The LA Times reported on March 18, 2015, that one of California’s biggest health insurers, Blue Shield of California, had lost its tax-exempt status. The report came after California’s Franchise Tax Board quietly revoked Blue Shield’s state tax-exempt status back in August 2014. One of the biggest reasons for doing so was because of Blue Shield’s huge financial reserves.

Blue Shield, founded in 1939, has approximately 3.4 million customers, 5,000 employees, and posted $13.6 billion in revenue last year. It is classified as a tax-exempt organization under California law, but is a 501(m) entity under federal law, which is subject to a lower federal tax than their for-profit counterparts, but not entirely tax-exempt.

The nonprofit built up about $4.2 billion in reserves at the end of 2014, which is four times as much as the Blue Cross Blue Shield Association requires its member insurers to hold to cover future claims. The unusual action to pull an entity’s tax-exempt status came after a lengthy state audit that looked at the justification for Blue Shield’s taxpayer subsidy.

Michael Johnson, who resigned from Blue Shield as the public policy director after 12 years at the company, stated he had become more and more troubled because Blue Shield had been operating like a for-profit company. Johnson has started an online petition demanding that Blue Shield “pay back the billions you owe Californians.” As of the date of this blog, approximately 11,400 people have signed the petition.

Blue Shield commented that it “as a company and management team firmly believes it is fulfilling its not-for-profit mission and commitment to the community.” It plans to appeal the decision of the Franchise Tax Board.

California’s decision to revoke Blue Shield’s tax-exempt status may have a significant ripple effect on hospitals and health systems. Indeed, scrutiny has been increasing in this area. For example, in 2013, the former Mayor of Pittsburgh, Luke Ravenstahl, sued UPMC, an integrated global nonprofit health enterprise, to revoke its tax-exempt status. The city argued that UPMC did not meet the requirements of an institution of purely public charity because it did not provide enough benefit to the city’s poorest residents. In 2011, the Illinois Department of Revenue denied long-pending requests for tax exemptions from Prentice Women’s at Northwestern Memorial Hospital in Chicago, Edward Hospital in Naperville, and Decatur Memorial Hospital in that Decatur. The decision stated that the properties were not owned by charitable organizations and were not being used for charitable purposes but did not elaborate on how it came to that conclusion.

Most recently, in Connecticut, a bill which would require nonprofit hospitals to pay property taxes was introduced. The bill is still up in the air and has not been signed into law.

Although some tax experts have opined that the Blue Shield decision is not significant because it only affects state taxes, hospitals should still be cognizant of the effect that a loss or denial of tax-exempt status could cause, as there is a potential for hospitals to have to shell out a significant amount of money in annual property taxes. Such uncertainties could ultimately affect a hospital’s future development. For example, hospitals may be faced with questions such as whether or not to build a new hospital wing, or buy a new piece of equipment – simply because they would have to guess at what their bottom line would be next year. Smaller hospitals with very little operating margin would feel the effects of such revocation even more.

If you have any questions, contact one of our healthcare attorneys.