Memorial Hermann v. CIR

Case: 23-60608 Document: 58-1 Page: 1 Date Filed: 10/28/2024

United States Court of Appeals

for the Fifth Circuit United States Court of Appeals

Fifth Circuit

____________ FILED

October 28, 2024

No. 23-60608 Lyle W. Cayce

____________ Clerk

Memorial Hermann Accountable Care Organization,

Appellant,

versus

Commissioner of Internal Revenue,

Appellee.

______________________________

Appeal from the United States Tax Court

Agency No. 4412-22X

______________________________

Before Southwick, Haynes, and Douglas, Circuit Judges.

Haynes, Circuit Judge:

Memorial Hermann Accountable Care Organization (“MHACO”)

appeals from a judgment of the United States Tax Court, which rejected

MHACO’s claim that it is an organization described in I.R.C. § 501(c)(4)

and thus exempt from federal income tax. We conclude that MHACO is

not entitled to a § 501(c)(4) tax exemption and therefore AFFIRM.

I. Background

A. MHACO and the Medicare Shared Savings Program

MHACO is a nonprofit corporation formed under Texas law in 2012.

Since then, it has participated as an “accountable care organization,” or

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ACO, in the Medicare Shared Savings Program (“MSSP”), a program

established under the Patient Protection and Affordable Care Act. 42 U.S.C.

§ 1395jjj(a)(1)(A). ACOs are groups of health care providers who “work

together to manage and coordinate care” for Medicare beneficiaries. Id. If

an ACO satisfies cost-savings benchmarks established by the Secretary of

Health and Human Services, the ACO is eligible to share in the savings

thereby achieved for the Medicare program. See id. § 1395jjj(d)(2).

Of the patients assigned to MHACO, approximately 10% are part of

MSSP. An additional 9% are covered by Medicare Advantage Plans

administered by commercial insurers. The remaining 81% are covered by

employer-sponsored health plans through commercial insurers. MHACO

provides no services for people without insurance.

The proportion of MHACO’s annual revenue that derives from

MSSP varies year to year. For example, in fiscal year 2014, none of

MHACO’s $7.8 million in revenue came from MSSP. The next year,

however, 87% of MHACO’s $32.8 million in revenue derived from MSSP.

MHACO claims that 65% of its revenue over the course of its life was

generated by its MSSP activities.

B. Procedural History

I.R.C. § 501(a) provides that an organization described in § 501(c) is

generally exempt from federal income tax.1 MHACO believes that it

qualifies as an organization described in § 501(c)(4), i.e., that it is an entity

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1

I.R.C. § 501(a) is the statutory provision that provides the exemption for

organizations described in § 501(c). For brevity’s sake, we refer in this opinion to the tax

exemption as being “under” § 501(c)(3) or (c)(4).

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“not organized for profit but operated exclusively for the promotion of social

welfare.” I.R.C. § 501(c)(4)(A) (emphasis added).2

Accordingly, MHACO filed with the Internal Revenue Service an

application for recognition as an organization described in § 501(c)(4). The

IRS issued a proposed adverse determination letter concluding that

MHACO did not qualify for a § 501(c)(4) tax exemption. Over MHACO’s

protest, the IRS Independent Office of Appeals then issued a final adverse

determination letter denying the tax exemption and concluding that

MHACO is “not organized and operated for the purposes of promoting the

social welfare and providing a community benefit.”

MHACO timely petitioned the tax court for a declaratory judgment

that it is exempt from income taxes under § 501(c)(4). The tax court upheld

the IRS’s determination, concluding that MHACO’s “non-MSSP

activities primarily benefit its commercial payor and healthcare provider

participants, rather than the public, and therefore constitute a substantial

nonexempt purpose.” MHACO filed two motions to vacate or revise,

which the tax court denied. MHACO then timely appealed. See Fed. R.

App. P. 13(a)(1).

II. Jurisdiction & Standard of Review

As required by I.R.C. § 7428(b)(2), MHACO exhausted

administrative remedies available within the IRS before filing its petition

with the tax court. The tax court had jurisdiction over the petition under

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2

Subparagraph (B) provides that subparagraph (A) “shall not apply to an entity

unless no part of the net earnings of such entity inures to the benefit of any private

shareholder or individual.” I.R.C. § 501(c)(4)(B). The parties do not contend that part of

MHACO’s net earnings inures to the benefit of a private individual or shareholder, so we

do not further discuss subparagraph (B).

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I.R.C. §§ 7428(a)(1)(E) and 7442. We have jurisdiction over this appeal

under I.R.C. § 7482(a)(1).

In an appeal of a final judgment entered by the tax court, we review

findings of fact for clear error and legal conclusions de novo. Nationalist

Movement v. Comm’r, 37 F.3d 216, 219 (5th Cir. 1994) (per curiam). “A

finding that a corporation is not operated exclusively for charitable purposes

cannot be disturbed unless clearly erroneous.” Id.

III. Discussion

MHACO raises three issues on appeal. First, it argues that the tax

court applied the wrong legal standard to the question whether MHACO

qualifies as a § 501(c)(4) organization. Second, MHACO contends that the

tax court’s review of the IRS’s § 501(c)(4) determination extended beyond

its appropriate scope. Third, MHACO argues that the tax court improperly

concluded that MHACO’s non-MSSP activities disqualify it from

exemption under § 501(c)(4). We address each issue in turn.

A. Legal Standard

To determine whether MHACO qualifies as an organization

“operated exclusively for the promotion of social welfare,” I.R.C.

§ 501(c)(4)(A) (emphasis added), the tax court applied a “substantial

nonexempt purpose” test. MHACO argues that the tax court instead

should have applied the “primary purpose” test found in 26 C.F.R.

§ 1.501(c)(4)-1(a)(2)(i), which MHACO contends is distinct from the

substantial nonexempt purpose test. Our court has not previously decided

the legal standard applied specifically to § 501(c)(4).

The substantial nonexempt purpose test comes from Better Business

Bureau of Washington, D.C. v. United States, a case in which the Supreme

Court construed § 811(b)(8) of the Social Security Act (“SSA”). 326 U.S.

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279, 283 (1945). SSA § 811(b)(8) provided a tax exemption to certain entities

“organized and operated exclusively for . . . educational purposes.” Id. at 280

n.1 (emphasis added) (quoting SSA § 811(b)(8)). The Court concluded that

to fall within SSA § 811(b)(8), “an organization must be devoted to

educational purposes exclusively,” which “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.” Better Bus. Bureau, 326 U.S. at 283 (emphasis added).

This “substantial nonexempt purpose” test governs cases under

I.R.C. § 501(c)(3). See, e.g., Nationalist Movement, 37 F.3d at 220. Indeed,

the SSA provision construed by the Court in Better Business Bureau was

“identical in relevant respects to . . . section 501(c)(3).” Alive Fellowship of

Harmonious Living v. Comm’r, 47 T.C.M. (CCH) 1134, 1140 (T.C. 1984).

This case involves § 501(c)(4), which exempts entities “operated

exclusively for the promotion of social welfare.” Although that provision and

§ 501(c)(3) both use the exact same phrase of “operated exclusively” which

was interpreted by the Supreme Court in Better Business Bureau, MHACO

argues that Better Business Bureau does not apply here. MHACO contends

that the proper test is found in 26 C.F.R. § 1.501(c)(4)-1(a)(2)(i), a Treasury

Department regulation, which provides that an organization is eligible for

exemption under § 501(c)(4) if it is “primarily engaged in promoting in some

way the common good and general welfare of the people of the community.”

MHACO calls this the “primary purpose” test.

We disagree. It makes little sense to treat the same phrase differently

in two neighboring paragraphs of the same statute. See United States ex rel.

Vavra v. Kellogg Brown & Root, Inc., 848 F.3d 366, 381–82 (5th Cir. 2017)

(stating that a “word or phrase is presumed to bear the same meaning

throughout a text” (quoting Antonin Scalia & Brian A. Garner,

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Reading Law 170 (2012))). Importantly, we no longer are required to

provide “Chevron deference” to the Treasury’s interpretation of § 501(c)(4)

(although we can certainly consider it). See Loper Bright Enters. v. Raimondo,

144 S. Ct. 2244, 2273 (2024), overruling Chevron U.S.A. Inc. v. Nat. Res. Def.

Council, Inc., 467 U.S. 837 (1984). But even considering the Treasury’s view,

it, as party to this case through the Commissioner of Internal Revenue, argues

that the substantial nonexempt purpose and primary purpose tests are not

meaningfully different, as both tests interpret the phrase “operated

exclusively,” which appears in both § 501(c)(3) and § 501(c)(4). Thus, the

Treasury does not think that § 501(c)(4) is looser than § 501(c)(3).

Cases from other circuits have endorsed the substantial nonexempt

purpose test from Better Business Bureau in the § 501(c)(4) context. E.g.,

People’s Educ. Camp Soc’y Inc. v. Comm’r, 331 F.2d 923, 931 (2d Cir. 1964)

(explaining that a single nonexempt purpose, if substantial in nature, takes

away the exemption); Comm’r v. Lake Forest, Inc., 305 F.2d 814, 815, 820

(4th Cir. 1962) (quoting Better Business Bureau and reversing tax court

judgment that respondent was “operated exclusively for the promotion of

social welfare” under § 501(c)(4) predecessor); Mut. Aid Ass’n of Church of

the Brethren v. United States, 759 F.2d 792, 796 (10th Cir. 1985) (holding that

the “presence of a substantial non-exempt purpose” precludes “exempt

status as an organization primarily engaged in the promotion of the social

welfare”). Further, MHACO cites no case explicitly refusing to apply the

substantial nonexempt purpose standard in the § 501(c)(4) context.

MHACO asks us to ignore the textual parallels between § 501(c)(3)

and (c)(4) in favor of sparse legislative history and an inference about

legislative intent based on the fact that § 501(c)(3) organizations receive

more favorable tax treatment than their § 501(c)(4) counterparts. But “the

Supreme Court has repeatedly and emphatically rejected the use of

legislative history where the text is unambiguous.” United States v.

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Palomares, 52 F.4th 640, 646 (5th Cir. 2022), cert. denied, 144 S. Ct. 1092

(2024). The Better Business Bureau decision shows that the word

“exclusively,” at least as used in § 501(c)(3), “plainly means that the

presence of a single non-[exempt] purpose, if substantial in nature, will

destroy the exemption regardless of the number or importance of truly

[exempt] purposes.” 326 U.S. at 283 (emphasis added). Congress chose to

use identical language in § 501(c)(4). Thus, assuming arguendo that the

relevant legislative history or legislative intent supports MHACO’s

position, such history or intent cannot override the unambiguous text here.

MHACO additionally relies on other documents, including the

Internal Revenue Manual, indicating the IRS has previously applied the

primary purpose test to § 501(c)(4) determinations. As noted above, the

IRS’s embrace of a legal standard cannot supplant our independent

interpretation of the statutory text. See Loper Bright Enters., 144 S. Ct. at

2273. Nor do these prior statements bind the IRS. See, e.g., Est. of Duncan

v. Comm’r, 890 F.3d 192, 200 (5th Cir. 2018) (stating the Internal Revenue

Manual “is not legally binding”).

We therefore reject MHACO’s argument that the tax court applied

the wrong legal test. Since § 501(c)(3) and (c)(4) both use the crucial phrase

“operated exclusively,” the Better Business Bureau standard applies under

both provisions.3 Accordingly, we decline to disturb the judgment of the tax

court on the ground that it applied the incorrect legal standard.

B. Scope of Review

MHACO next argues that the tax court exceeded the proper scope of

review of the IRS’s § 501(c)(4) determination. MHACO reads the IRS’s

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3

In any event, in this particular case, applying either test—“substantial

nonexempt” or “primary purpose”—would lead to the same result anyway.

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final adverse determination letter as rejecting the substantial nonexempt

purpose test, as the letter said an organization exempt under § 501(c)(4)

“may engage in substantial non-exempt activities since the test for

exemption . . . is one of primary activities.” The tax court thus, according to

MHACO, should not have upheld the IRS’s determination on the basis of

the substantial nonexempt purpose test. See Global Van Lines, Inc. v.

Interstate Com. Comm’n, 714 F.2d 1290, 1298 (5th Cir. 1983) (stating that

“[t]he grounds upon which an administrative order must be judged are those

upon which the record discloses that its action was based” (alteration in

original) (quoting SEC v. Chenery Corp., 318 U.S. 80, 87 (1943))).

Importantly, despite that statement in the letter, we read the

statement in context and conclude that on the whole, the IRS’s reasoning is

consistent with the tax court’s reasoning. The final adverse determination

letter extensively discussed Vision Service Plan v. United States, No. 2:04-CV-

1993, 96 A.F.T.R.2d (RIA) 2005-7440, 2005 WL 3406321, at *4 (E.D. Cal.

Dec. 12, 2005), quoting that case for the proposition that the “presence of a

single substantial non-exempt purpose precludes exempt status regardless of

the number or importance of the exempt purpose.” Vision Serv. Plan, 2005

WL 3406321, at *4 (quotation omitted), aff’d, 265 F. App’x 650 (9th Cir.

2008). The tax court’s inquiry accordingly did not exceed its proper scope.

C. Qualification Under § 501(c)(4)

The remaining issue is the ultimate question whether the tax court

erred in determining that MHACO does not qualify as a § 501(c)(4)

organization. We may only disturb the factual findings underlying this

conclusion if we conclude that they were clearly erroneous. See Nationalist

Movement, 37 F.3d at 219. Further, MHACO bears the burden to establish

that it is entitled to a tax exemption. See id. at 220; Haswell v. United States,

500 F.2d 1133, 1140 (Ct. Cl. 1974) (“Tax exemptions are matters of

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legislative grace and taxpayers have the burden of establishing their

entitlement to exemptions.”).

MHACO contends that the tax court improperly concluded that

MHACO is not “operated exclusively for the promotion of social welfare”

within the meaning of § 501(c)(4). It argues that its operations are intended

to increase the quality and lower the cost of health care for the greater

Houston community and that any benefits accruing to insurance companies,

private payors, and private providers are merely incidental.

We disagree. Many private enterprises have salutary effects on the

greater community. That alone does not entitle them to a federal income tax

exemption. Here, MHACO’s care-coordination services are not offered to

the greater Houston community; rather, they are provided to people with

health insurance.4 Similarly, MHACO contends that its private insurance

contracts provide it with “otherwise inaccessible patient-level data” used to

“judge the success of the community benefits it aims to deliver,” but it

appears that MHACO only uses this data to benefit its members.

MHACO’s members-only benefits system counsels against a conclusion

that it is “operated exclusively for the promotion of social welfare.” I.R.C.

§ 501(c)(4); cf. Lake Forest, 305 F.2d at 820 (noting that membership in

organization provides opportunities unavailable to individuals acting alone,

which are “advantages wholly proper but nonetheless private gain”);

Contracting Plumbers Coop. Restoration Corp. v. United States, 488 F.2d 684,

687 (2d Cir. 1973) (holding that organization was not tax-exempt under

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4

MHACO does not purport to directly provide services to people without

insurance, but it notes that its parent company, Memorial Hermann Health System,

operates hospitals that are “open to the community, including to the uninsured.”

MHACO, however, cites no authority suggesting that the operations or tax-exempt status

of its parent company should affect our analysis of whether MHACO is eligible for tax

exemption.

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§ 501(c)(4) because it “provides substantial and different benefits to both the

public and its private members”); Vision Serv. Plan, 2005 WL 3406321, at *4

(“It is frequently the case that an organization is found not to qualify under

501(c)(4) because it is operating primarily for the benefit of its members,

rather than for the purpose of benefitting the community as a whole.”).

Further, even if MHACO’s coordinated-care services did benefit

social welfare beyond its membership pool, the magnitude of MHACO’s

commercial activities would still exclude it from tax exemption under

§ 501(c)(4). See Better Bus. Bureau, 326 U.S. at 283. Approximately 80% of

MHACO’s patient population is covered by employer-sponsored health

plans through commercial insurers. Accordingly, the vast majority of

MHACO’s operations pertain to creating cost savings that turn into

revenue for insurance companies, private providers, and private payors.5 To

sum up, MHACO does not assist the entirety of Houston given its lack of

addressing uninsured people who lack Medicare.

MHACO’s direct benefits accrue exclusively to its members, the

vast majority of whom are not a part of MSSP. Based on the evidence in the

record, it is not clear that MHACO’s services even indirectly benefit the

broader community. For these reasons, we hold that the tax court did not

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5

MHACO argues that 65% of its revenue over its lifetime is from MSSP, which

indicates that “the substantial majority of the medical savings MHACO has generated

have been in the public health sector through the MSSP.” We think the patient population

breakdowns may provide a more reliable indicator of MHACO’s “purpose as

demonstrated by the fact of its operations,” People’s Educ. Camp Soc., 331 F.2d at 932,

particularly because contractual differences likely account for at least some of the

differences in MSSP and non-MSSP revenue. Additionally, the revenue split can and

does change year to year. In any event, the fact that more than a third of MHACO’s

revenue comes from its non-MSSP contracts further supports the argument that

MHACO’s commercial activities are a substantial non-exempt purpose that disqualifies it

from tax exemption under § 501(c)(4). Cf. Better Bus. Bureau, 326 U.S. at 283.

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clearly err when it determined MHACO is not “operated exclusively for the

promotion of social welfare.” I.R.C. § 501(c)(4).

IV. Conclusion

For the reasons stated above, we AFFIRM the judgment of the tax

court.

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