If a Code Section 501(c)(3) organization (501(c)(3)) or State or
local government (collectively Exempt Entity) hospital or other
facility financed with tax-exempt bonds has "too much"
private business use of such facility, the bonds will lose their
exempt status. Various arrangements, including partnerships or
management agreements with non-exempt persons can constitute
private business use. There has been a concern that an Exempt
Entity hospital or other healthcare organization with exempt bond
financing participating in an accountable care organization (ACO)
could represent an arrangement that constitutes a private business
use and disqualify the exempt status of the bonds. The IRS has now
confirmed this concern and provided a useful but limited path to
avoid the private business use in the context of ACOs and
management contracts.
On October 24, 2014, the Internal Revenue Service ("IRS")
released Notice 2014-67 (the Notice) which implicitly affirms that
an Exempt Entity's participation in an ACO with non-exempt
persons may constitute a private business use unless the ACO and
the Exempt Entity's participation is carefully structured and
meets the safe-harbor requirements set forth therein. While failure
to comply with Rev. Proc. 97-13's safe-harbors does not, as a
matter of law, automatically mean the arrangement disqualifies the
exempt bonds, it will be a rare organization that will want to test
the waters outside of the arrangements approved by the
Notice.
The Notice provides the first interim guidance for determining the
circumstances under which healthcare tax-exempt bond financed
facilities will or will not be considered to have private business
use in the context of ACOs. The Notice also provides guidance as to
whether a tiered productivity award such as for the achievement of
quality performance standards resulting in participation in the
Medicare Shared Savings Program contemplated under the Affordable
Care Act ("Shared Savings Program") will be considered a
permitted form of compensation under Rev. Proc. 97-13. As the
reader is aware, Rev. Proc. 97-13 is the IRS's primary
pronouncement for determining the types of compensation
arrangements under management contracts between Exempt Entities and
service providers which are permitted under the tax-exempt bond
rules and do not result in private business use. Management
contracts are broadly defined in the Treasury Regulations as a
management, service, or incentive payment contract between an
Exempt Entity and a service provider (for example, physicians and
other healthcare practitioners) under which the service provider
provides services involving all, a portion, or any function of a
facility. The Notice solicits public comments with respect to the
interim guidance as well as further guidance needed to facilitate
participation in the Shared Savings Program.
Under the Internal Revenue Code, governmental bonds or bonds issued
for the benefit of 501(c)(3)s may be issued on a tax-exempt basis
as long as, among other requirements, the bond financed facilities
do not have too much "private business use." In the case
of governmental bonds, too much private use consists of more than
10% of the proceeds being used in a trade or business of a private
person at the facility in question. In the case of a 501(c)(3), too
much private business use consists of more than 5% of the net
proceeds. Private business use generally can be found if the
private user has special legal entitlements to use the tax-exempt
bond financed property, whether through ownership, lease,
management contract or other arrangements.
Private business use is use other than as a member of the general
public by a non-governmental person or by a 501(c)(3) whose
activities at the bond financed facility in question consists of
unrelated trade or business. In the context of an ACO operating at
a tax-exempt bond financed facility, various participants could be
eligible to receive payments under the Shared Savings Program if
the ACO meets certain performance standards and achieves savings
benchmarks established by Centers for Medicare and Medicaid
Services (CMS) against expected average per capita Medicare fee for
services expenditures. Consequently, participation in an ACO might
be deemed some "other arrangement" that could trigger
adverse findings of private business use.
In the Notice, the IRS determined that participation by an Exempt
Entity user in the Shared Savings Program through an ACO itself
will not result in private business use at the facility in question
if the ACO satisfied all of the following conditions:
- The term of the user's participation in the Shared Savings Program are set forth in advance in a written agreement negotiated at arm's length;
- CMS has accepted the ACO and has not terminated the ACO from its Shared Savings Program;
- The user's share of economic benefit derived from the ACO is proportional to the benefits or contributions the user provides the ACO, the ownership interest is proportional and equal in value to its capital contributions to the ACO, and all ACO return of capital, allocations and distributions are made in proportion to such ownership interest;
- The user's share of ACO losses does not exceed the share of ACO economic benefits to which the user is entitled;
- All contracts entered into by the user with the ACO and its participants and any other parties are at fair market value; and
- The user does not contribute or transfer the financed property to the ACO unless the ACO itself is an Exempt Entity.
The Notice contemplates that Exempt Entities may enter into management contracts (as broadly defined) with nongovernmental persons to provide healthcare services at the Exempt Entities' tax-exempt bond financed facilities. The Notice contemplates such contracts will take into account the quality performance and Medicare fee-for-service expenditures relevant to participation in the Shared Savings Programs. Similarly, in evaluating whether a management contract (as broadly defined) entered into with an ACO will give rise to private business use, the Notice amplifies Rev. Proc. 97-13. The Notice provides that participation in a productivity reward for services does not cause the compensation to be deemed to be based on a share of the net profits of the financed facility if certain conditions are met. Generally speaking, management contracts which provide for the service provider to share in the facility's net profits are prohibited. Nevertheless, under the Notice, participation in a productivity reward for services will not be deemed to be a sharing in the net profits of the enterprise in question as long as:
- The eligibility for the productivity award is based on the quality of the services provided under the management contract (for example, achievement of the Medicare Shared Savings Program quality performance standards or meeting the data reporting requirements); and
- 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. Percentage productivity awards as opposed to fixed amounts are not blessed by the Notice! A fixed amount grid may be required rather than a percentage mechanism.
Rev. Proc. 97-13 requires that management contracts with Exempt
Entities must be described in specific subsections of section 5.03
of Rev. Proc. 97-13 to be a contract that does not give rise to
private business use. The Notice amplifies Rev. Proc. 97-13 by
adding a new section 5.03(7) which permits a contract with a term
of five years or less (including all renewal options) to have
compensation based on a stated amount; periodic fixed fee; a
capitation fee; a per unit fee; or a combination of the preceding.
The compensation for services also may include a percentage of
gross revenues, adjusted gross revenues, or expenses of the
facility (but not both revenues and expenses). For this contract, a
tiered productivity award meeting the requirements discussed above,
will be treated as a stated amount or a periodic fixed fee as
appropriate. Such a contract is not required to be able to be
terminable by the Exempt Entity prior to the end of the term.
The Notice thus provides useful guidance that should allow Exempt
Entity healthcare providers and other participants to join an
ACO's Shared Savings Program with assurance that no adverse
tax-exempt bond consequences will be encountered as long as the
conditions set forth in the Notice are satisfied. In addition, the
amplification of Rev. Proc. 97-13 permitting tiered productivity
awards and the management agreement described in new section
5.03(7) therein may also present more compensation flexibility in
the ACO context and in some non-ACO circumstances as the guidance
by its terms is not limited to ACO application.
Basically, participation in a Shared Savings Program is permitted
as long as the allocation of the savings are made in proportion to
the parties' capital accounts, and no disproportionate
allocations are permitted and no losses in excess of the user's
economic benefit in the ACO are permitted. For facilities with
management contracts, it is likely that the amplifications to Rev.
Proc. 97-13 made by the Notice will be particularly useful as it
provides greater flexibility in structuring service provider
compensation arrangements by explicitly permitting the use of a
tiered system of fixed dollar compensation. Importantly,
the use of tiered fixed percentage compensation is not
permitted. The ability to use a sliding scale or grid system based
on achievement of the Shared Savings Program quality performance
standards or meeting data reporting requirements should provide
significantly greater flexibility in determining how service
provider compensation can be structured without running afoul of
the private activity bond rules.
The Notice applies to exempt bonds sold on or after January 22,
2015 and contracts entered into, materially modified, or extended
(other than pursuant to a renewal option) on or after January 22,
2015. The Notice cryptically states that the operative provisions
may be applied to bonds sold or contracts entered into before
January 22, 2015. Presumably this "before" language means
that taxpayers may rely on this guidance for protection for bonds
sold before or contracts entered into before January 22, 2015 which
meet the requirements. It should not mean that bonds sold or
contracts entered into before January 22, 2015 that do not meet the
Notice's requirements are automatically to be challenged by the
IRS on the basis that the requirements were not met.
At a time when many Treasury Regulations are trending toward
restricting opportunities, the welcomed addition of the tiering
structure should prove useful in developing acceptable compensation
packages.
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