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IRS Releases Guidance on Private Business Use Limitation for ACOs

IRS Releases Guidance on Private Business Use Limitation for ACOs

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The Internal Revenue Service (“IRS”) issued Notice 2014-67 (“Notice”) on October 24, 2014 which expands the safe harbor provisions of Revenue Procedure 97-13 regarding certain management contracts.

In the Notice the IRS states, “The Internal Revenue Service (“IRS”) is considering the application of the provisions of the Internal Revenue Code (“Code”) governing tax-exempt bonds to arrangements entered into by hospitals or other health care organizations participating in the Medicare Shared Savings Program (“Shared Savings Program”) described in §§3022 and 10307 of the Patient Protection and Affordable Care Act, Pub. L. 111-148, 124 Stat. 119 (“Affordable Care Act”), enacted March 23, 2010. This notice provides interim guidance for determining whether a State or local government entity or an organization described in §501(c)(3) of the Code that benefits from tax-exempt bond financing will be considered to have private business use of its bond-financed facilities under §141 or §145(a)(2)(B) of the Code as a result of its participation in the Share Savings Program through an accountable care organization (“ACO”).”


Revenue Procedure 97-13 sets forth conditions under which a management contract does not result in private business use under Internal Revenue Code (“IRC”) §141(b). The Revenue Procedure also applies to determinations of whether a management contract causes the test in IRC §145(a)(2)(B) to be met for qualified IRC §501(c)(3) bonds.

Private business use occurs when a qualified user, generally the borrower or issuer of the tax-exempt bond, which includes any State or local government or IRC §501(c)(3) tax-exempt organization, enters into a management contract with a for-profit organization or service provider. Any IRC §501(c)(3) organization that finances its projects with tax-exempt bonds risks losing its tax-exempt bond financing if the percentage of business use exceeds a certain threshold. This is determined by the private business use test which places the threshold at more than 10% (5% for an IRC §501(c)(3) tax-exempt organization) of the proceeds being used in a trade or business of a private person at the facility in question. It remains unclear whether or not tax-exempt hospitals or healthcare organizations participating in an ACO utilizing tax-exempt bond financing represents a private business use arrangement. The Notice provides guidance for tax-exempt organizations to follow for clarification in these situations.

Interim Guidance on ACO Participation in Shared Savings Program

Participation by a user of a healthcare facility financed with tax-exempt bonds in the Medicare Shared Savings Program (“MSSP”) through an ACO that includes nongovernmental participants must be structured so as to not result in private business use of the facility that exceeds the threshold amount. Any IRC §501(c)(3) organizations entering into these types of transactions should take this into consideration to avoid any tax-exempt status issues or creation of any unrelated trade or business income. The Notice specifies that private business use will not result if all of the following conditions are met:

  1. The terms of the qualified user’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 negotiated at arm’s length;
  2. Centers for Medicare and Medicaid Services has accepted the ACO into, and has not terminated the ACO from, the MSSP;
  3. The qualified user’s share of economic benefits derived from the ACO (including its share of MSSP payments) is proportional to the benefits or contributions the qualified user provides to the ACO. If the qualified user receives an ownership interest in the ACO, the ownership interest received is proportional and equal in value to its capital contributions to the ACO and all ACO returns of capital, allocations, and distributions are made in proportion to ownership interests;
  4. The qualified user’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 qualified user is entitled;
  5. All contracts and transactions entered into by the qualified user 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; and
  6. The qualified user does not contribute or otherwise transfer the property financed with tax-exempt bonds to the ACO unless the ACO is an entity that is a governmental person, or in the case of qualified IRC §501(c)(3) bonds, either a governmental person or an IRC §501(c)(3) organization.

Additional New Rules

A qualified user of hospitals and healthcare facilities that are financed with tax-exempt bonds typically enters into management agreement contracts with nongovernmental persons, such as physicians, to provide healthcare services at the facility. Contracts of this type should be structured to avoid any private business use issues. The Notice provides increased flexibility as to who is deemed to be a qualified user, allowing them to enter into five-year contracts without requiring the contract to contain any such termination clause, as previously contained in Revenue Procedure 97-13.

Additionally, the Notice expands upon the various types of permitted productivity rewards and arrangements specified in Revenue Procedure 97-13 that do not result in private business use, provided all other requirements of the Revenue Procedure are met. A productivity reward will be permitted if:

  1. The eligibility for the productivity award is based on the quality of the services provided under the management contract, rather than increases in revenues or decreases in expenses of the facility; and
  2. The amount of the productivity award is a stated dollar amount, a periodic fixed fee, or a tiered system of stated dollar amounts or periodic fixed fees based solely on the level of performance achieved with respect to the applicable measure.


The Notice is applicable to tax-exempt bonds sold on or after January 22, 2015, however, may be applied to bonds sold before that date. The new safe harbor rules apply to management contracts entered into, materially modified, or extended (other than pursuant to a renewal option) on or after January 22, 2015, however, may also be applied to contracts entered into before that date.

The IRS understands that governmental persons (as defined in IRS Treasury Regulation §1.141-1(b)) and IRC §501(c)(3) organizations typically will be participating in the MSSP through ACOs with nongovernmental persons. The IRS further understands that this participation may take a variety of forms, including membership in a nonprofit corporation, ownership of shares in a corporation, a partnership interest in a partnership, and a membership interest in an LLC.

Under the private business use test described above, participation by a user of a healthcare facility financed with tax-exempt bonds in the MSSP through an ACO that includes participants that are nongovernmental persons should be structured so as not to result in private business use of the facility. In addition, any IRC §501(c)(3) organization using a facility financed with tax-exempt bonds must structure its participation in an ACO so that its participation neither jeopardizes its IRC §501(c)(3) tax-exempt status nor causes it to be engaged in an unrelated trade or business under IRC §513(a).

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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your individual facts and circumstances.

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