Is the IRS a Friend or Foe of Accountable Care Organizations?

When Section 3022 of the Patient Protection and Affordable Care Act ("PPACA") was passed in March 23, 2010, it became clear that, in order to establish a Medicare Shared Savings Program ("MSSP"), it would take groups of physicians and other health care practitioners to combine in networks, partnerships or joint ventures with tax-exempt hospitals or health systems to obtain the coverage necessary to achieve the government's goals:  higher quality and health care savings.

The immediate tax question was how the IRS would treat ACOs that intended to split cost savings between exempt organizations and independent physician practices or providers.  Under the Internal Revenue Code Section 501(c)(3) and the relevant Treasury Regulations (Section 1.501(c)(3)-1(c)(2)), an exempt organization is "not operated exclusively for charitable purposes if its net earnings inure in whole or in part to the benefit of private shareholders or individuals".  The question the industry faced when establishing ACOs was whether the split of shared savings between exempt and taxable providers pursuant to the MSSP would (i) jeopardize the exemption of the participating tax-exempt organizations or (ii) create unrelated business taxable income for the exempt organizations.

On March 31, 2011 the IRS issued Notice 2011-20 in which the Service published a set of principals on how its review of ACOs would be guided.  The Service also solicited comments concerning whether further guidance was needed regarding the tax implications for tax-exempt organizations participating in activities in the MSSP and in activities unrelated to MSSP, including shared savings arrangements with commercial health insurance payers through ACOs.

First, the IRS concluded that as a general matter, it will not consider a tax-exempt organization's participation in the MSSP through an ACO to result in "inurement or impermissible private benefit" to the private party ACO participants (i.e., physicians and other health care providers) if:

1. The terms of the exempt organization's participation in the MSSP, including its share of MSSP payments or losses and expenses, are set forth in advance, in a written agreement negotiated at arms length with the parties.
2. CMS has accepted the ACO into its MSSP and this acceptance has not been terminated or revoked
3. The exempt organization's share of economic benefits derived from the ACO, including its share of MSSP payments, is proportional to the benefits or contributions that the exempt organization provides to the ACO.
4. If the exempt organization receives an ownership interest in the ACO, the ownership interest is proportional and equal in value to the exempt organization's capital contributions to the ACO and all ACO returns of capital, allocations and distributions are made in proportion to the ownership interest between the exempt organization and the other taxable physicians and health care providers.
5. The exempt organization's share of the ACO losses, including its share of MSSP losses, does not exceed the share of ACO economic benefits to which the exempt organization is entitled.
6. All contracts and transactions entered into by the exempt organization with the ACO and the ACO's participants and by the ACO with the ACO's participants and other parties are at fair market value.

As a corollary, the IRS also concluded in its Notice 2011-20 that absent inurement or impermissible private benefit, any MSSP payments (the shared cost savings with CMS) received by an exempt organization from an ACO would derive from activities that are substantially related to the charitable purpose of "lessening the burdens of government" as long as the ACO met all of the eligibility requirements established by CMS for participating in MSSP.  This is under the theory that the federal government considers the provision of Medicare to be its burden.  Therefore, the share of the MSSP payments received by a tax-exempt organization will not be subject to unrelated business income tax ("UBIT") under Code Section 511, since such payments will be substantially related to the exercise or performance of the tax-exempt organization's charitable purposes.

The IRS also requested comments concerning ACOs that conduct activities unrelated to the MSSP.  Many ACOs wish to go beyond the Medicare program and negotiate with private health insurers to provide the panel of health care providers (exempt and non-exempt) for shared savings payments.  This type of non-MSSP activity will typically not lessen the burdens of government and negotiating with private health insurers is ultimately not a charitable activity.  However, ACOs that participate in shared savings arrangements with Medicaid may very well further the charitable purpose of relieving the poor and distressed or underprivileged.  See Treasury Reg. Section 1.501(c)(3)-1(d)(2).  The Service points out that although the promotion of health has been recognized as a charitable purpose not every activity that promotes health supports a tax exemption.  Therefore, in Notice 2011-20, the IRS solicits comments about what guidance is necessary for tax-exempt organizations who wish to participate in non-MSSP activities through an ACO.

Therefore, the Service through its recent Notice 2011-20 has given comfort to the health care industry that exempt organizations may combine with taxable providers through physician hospital organizations, partnerships, limited liability companies or other structures as an ACO in order to participate in the Medicare Shared Savings Program without jeopardizing their federal tax exemption.  However, it is not clear that such an ACO, engaged in non-MSSP activities, would continue to further the exempt purposes of the tax-exempt sponsoring entity and hopefully the IRS will give further guidance in this area after all comments are filed by May 31, 2011.