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An organization described in section 501(c)(3) or 501(c)(4) can be tax-exempt "only if no substantial part of its activities consists of providing commercial-type insurance," under section 501(m). When it enacted section 501(m) as part of the Tax Reform Act of 1986, Congress was concerned
that certain tax-exempt organizations that provided types of insurance coverage that taxable insurance companies also provided benefited from an unfair tax-based competitive advantage.
The Ways and Means Committee Report for the Tax Reform Act of 1986 stated that the committee
was, concerned that exempt charitable and social welfare organizations that engage in insurance activities are engaged in an activity whose nature and scope is so inherently commercial that tax[-]exempt status is inappropriate.The committee believes that the tax-exempt status of organizations engaged in insurance activities provides an unfair competitive advantage to these organizations.
In Notice 2003-31, the Service indicated that it intends to issue proposed regulations providing guidance under section 501(m). A commercial-type insurance activity of an organization that remains
tax-exempt because only an insubstantial part of its activities consist of providing commercial-type insurance is treated as an "unrelated trade or business" under section 501(m)(2)(A). Such organization is "treated as an insurance company for purposes of applying subchapter L with respect to
such activity."
Section 501(m)(3) provides certain exclusions from commercial-type insurance, including "incidental health insurance provided by a health maintenance organization of a kind customarily provided by such organizations," under section 501(m)(3)(B). This exclusion has been very controversial and is addressed in detail below.
