Hospital Corporation of America v. Commissioner
| Citation | 74 T.C.M. 1020 |
| Decision Date | 27 October 1997 |
| Docket Number | Docket No. 10663-91.,Docket No. 13074-91.,Docket No. 28588-91.,Docket No. 6351-92. |
| Parties | Hospital Corporation of America and Subsidiaries v. Commissioner. |
| Court | United States Tax Court |
N. Jerold Cohen, Atlanta, Ga., Randolph W. Thrower, J.D. Fleming, Jr., Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark, Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley, and John W. Bonds, Jr., for the petitioners in Docket No. 10663-91. N. Jerold Cohen, Randolph W. Thrower, J.D. Fleming, Jr., Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark, Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley, John W. Bonds, Jr., and Daniel R. McKeithen, for the petitioners in Docket No. 13074-91. N. Jerold Cohen, Walter H. Wingfield, Stephen F. Gertzman, Amanda B. Scott, Reginald J. Clark, Randolph W. Thrower, Walter T. Henderson, Jr., and John W. Bonds, Jr., for the petitioners in Docket No. 28588-91. N. Jerold Cohen, Reginald J. Clark, Randolph W. Thrower, Walter T. Henderson, Jr., and John W. Bonds, Jr., for the petitioners in Docket No. 6351-92. Robert J. Shilliday, Jr., Vallie C. Brooks, and William B. McCarthy, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
These cases were consolidated for purposes of trial, briefing, and opinion and will hereinafter be referred to as the instant case.1 Respondent determined deficiencies in petitioners' consolidated corporate Federal income tax as follows:
TYE Deficiency
1978 ........................... $ 2,187,079.00
1980 ........................... 388,006.58
1981 ........................... 94,605,958.92
1982 ........................... 29,691,505.11
1983 ........................... 43,738,703.50
1984 ........................... 53,831,713.90
1985 ........................... 85,613,533.00
1986 ........................... 69,331,412.00
1987 ........................... 294,571,908.00
1988 ........................... 25,317,840.00
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The issues to be decided are:
(1) Whether Parthenon Insurance Co. (Parthenon), a wholly owned subsidiary of petitioner Hospital Corporation of America (HCA), is an insurance company within the meaning of the Internal Revenue Code; and
(2) if Parthenon is an insurance company, what portion of its unpaid loss reserves and expenses are deductible pursuant to section 832(c).2
Some of the facts have been stipulated for trial pursuant to Rule 91. The parties' stipulations of fact are incorporated herein by reference and are found as facts in the instant case.
Petitioners are members of an affiliated group of corporations of which HCA is the common parent. HCA was incorporated during 1960 under the laws of the State of Tennessee as Park View Hospital, Inc. During 1968, Park View Hospital, Inc. joined with 11 other hospitals to form HCA. After that date, and through the years in issue, HCA's stock was publicly held and traded on the New York Stock Exchange.3
HCA maintained its principal offices in Nashville, Tennessee, on the date the petitions were filed. For each of the years involved in the instant case, HCA and its domestic subsidiaries filed a consolidated Federal corporate income tax return (consolidated return) on Form 1120 with the Director of the Internal Revenue Service Center at Memphis, Tennessee.
Petitioners' primary business is the ownership, operation, and management of hospitals. Petitioners' hospitals provide health care customarily provided by hospitals. Most of petitioners' hospitals are acute care hospitals providing a facility, personnel, equipment, and medical supplies and pharmaceuticals needed to perform medical and surgical procedures to treat sick or injured persons with various physical disorders. Some of petitioners' facilities are psychiatric hospitals providing medical treatment to persons with mental or emotional disorders and drug and alcohol dependency problems. Additionally, certain petitioners operate a variety of medically-related businesses ancillary to petitioners' primary business.4 A fundamental component of petitioners' business philosophy is the use of their combined purchasing power to obtain goods and services at the lowest possible cost whenever practical to do so.
At the outset of its organization, HCA generally placed all newly constructed or acquired hospitals in separate corporations. In later years, in some cases, HCA placed all newly acquired or newly constructed hospitals located in a particular State in a separate corporation rather than having a separate corporation for each hospital in that State. In a few instances, HCA acquired a group of hospitals that, for various business reasons, were placed in a single corporation or were allowed to remain in the acquired corporation.
During the years ended 1981 through 1988, as of yearend HCA owned the following number of subsidiaries and hospitals, and had the following number of patient beds:
Number of Hospitals Patient
Year Subsidiaries Owned Beds
1981 ......................................... 124 188 29,298
1982 ......................................... 124 186 29,720
1983 ......................................... 126 196 31,393
1984 ......................................... 123 200 32,515
1985 ......................................... 135 230 37,423
1986 ......................................... 122 227 37,490
1987 ......................................... 741 1321 24,0871
1988 ......................................... 74 131 23,849
1 During 1987, pursuant to a plan of reorganization, petitioners divested 104 hospitals from the HCA
organization by selling the stock of the subsidiaries owning those hospitals to HealthTrust, Inc.—The Hospital
Co. See Hospital Corp. of Am. v. Commissioner [Dec. 51,705(M)], T.C. Memo. 1996-559, for a detailed
description of that transaction
Prior to calendar year 1977, petitioners purchased general and professional liability insurance from Continental Insurance Co. (Continental). The hospitals owned by petitioners were not permitted to purchase insurance individually from other sources.
Every State regulates the insurance companies licensed to do business within its borders. Insurance companies that are fully licensed in a particular jurisdiction often are referred to as admitted companies. Admitted insurance companies can insure any insurable risk. Other insurance companies may be licensed to write only on a surplus lines basis; i.e., they are allowed to underwrite only risks that admitted companies in the State do not or will not cover. Admitted insurance companies are required to file annual reports on a calendar year basis with the appropriate State insurance department in a form specified by the National Association of Insurance Commissioners (NAIC).
A line of business refers to a group of insurance policies involving similar risks. Some lines of business, such as workers' compensation, can be written only by admitted carriers. Marketing is the process of selling policies to insureds. Underwriting is the selection and pricing of risks to be insured. The pricing portion of the underwriting function is the process of setting premiums in amounts that are expected to be sufficient to cover insured losses and the expenses of adjusting claims, and the costs of operating the company and any planned underwriting profit. State regulatory agencies limit the premiums that may be written by insurance companies to amounts that are prudent in light of the companies' capitalization. Premiums are usually set by trained underwriters or actuaries, who may be employees or outside consultants. For certain lines of insurance, such as workers' compensation, rates are set by law on the basis of statistical information compiled by rating bureaus, with only specified modifications permitted to take into account the loss experience of the particular employer.
The insurance laws of some States provide for a category of limited purpose insurance companies, popularly called captive insurance companies or captive insurers. Captive insurance company statutes generally apply to companies that insure on a direct basis only the risks of companies related by ownership to the insurer. Because pure captive insurance companies typically are formed for the purpose of insuring the risks of related companies, the function of risk selection, in essence, is attained at the onset.
The State of Colorado's Captive Insurance Company Act (Colorado captive insurance statute) allows the formation of pure captive insurance companies whose authority to write direct insurance business is limited to insuring the risks of related corporations. The Colorado captive insurance statute requires a pure captive insurance company licensed in that State to maintain and to deposit with the commissioner of insurance minimum actual capital of $300,000 and accumulated surplus of $200,000, which deposit may be in the form of an irrevocable letter of credit.
The State of Tennessee's Captive Insurance Company Act (Tennessee captive insurance statute) requires a pure captive insurance company licensed in that State to maintain minimum capital and surplus of $750,000, with the surplus to be at least $350,000. For captive insurance companies, the Tennessee Department of Commerce and Insurance, Division of Insurance (Department of Insurance), requires the ratio of net written premiums to policyholders' surplus (i.e., the net worth of an...
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