IRS Denies Tax-Exemption to Accountable Care Organization

IRS Denies Tax-Exemption to Accountable Care Organization

The January 15, 2016 adverse determination letter, the first of its kind, can have significant effects on other non-MSSP ACOs seeking tax-exemption as well as current tax-exempt organizations that may now have to account for these ACO’s as unrelated business income.

IRS Notice 2011-20

A tax-exempt hospital’s participation in the MSSP (or other similar program) through an ACO will not result in private inurement or private benefit if the following factors are met:

• The terms of the tax-exempt hospital’s participation in the MSSP through the ACO (including its share of MSSP payments or losses and expenses) are set forth in advance in a written agreement for at least three years with the Department of Health and Human Services, negotiated at arm’s length;

• CMS has accepted the ACO into and has not terminated the ACO from the MSSP;

• The tax-exempt hospital’s share of economic benefits derived from the ACO (including its share of MSSP payments) is proportional to the benefits or contributions the hospital provides to the ACO;

• The ownership interest received by the tax-exempt hospital, if any, is proportional and equal in value to its capital contributions to the ACO. All ACO returns of capital, allocation, and distributions are made in proportion to such ownership interest;

• The tax-exempt hospital’s share of the ACO’s losses (including its share of MSSP losses) does not exceed the share of ACO economic benefits to which the hospital is entitled; and

• All contracts and transactions entered into by the tax-exempt hospital with the ACO and the ACO’s participants, and by the ACO with the ACO’s participants and any other parties, are at fair market value.

ACOs and Unrelated Business Income (“UBI”)

The IRS has stated that a tax-exempt organization’s participation in and receipt of payments received from the MSSP through an ACO generally will be considered as a substantially related activity of the organization furthering its charitable purposes and lessening the burdens of government; thus the revenue is not subject to income tax as UBI. In addition, an ACO can conduct activities unrelated to the MSSP (e.g. negotiating with private health insurers on behalf of unrelated parties) without jeopardizing its tax-exempt status. However, the issue of whether or not the revenue generated being treated as UBI will depend based upon all of the relevant facts and circumstances involved.

Non-MSSP ACO

An unidentified non-profit ACO was established to assist a related IRC §501(c)(3) integrated healthcare delivery system (“System”). The ACO aimed to support the system by integrating physicians employed by the system as well as unaffiliated physicians to achieve “clinical care integration, coordination and accountability”.

The integrated ACO stated that they intended to establish an organization which operated in furtherance of the “Triple Aim” established by the Affordable Care Act (“ACA”). The Triple Aim was initially established by the Institute for Healthcare Improvement in 2008. The Triple Aim was developed as a guide for the development of new approaches to address the appropriate delivery of healthcare services. The Triple Aim was intended to correct problems evident in current methods and includes the following three criteria:

• Improve patient experience;
• Improve population health; and
• Reduce per capita cost.

While implementing the goals set forth by the ACA and Triple Aim initiatives, the ACO applying for tax-exemption stated explicitly that they did not intend to participate in the MSSP.

The MSSP addressed in Section 3022 of the ACA, established a Medicare shared savings program that “promotes accountability for the care of Medicare beneficiaries, improves coordination of Medicare fee-for-service items and services and encourages investment in infrastructure and redesigned care processes for high quality and efficient service delivery.” While other organizations have established ACOs outside of the MSSP, they negotiate and execute agreements with commercial payers as a way to obtain similar benefits for non-Medicare patients.

The ACOs lack of participation in the MSSP appears to be what ultimately led to the IRS’ denial of tax-exemption.

IRS Ruling and Denial

After the IRS reviewed the ACOs application for tax-exemption, the IRS issued an initial exemption denial letter in August of 2014. The denial was appealed by the ACO through the IRS’ Tax Exempt and Government Entities Appeal Program. However, the denial letter indicated that the ACOs promotion of health was not itself sufficient for tax-exemption due to their lack of participation in the MSSP.

The IRS reiterated that to qualify for tax-exemption under IRC §501(c)(3), an organization must be both organized and operated exclusively for one or more charitable purposes. While promotion of health is recognized as a charitable purpose, the ACOs lack of participation in the MSSP does not lessen the burden of government, which is also a specified exempt charitable purpose. Additionally, the adverse determination letter addressed the ACOs role in negotiating payer contracts. The IRS stated that the organization’s negotiation with private health insurers on behalf of unrelated providers is not a charitable activity. The IRS noted that the negotiation of these agreements offers incidental benefits to non-System affiliated providers and ultimately determined that the ACO was not operated exclusively for exempt purposes and therefore ineligible for exemption.

Conclusion

This adverse determination seems to set forth a precedent that participation in a MSSP may be a prerequisite in order for an ACO to qualify for tax-exemption. The adverse determination will likely cause potential difficulties for other non-MSSP ACOs seeking tax-exempt status.

The determination letter is included in Private Letter Ruling 201615022 wherein the IRS states that the denial of tax-exemption to the non-MSSP ACO was made for the following reasons:

1. The ACO is not operated exclusively for exempt purposes within the meaning of IRC§501(c)(3) and Treasury Regulation §1.501(c)(3)-1(d). The ACO does not engage primarily in activities that accomplish one or more of the exempt purposes specified in IRC §501(c)(3). More than an insubstantial part of the ACO’s activities are in furtherance of a non-exempt purpose.
2. The ACO is not operated primarily for a public purpose as is required by IRC §501(c)(3) and Treasury Regulation §1.501(c)(3)-1(d)(1)(ii). The ACO operates for the benefit of private interests.

Many integrated healthcare delivery systems have already established and instituted non-MSSP ACOs with the premise that these ACOs further the goals of the ACA and therefore act in furtherance of the healthcare delivery system’s tax-exempt charitable purposes. This adverse ruling and denial of tax-exemption signals that other similarly structured ACOs may be viewed as an unrelated trades or businesses and therefore may potentially be taxed as unrelated business income. Furthermore, these ACOs can potentially threaten the tax-exempt status of the organization that runs these activities through a disregarded entity.

It is imperative that all organizations with non-MSSP ACOs review their activities and independent physician contracts to ensure proper structuring and avoid jeopardizing the tax-exempt status of the ACO.

Private Letter Ruling 201615022

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