IRS issued a final adverse determination
letter, revoking the tax-exempt status for Parent effective as of January 1, 20xx. Underlying and
justifying the revocation of Parent exempt status, Letter Ruling was issued to Parent in response
to a request for technical advice, providing in relevant part:

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer , Year/Period Ended
ORG 12/31/20xx and
forward

... L, had _affiliated organizations located in states other that a state which were
engaged in substantially the same activities as Parent. (Collectively, these
organizations are referred to as “L Affiliates.”) In general, each L Affiliate was
organized as a non-profit corporation under the laws of the state where it
performed its activities. In addition, as of December 31, 19xx, Parent owned all
of the stock of a for-profit corporation that was engaged in the* business
and all of the stock of several other for-profit corporations that were engaged

ir** activities.

Parent’s social welfare activities during the examination years, whether
considered in relation to Parent’s total revenues, total expenses, accumulated
surplus, or total enrollment, are minor, incidental and insignificant. See People’s
Educational Camp Society, Inc. v. Commissioner, supra. Therefore, based on any
measure, it cannot be said that Parent is primarily engaged in promoting the
common good and general welfare of the people of the community within the
meaning of section 1.501(c)(4)-1(a)(2) of the regulations.

Further, a nonprofit corporation whose activities benefit primarily its enrollees,
rather than the general public, does not promote the common good and general
welfare of the people of the community within the meaning of section
1.501(c)(4)-1(a) of the regulations....

Finally, section 1.501(c)(4)-1(a)(2)(i) of the regulation states that an
organization is not operated primarily for the promotion of social welfare if its
primary activity is carrying on a business with the general public in a manner
similar to organizations which are operated for profit. Parent has not established
that its activities, including arranging for the provision of * services for
Medicare and Medicaid beneficiaries, are significantly distinguishable for the
same activities carried on by for-profit*** service organizations.

In conclusion, based on all the facts and circumstances, Parent has not
established that it is operated primarily for the purpose of bringing about civic
betterments and social improvements within the meaning of section 1.501(c)(4)-
1(a)(2)(i) of the regulations. Parent’s operations benefit, almost exclusively, its
enrollees. Its social welfare activities, in relation to its total activities, are minor,
incidental and insignificant. Finally, Parent has not established that its activities
are significantly distinguishable from the same activities carried on by a business
operated for profit, as required in section 1.501(c)(4)-1(a)(2)(ii). Thus, Parent is
not primarily engaged in promoting the common good and general welfare of the
people of the community. As a result, it is not operated exclusively of the
promotion of social welfare within the meaning of section 1.501(c)(4)-1(a)(2)(i).

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
' Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

Consequently, Parent does not continue to qualify for exemption under 501(a) of
the code as an Organization described in section 501(c)(4).

For tax years beginning January 1, 20xx, Parent filed Form 1120PC’s with the IRS to report
its net profit from operations and paid federal income tax on its earning. Parent filed claims for
refund of these income taxes. The claim for 20xx was denied by the IRS. The Parent brought a
suit for refund for the 20xx tax year in the United States District Court for the Eastern District of
State on the grounds that it was a tax-exempt organization pursuant to IRC §501(c)(4).

On December 12, 20xx, the District Court held that Parent was not a tax-exempt organization
within the meaning of IRC §501(c)(4). The Court stated that Parent is operating primarily for the
benefit of its subscribers rather than for the purpose of benefiting the community as a whole, and
Parent carries on business with the public in a manner similar to organizations which are
operated for profit. Therefore, the District Court held and concluded, Parent is not operated
“exclusively for the promotion of social welfare” as provided for in 501(c)(4).

Parent appealed the District Court decision to the United States Court of Appeals for the
Ninth Circuit. On January 29, 20xx, the Ninth Circuit affirmed the decision of the District Court.
Parent petitioned for a writ of Certiorari to the Supreme Court of the United States on August 7,
20xx. On January 12, 20xx, the writ of Certiorari was denied.

During all the years in operation which includes the examination years FYE 20xx to FYE
20xx, the Parent and its Subsidiaries, which include ORG, operated in substantially the same
manner and under common control. All claims for benefit and payments to suppliers and
contractors are processed through Parent . All accounting matters including payroll are processed
through Parent. Parent and its Subsidiaries have the same manner and mode of operation. They
have similar categories with different mixes of subscriber and enrollees, as well as subsidized
and discounted care, and similar fee structure.

ORG, Inc.’s number of subscribers at various size levels (measured by the number of
members, or enrollees), individual plan members and levels of subsidized and discounted care
for the years FYE 20xx & FYE 20xx are as follows:

ORG, Inc. # of Clients _20xx Members Claim $ # of Clients _20xx Members Claim $
25 or less Members

26-50 Members

51-100 Members

101-1,000 Members

Greater than 1,000 Members

Medicaid/SCHIPS
Medicare
Sight for Students 0
Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -4-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward
American Red Cross
Individual Plan

Total 0

Certain Parent subsidiaries began offering individual vision care plans under pilot programs in
20xx, 20xx, and 20xx. ORG, Inc. did not offer policies to individuals in 20xx and 20xx.
However, individuals residing in the state serviced by this subsidiary could purchase coverage
through another subsidiary. Affiliate, an affiliate incorporated in State, which is not under
examination, issued a group policy dated January 1, 20xx to The Association , a State
corporation with a membership structure. Any individual in any state may join The Association
for a membership fee of $18.00. Members received access to consumer goods, discounts,
services, and information that may not otherwise be available to them, including health, travel,
and business services. Individuals residing in any state (other than Florida) who wish coverage
for vision care may pay the $18.00 membership fee to join the Association and obtain vision care
coverage under the Association policy by paying premiums. The individual may access this
information and purchase coverage through the Parent.

ORG, Inc’s. address is the same as Parent :Address.. The structuring of the Board of Directors
is similar to other subsidiaries with three individuals serving as members on all of the Boards.
The ORG, Inc. has additional board members.

ORG, Inc., has been filing Form 990 until FYE 20xx. Beginning in FYE 20xx, all subsidiaries,
which include ORG, Inc., filed on a consolidated basis with Parent and did not file separate
Forms 1120.

Law and Government’s Position:

Internal Revenue Code § 501(c)(4) provides exemption from income tax for organizations
that are not organized for profit but “operate exclusively for the promotion of social welfare”
and the net earnings of which are devoted exclusively to charitable, educational, or recreational

purposes.

Section 1.504(c)(4)-1(a)(2) of the regulations provides that an organization is operated
exclusively for the promotion of social welfare if it is primarily engaged in promoting the
common good and general welfare of the people of the community. These regulations also state
that an organization is embraced within this provision if it is operated primarily for the purpose
of bringing about civic betterments and social improvements.

In Rev. Rul. 55-311, 1955-1 C.B. 72, the members of a local association of employees
consisted solely of the employees of a particular corporation. The association operated a bus for
the convenience of its members. The association’s income was derived from bus fares used to

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886 A Department of the Treasury - Internal Revenue Service : Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

pay for the operation of the bus. Since the bus operated primarily for the benefit of the
association’s member, the revenue ruling concluded that the association did not qualify for
exemption under section 501(c)(4) of the Code.

In Rev. Rul. 73-349, 1973-2 C.B. 179, an organization was formed to purchase groceries for
its membership at the lowest possible prices. It received orders from its members, consolidated
them, and purchased the food in quantity. Each member paid for the cost of his food, and each
member was assessed an equal monthly service charge for the monthly operating cost.
Membership was open to all individuals in a particular community. This revenue ruling stated
that the organization was a private cooperative enterprise for the economic benefit or
convenience of its members. Citing Commissioner v. Lake Forest, Inc., this ruling stated that the
organization operated primarily for the private benefit of members. Any benefits to the
community were not sufficient to meet the requirement of the regulations that the organization
operate primarily for the common good and general welfare of the people of the community.
Accordingly, it did not qualify for exemption under section 501(c)(4) of the code.

In Vision Service Plan v. United States, 956 A.F.T.R.2d 2005-7440 (E.D. Cal. 2005), VSP
Parent requested a ruling by means of a motion for summary judgment that it is a social welfare
organization under section 501(c)(4). The motion for summary judgment took place in the
context of a suit for a refund of its 2003 income tax payment. The government asked for
summary judgment in the refund suit on the grounds that VSP does not qualify for exemption
under section 501(c)(4.)

The District Court found that VSP provides eyecare health coverage and related benefits to its
members (enrollees) through participating employers (subscribers). VSP was required, under
summary judgment practice, to demonstrate to the court’s satisfaction that its operation were
primarily for the promotion of social welfare and, further, that it was not organized for profit.
While VSP maintained that it provided charity care to many non-enrollees, the District Court
found that the number of these services was relatively small and did not establish VSP as
primarily engaged in promoting social welfare.

Regarding the promotion of social welfare, the District Court concluded that VSP did not
establish that they were primarily engaged in promoting social welfare, holding:

In sum these [charity and community] programs and services do not
demonstrate that VSP is primarily engaged in the promotion of social welfare.
While VSP does contribute to the betterment of society, like the organization in
Lake Forest, it is a “publicly spirited but privately-devoted endeavor.” Lake
Forest, 305 F.2d at 818. VSP’s work “incidentally redounds to society but this is
not the “social welfare” of the tax statute.”

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

Put directly, the court must conclude that VSP’s services are most beneficial to
private paying members, the subscribers and the enrollees. Like the members of
the plumbers cooperative in Contracting Plumbers, members of VSP enjoy the
benefit of VSP’s services precisely to the extent that members use and pay for the
services. Contracting Plumbers, 488 F.2d at 687. Serving the interests of these
private subscribers is clearly a non-exempt purpose. This non-exempt purpose
destroys VSP’s exemption status, regardless of the number or importance of truly
exempt purposes.

Regarding if VSP was organized as a non-profit and operates like one, the District Court
concluded that VSP carries on business with the public “in a manner similar to organizations
which are operated for profit,” holding:

This issue, however, is not whether plaintiff is a nonprofit corporation for
corporation law purposes, but whether it is one for federal tax purposes.

To qualify for an exemption under 501(c)(4), an organization must
establish that it operates exclusively for the promotion of social welfare.
According to the Treasury regulations, an organization is not operated primarily
for the promotion of social welfare if its primary activity is “carrying on a
business with the general public in a manner similar to organizations which are
operated for profit.” 26 C.F.R. §1.501(c)(4)-1(a)(2)(ii). Moreover, a corporation
that devotes much of its revenue to improving its ability to compete commercially
through accumulation of large surpluses and expansion of its income producing
facilities is not entitled to exemption under Section 501(c)(4). People’s
Educational Camp Soc, Inc. v. C.I.R., 331 F.2d 923, 932 [13 AFTR 2d 1319] (2d

Cir.1964).

VSP engages in cost-cutting measures common to for-profit
businesses...

Second, VSP strives to remain competitive in ways that do not appear to
be consistent with the operations of a non-profit.

The Ninth Circuit Court of Appeals affirmed the District Court’s opinion, concluding that:

VSP is not operated exclusively for the promotion of social welfare because it
is not primarily engaged in promoting the common good and general welfare of
the community. See 26 C.F.R. §1.501(c)(4)-1(a)(2)(i) (“An organization 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.”) While VSP offers some public benefits, they are not enough for

Form 886-A(Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -7-

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20xx and
forward

us to conclude that VSP is primarily engaged in promoting the common good and
general welfare of the community.

The government contends that ORG, Inc. is not operating for the promotion of social
welfare, and is operated more like a business for profit; i.e., the same reasons supplied by the
District Court’s holding with regard to Parent .

Parent and its subsidiaries, including ORG, Inc., operate in substantially the same
manner. The subsidiaries, including ORG, Inc., operate under the control and direction of Parent
. They engage in the same activities, same fee structure and the same manner of operations. The
mix of subscriber information with regard to ORG, Inc. is not materially different from the mix
of subscriber information with regard to Parent. Parent and the subsidiary have not significantly
changed its manner of operation between 19xx and 20xx.

For the FYE December 31, 20xx, the Subsidiaries have filed their 1120’s on a consolidated basis
with Parent . The Subsidiaries should have begun to file Form 1120’s effective for years
beginning 1/1/20xx.

Letter Ruling concluded that the Parent was not primarily engaged in promoting the common
good and general welfare of the people of the community within the meaning of section
1.501(c)(4)-1(a)(2). We have concluded that the affiliates were engaged in substantially the same
activities as those of the parent, and therefore conclude that the affiliates were not primarily
engaged in promoting the common good and general welfare of the people of the community
within the meaning of section 1.501(c)(4)-1(a)(2) of the regulations. Furthermore, the operations
benefit almost exclusively its enrollees and its activities are not distinguishable from the same
activities carried on by a business operated for profit.

In Vision Service Plan v. United States, which was also upheld by the appellate court, the
District Court appropriately concluded that Parent is not primarily engaged in the promotion of
social welfare. The logical inference is that the ruling with respect to Parent applies to its
integrated subsidiaries, like ORG, Inc., with equal force. Their services are most beneficial to the
paying members, subscriber, and enrollees; in addition, its primary activity is “carrying on a
business with the general public in a manner similar to organizations which are operated for
profit” business with the public.

Conclusion:

Revocation of the ORG, Inc. tax-exempt status is warranted effective the same date as the
parent, 12/31/20xx. The F4549 reflects adjustments to tax for the years open by statute of
limitations; FYE December 31, 20xx to December 31, 20xx.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -8-