Facilities financed with tax-exempt bonds may not have more than ten percent of the bond proceeds used for any “private business use” in order to maintain the bonds’ tax exemption. Recently, the IRS released Notice 2014-67 impacting the types of arrangements that will or will not qualify as private business use in two particular contexts. First, the new Notice amplifies and expands the safe harbor provisions of IRS Revenue Procedures 97-13 and 2001-39 regarding certain management contracts that are not treated as private business use of a facility. Second, the Notice provides interim guidance for determining whether participation by an issuer of tax-exempt bonds in the Affordable Care Act’s Medicare Shared Savings Program through an Accountable Care Organization (ACO) will be considered private business use of its bond-financed facilities.
Expansion of Safe Harbor for Management Contracts
A qualified user of hospitals or other health care facilities financed with tax-exempt bonds must properly structure its management contracts with nongovernmental persons regarding those facilities to avoid such contracts being deemed private business use. A qualified user is any State or local government or instrumentality thereof, or a 501(c)(3) organization if the financed property is not used in an unrelated trade or business. Provided all other requirements of section 5 of Rev. Proc. 97-13 are met, Notice 2014-67 expands the permitted types of contracts and other arrangements that do not qualify as private business use.
First, the Notice broadens the types of permitted productivity rewards. To avoid private business use, management contracts may not provide any compensation based, in whole or in part, on a share of net profits from the operation of the facility. The Notice expands the types of productivity rewards that will not be considered to be based on a share of net profits. A productivity reward will be permitted if:
- the eligibility for the productivity award is based on the quality of the services provided under the management contract (for example, the achievement of Medicare Shared Savings Program quality performance standards or meeting data reporting requirements), rather than increases in revenues or decreases in expenses of the facility; 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.
Second, the Notice establishes a new, more favorable safe harbor for certain contracts with a term of five years or less. The compensation for services under these contracts will not result in private business use if it is based on a stated amount, periodic fixed fee, a capitation fee, a per-unit fee, or a combination of the preceding. The compensation also may include a percentage of gross revenues, adjusted gross revenues, or expenses of the facility (but not both revenues and expenses). Importantly, unlike the existing short term safe harbors for two-year, three-year, and five-year contracts, contracts under this new safe harbor need not be terminable by the qualified user prior to the end of the five-year term. In practice, this new safe harbor will likely displace the existing two-year, three-year, and five-year safe harbors in most instances (though such safe harbors remain in place and may still be relied upon).
Treatment of ACOs under the Medicare Shared Savings Program
Participation in the Shared Savings Program through an ACO that includes nongovernmental participants must be structured in a way that does not result in private business use of a health care facility financed with tax-exempt bonds. The Notice provides that such participation will not result in private business use if all of the following conditions are met:
- the terms of the qualified user’s participation in the Medicare Shared Savings Program through the ACO (including its share of Shared Savings Program payments or losses and expenses) are set forth in advance in a written agreement negotiated at arm’s length;
- the Centers for Medicare and Medicaid Services has accepted the ACO into, and has not terminated the ACO from, the Medicare Shared Savings Program;
- the qualified user’s share of economic benefits derived from the ACO (including its share of Medicare Shared Savings Program 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;
- the qualified user’s share of the ACO’s losses (including its share of Medicare Shared Savings Program losses) does not exceed the share of ACO economic benefits to which the qualified user is entitled;
- 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
- 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 501(c)(3) bonds, either a governmental person or a 501(c)(3) organization.
While this guidance is helpful for the treatment of ACOs in the limited context of the Medicare Shared Savings Program, broader guidance related to many other types of ACOs is needed. However, the favorable treatment for ACOs in this context is similar to the favorable approach taken in IRS Notice 2011-20 regarding the effect of ACOs on an organization’s 501(c)(3) status, and nonprofits may apply Notice 2014-67 as framing helpful standards in the analysis of ACO treatment in other arrangements.
Practical Implications of the New Rules
The new rules in this Notice may be applied immediately to outstanding bond issues and contracts. Issuers of tax-exempt bonds, particularly nonprofit hospitals, should consider revising post-issuance compliance procedures to reflect the new, more favorable rules and may be able to reduce the amount of private business use reported in Form 990, Schedule K. Issuers of tax-exempt bonds and service providers should also consider amending (or renewing on different terms) their existing management contracts to reflect the new private business use rules, especially if the new rules allow for mutually desirable business terms that were previously not permitted. As for new issues or refundings moving forward, the new rules may reduce or eliminate the need for “carve outs” that reduce the size of the tax-exempt portion of a financing to comply with private business use limitations.