Earlier this month, the IRS released a denial of an exemption
application for an accountable care organization ("ACO")
outside of the Medicare Shared Savings Program ("MSSP")
that was seeking exemption under section 501(c)(3). This is the
first publicly available IRS ruling on a non-MSSP ACO, and it
confirms that the IRS is not yet persuaded that the private benefit
to physicians from integrated contracting combined with population
health analytics is only incidental to the community benefits of
pursuing better care and better health for patients at lower cost.
This ruling casts doubt on whether ACOs that are not 100 percent
MSSP or Medicaid ACOs can qualify for tax-exempt status. It also
could affect any ACO or clinically integrated network that does not
participate exclusively in MSSP or Medicaid and is structured as an
LLC or partnership in which one or more section 501(c)(3) health
care providers is a member or partner.
The ACO in question was formed as a separate corporation by an
existing nonprofit tax-exempt health care system. The ACO proposed
to create a clinically integrated network of health care providers
that included: (i) physicians employed by the system; (ii)
physicians who are part of independent practice groups and members
of the medical staff of hospitals and facilities affiliated with
the system; and (iii) physicians practicing at hospitals that were
not affiliated with the system. Approximately half of the
physicians in the network were in the last two categories.
To achieve its goals of better care, better health, and lower cost,
the ACO represented the participating providers in negotiating and
executing contracts with third-party payors. The terms of the
contracts would create financial incentives that would reward the
providers for collaborating to provide better care at lower cost
while keeping patients healthier. The ACO also proposed to gather
and analyze data, including clinical data on patients and provider
performance data, to help the participating providers meet the
performance goals and earn the financial incentives.
The IRS concluded that the ACO was operating for the private
benefit of the participating physicians and not exclusively to
promote health for the benefit of the community as a whole.
Therefore, it did not qualify for section 501(c)(3) exemption
because it was not operated exclusively for charitable purposes.
The IRS did not explain how it measured the extent of private
benefit to the physicians relative to the extent of the benefit to
the broader community from the improvement of population health and
health outcomes combined with reduced costs.
This is a single IRS denial letter, and even though it was reviewed
at the national level by the IRS appeals function, it is not
precedential. It is possible that another ACO equipped with more
data on the effectiveness of ACOs in improving population health,
an ACO with a narrower network limited to system employees and
medical staff members, or an ACO that participates in MSSP or
Medicaid and also contracts with commercial payors could persuade
the IRS to rule favorably. The paradigm in health care delivery is
shifting from providing hands-on care to improving population
health and reducing the need for and acuity of care. So far,
however, the IRS seems unprepared to accept this new paradigm of
population health management as an activity that necessarily
promotes the health of a sufficiently broad segment of the
community to satisfy the community benefit standard for exemption
under section 501(c)(3).
In the meantime, section 501(c)(3) tax-exempt health care providers
that are already participating in non-MSSP ACOs should review their
arrangements and assess whether they may need to take action if
their ACO is structured as a pass-through (partnership or LLC taxed
as a partnership). The activities of a pass-through entity are
attributed to the tax-exempt participant for tax purposes as if the
tax-exempt participant were conducting the activities
directly.
Based on the approach in this denial letter, the IRS likely would
treat non-MSSP/non-Medicaid ACO activities as an unrelated trade or
business, making the income received from the ACO subject to
unrelated business income tax. Treating ACO activities as unrelated
also raises the potential for impermissible private use if ACO
activities are taking place in, or ACO participants have special
privileges at, facilities financed with tax-exempt bonds unless a
safe harbor applies. If the ACO activities become a substantial
part of the section 501(c)(3) organization's overall
activities, participation in the ACO also could jeopardize
exemption under the IRS's current approach.
Tax-exempt health care providers may want to assess the scope of
potential unrelated business income from ACO activities and review
compliance with bond financing safe harbors for private use.
Depending on the results of that review, it may be helpful to
restructure participation in the ACO to protect against the risk of
an exemption dispute with the IRS, such as by using a taxable
subsidiary to hold the hospital's interest in an ACO organized
as an LLC or setting up the ACO as a taxable corporation, and/or to
revise any existing contractual arrangements in light of the
private use safe harbors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.