26 U.S.C. § 833 — Treatment of Blue Cross and Blue Shield organizations, etc.

(a) General rule. For an organization covered by this section: (1) Treated as stock company. The organization is taxed under this part as if it were a stock insurance company. (2) Special deduction allowed. The deduction calculated under subsection (b) is allowed for each taxable year. (3) Reductions in unearned premium reserves not to apply. In section 832(b)(4)(B), “100 percent” is substituted for “80 percent.” Section 832(b)(4)(C) does not apply. (b) Amount of deduction. (1) In general. Unless paragraph (2) limits it, the deduction for a taxable year is the excess, if any, of (A) 25 percent of the total of (i) claims incurred and liabilities incurred under cost-plus contracts during the year, plus (ii) expenses incurred administering, adjusting, or settling claims or administering cost-plus contracts, over (B) the adjusted surplus at the beginning of the year. (2) Limitation. The deduction may not exceed the organization’s taxable income for the year, calculated without this deduction. (3) Adjusted surplus. (A) In general. Beginning-of-year adjusted surplus equals the preceding year’s beginning adjusted surplus, increased by adjusted taxable income for that preceding year or decreased by adjusted net operating loss for that preceding year. (B) Special rule. For the organization’s first taxable year beginning after December 31, 1986, adjusted surplus is its surplus at the beginning of that year. “Surplus” means total assets minus total liabilities as shown on the annual statement. (C) Adjusted taxable income. This means taxable income calculated without this subsection’s deduction, without a carryforward or carryback to the year, and with gross income increased by net exempt income for the year. (D) Adjusted net operating loss. This means the net operating loss calculated using the adjustments in subparagraph (C). (E) Net exempt income. This means (i) tax-exempt interest received or accrued during the year, reduced by any amount not otherwise deductible that would have been deductible if the interest were taxable, plus (ii) the total deductions allowed for the year under sections 243 and 245. The amount under clause (ii) is reduced by any decrease in deductions allowed because of section 832(b)(5)(B), to the extent the decrease is attributable to deductions under sections 243 and 245. (4) Only health-related items taken into account. Every calculation under this subsection must consider only items attributable to the taxpayer’s health-related business. (c) Organizations to which section applies. (1) In general. This section applies to (A) an existing Blue Cross or Blue Shield organization and (B) another organization meeting paragraph (3). (2) Existing Blue Cross or Blue Shield organization. This means a Blue Cross or Blue Shield organization that (A) existed on August 16, 1986, (B) was determined exempt from tax for its last taxable year beginning before January 1, 1987, and (C) had no material change in its operations or structure after August 16, 1986, and before the end of the taxable year. To the extent the Secretary permits, a successor to a qualifying organization, and an organization formed by merger or consolidation of organizations that each qualified, is treated as an existing Blue Cross or Blue Shield organization. (3) Other organizations. (A) In general. An organization qualifies for a taxable year if (i) substantially all its activities provide health insurance; (ii) at least 10 percent of its health insurance, excluding Medicare supplemental coverage, is provided to individuals and small groups; (iii) it offers continuous, full-year open enrollment, including conversions, for individuals and small groups; (iv) its individual policies fully cover high-risk individuals’ pre-existing conditions without a price difference, subject to a reasonable waiting period, and cover people under age 65 without regard to age, income, or employment status; (v) at least 35 percent of its premiums are set on a community-rated basis; and (vi) no part of its net earnings benefits a private shareholder or individual. (B) Small group defined. “Small group” means the lesser of 15 individuals or the number of individuals that applicable State law requires for a small group. This section does not define “community-rated basis.” (C) Special adjusted-surplus rule. For subsection (b), a qualifying organization’s adjusted surplus at the beginning of the first taxable year for which it qualifies is its surplus at that time. (4) Treatment as existing Blue Cross or Blue Shield organization. (A) General rule. Paragraph (2) applies to an organization described in subparagraph (B) as if that organization were a Blue Cross or Blue Shield organization. (B) Applicable organization. This means an organization organized under and governed by State laws specifically and exclusively for nonprofit health insurance or health-service organizations, and that is not a Blue Cross or Blue Shield organization or a health maintenance organization. (5) Nonapplication in case of low medical loss ratio. Despite the preceding paragraphs, subsection (a)(2) and (3) do not apply unless, during the taxable year, the organization spent at least 85 percent of total premium revenue on clinical-service reimbursement and activities that improve the quality of health care provided to enrollees under its policies, as reported under section 2718 of the Public Health Service Act.