Geisinger Health Plan v. C.I.R.

• Decision Date: 27 July 1994
• Docket Number: No. 93-7699,93-7699
• Citation: 30 F.3d 494
• Parties: -5395, 63 USLW 2116, 94-2 USTC P 50,398 GEISINGER HEALTH PLAN, Appellant, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee.
• Court: U.S. Court of Appeals — Third Circuit

Page 494

30 F.3d 494

74 A.F.T.R.2d 94-5395, 63 USLW 2116,

94-2 USTC P 50,398

GEISINGER HEALTH PLAN, Appellant, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee.

No. 93-7699.

United States Court of Appeals, Third Circuit.

Argued May 19, 1994.

Decided July 27, 1994.

Lawrence J. Goode, Frederick J. Gerhart (argued), Melissa B. Rasman, Philadelphia, PA, for appellant.

Gary R. Allen, Teresa E. McLaughlin (argued), U.S. Dept. of Justice, Tax Div., Washington, DC, for appellee.

Before: BECKER and LEWIS, Circuit Judges, and IRENAS, District Judge. ^*

OPINION OF THE COURT

LEWIS, Circuit Judge.

In Geisinger Health Plan v. Commissioner of Internal Revenue, 985 F.2d 1210 (3d Cir.1993) ("Geisinger I "), we held that the Geisinger Health Plan ("GHP"), a health maintenance organization ("HMO"), was not entitled to exemption from federal income taxation as a charitable organization under 26 U.S.C. Sec. 501(c)(3). We remanded the case for determination of whether GHP was entitled to exemption from taxation by virtue of being an integral part of the Geisinger System (the "System"), a comprehensive health care system serving northeastern and northcentral Pennsylvania. We will affirm the Tax Court's decision that it is not exempt as an integral part of the System.

I.

GHP is a prepaid health care plan which contracts with health care providers to provide services to its subscribers. The facts relevant to GHP's function are detailed in our opinion in Geisinger I, and we need not repeat them here. Instead, far more relevant to this appeal is GHP's relationship with the Geisinger System and its other constituent entities, a relationship which we must examine in some detail to decide the issue before us.

The Geisinger System consists of GHP and eight other entities, all involved in some way in promoting health care in 27 counties in northeastern and northcentral Pennsylvania. They are: the Geisinger Foundation (the "Foundation"), Geisinger Medical Center ("GMC"), Geisinger Clinic (the "Clinic"), Geisinger Wyoming Valley Medical Center ("GWV"), Marworth, Geisinger System Services ("GSS") and two professional liability trusts. All of these other entities are recognized as exempt from federal income taxation under one or more sections of the Internal Revenue Code.

The Foundation controls all these entities, as well as three for-profit corporations. It has the power to appoint the corporate members of GHP, GMC, GWV, GSS, the Clinic and Marworth, and those members elect the boards of directors of those entities. The Foundation also raises funds for the Geisinger System. Its board of directors is composed of civic and business leaders in the area.

GMC operates a 569-bed regional medical center. As of March 31, 1988, it had 3,512 employees, including 195 resident physicians and fellows in approved postgraduate training programs. It accepts patients without regard to ability to pay, including Medicare, Medicaid and charity patients. It operates a full-time emergency room open to all, regardless of ability to pay. It also serves as a teaching hospital.

GWV is a 230-bed hospital located in Wilkes-Barre, Pennsylvania. It accepts patients regardless of ability to pay, and it operates a full-time emergency room open to all, regardless of ability to pay.

The Clinic provides medical services to patients at 43 locations throughout the System's service area. It also conducts extensive medical research in conjunction with GMC and physicians who perform medical services for GMC, GWV and other entities in the Geisinger System. As of March 31, 1988, it employed 401 physicians. It accepts patients without regard to their ability to pay.

Marworth operates two alcohol detoxification and rehabilitation centers and offers educational programs to prevent alcohol and substance abuse.

GSS employs management and other personnel who provide services to entities in the Geisinger System.

As we noted in Geisinger I, the Geisinger System apparently decided to create GHP after GMC experimented with a pilot prepaid health plan between 1972 and 1985. The experience was positive, and the Geisinger System formed GHP to provide its own prepaid health plan.

It organized GHP as a separate entity within the System (as opposed to operating it from within the Clinic, GMC or GWV) for three reasons. First, HMOs in Pennsylvania are subject to extensive regulation by the Commonwealth's Departments of Health and Insurance. See generally 40 P.S. Secs. 1551 et seq. Operating GHP separately enables other entities in the System to avoid having to comply with the burdensome requirements associated with that regulation. Second, those administering the System believe it preferable for GHP's organization and management to remain separate from those of the System's other entities because it serves a wider geographic area than any of those other entities. Finally, under Pennsylvania law at least one-third of GHP's directors must be subscribers. 28 Pa.Code Sec. 9.96(a). Establishing GHP as a separate entity avoids disrupting the governance of the other Geisinger System entities to comply with this requirement. For example, establishing an HMO within GMC would have required GMC to canvass its board of directors to ensure that one-third of them subscribed to the HMO. If they did not, GMC would have had to amend its by-laws or other governing documents to add directorships so that one-third of the directors were subscribers. Incorporating GHP separately eliminates the need for such reorganization.

For the year which ended June 30, 1987, GHP generated 8.8 percent of the aggregate gross receipts of the five health care providers ¹ in the Geisinger System. At the time this case was first submitted to the Tax Court, projections indicated that by June 30, 1991, GHP would generate 14.35 percent of the System's aggregate gross receipts. ²

GHP's interaction with other Geisinger System entities is varied. Its most significant contact is with the Clinic, from which it purchases the physician services its subscribers require by paying a fixed amount per member per month, as set forth in a Medical Services Agreement. Eighty-four percent of physician services are provided by doctors who are employees of the Clinic; the remaining 16 percent are provided by doctors who are not affiliated with the Clinic but who have contracted with the Clinic to provide services to GHP subscribers. GHP has similarly entered into contracts with GMC and GWV, as well as 20 non-related hospitals. When GHP's subscribers require hospital care, these hospitals provide it pursuant to the terms of their contracts, for either a negotiated per diem charge or a discounted percentage of billed charges. GHP has also contracted with GSS to purchase office space, supplies and administrative services.

Except in emergency situations, only physicians who either work for the Clinic or have contracted with the Clinic may order that a GHP subscriber be admitted to a hospital. When such admission is ordered, it generally must be to GMC, GWV or one of the 20 other hospitals with which GHP has contracted. The only exceptions to this requirement are in a medical emergency outside of GHP's service area or when approved in advance by GHP's medical director; in those instances, a subscriber may be admitted to a hospital with which GHP has no contractual relationship.

GHP has also entered into contracts with pharmacies, durable medical equipment suppliers, ambulance services and physical therapists. Those entities' services are available to subscribers only (1) in a medical emergency or (2) when prescribed by a doctor who is employed by the Clinic or who is under contract with the Clinic to provide care to GHP subscribers.

The Tax Court considered GHP's role in the Geisinger System when, on remand from Geisinger I, it decided that GHP did not qualify for exempt status under the integral part doctrine. Geisinger Health Plan v. Commissioner of Internal Revenue, 100 T.C. 394, 1993 WL 137137 (1993) ("Geisinger II "). The court first distinguished a series of "group practice cases," in which incorporated groups of doctors on hospital or faculty medical staffs were held to be exempt from taxation as integral parts of the tax-exempt hospitals or medical schools with which they were associated. The Tax Court found that those cases did not control its decision because "[f]or [them] to apply here, the population of [GHP's] subscribers would have to overlap substantially with the patients of the related exempt entities [and t]he facts indicated that it does not." Geisinger II, 100 T.C. at 404. Moreover, it held, GHP was not entitled to tax-exempt status as an integral part of the System because it would produce unrelated business income for the Clinic, GMC or GWV if one of those entities were to absorb its activities. Id. at 404-06. A timely appeal followed; as noted previously, we will affirm, although we will do so on grounds which differ from those on which the Tax Court rested. Specifically, because we deem it unnecessary to decide, we will not reach the issue whether GHP would produce unrelated business income if it were part of some entity created by merging its operations with one of the other Geisinger System entities.

II.

Generally, separately incorporated entities must qualify for tax exemption on their own merits. Mutual Aid Association of the Church of the Brethren v. United States, 759 F.2d 792, 795 n. 3 (10th Cir.1985); cf. Moline Properties, Inc. v. Commissioner of Internal Revenue, 319 U.S. 436, 63 S.Ct. 1132, 87 L.Ed. 1499 (1943). In Geisinger I, we decided that GHP cannot qualify for tax exemption on its own merits. The question before us now is whether it comes within the "integral part doctrine," which may best be described as an exception to the general rule that entitlement to exemption is derived solely from an entity's own characteristics. See Internal Revenue Service ("IRS") brief at 20 (regulation providing...