The US Internal Revenue Service has released new guidance to coincide with CMS' issuance of the final Accountable Care Organization (ACO) rules. The IRS' new pronouncements, like the final ACO rules, are less restrictive than those found in their earlier guidance in April, 2011. They also provide greater detail with respect to the tax exemption consequences of various aspects of ACO participation. Finally, they tackle a critical question that was ignored in the IRS' earlier notice: whether an ACO entity can qualify for tax-exempt status.
On October 20, 2011, the IRS published Fact Sheet 2011-11 on the topic of tax-exempt organizations participating in the Medicare Shared Savings Program ("Shared Savings Program" or "MSSP") through Accountable Care Organizations. The Fact Sheet notes that the Centers for Medicare & Medicaid services (CMS) had just released final regulations describing the rules for the Shared Savings Program and Accountable Care Organizations. On April 18, 2011, the IRS had published Notice 2011-20 to coincide with CMS’ proposed rule on the Shared Savings Program. That Notice summarized the IRS’ views regarding the application of existing IRS guidance to charitable tax-exempt organizations, such as hospitals, that plan to participate in the Shared Savings Program through ACOs. The Fact Sheet confirms that Notice 2011-20 continues to reflect the IRS’ position in this area, but the new guidance also offers a more flexible analysis and provides important new information. The Fact Sheet uses a question and answer format, which both reviews the basic principles of the Shared Savings Program and applies IRS guidance to its core elements.
With respect to ACO structure, the IRS notes simply that the tax consequences for the ACO and its tax-exempt participants will vary depending on the type of entity chosen by the participants. Reciting its longstanding position, as well as that of the courts, the Fact Sheet notes that an ACO structured as a corporation for federal tax purposes is generally treated as a separate taxable entity from its owners. An ACO structured as a partnership for federal tax purposes will generally find that its activities are attributed to its partners under the well-settled aggregate theory of partnership taxation. The Service further noted that an ACO structured as a limited liability company may choose to be treated as a corporation, or as a partnership, or as an entity that is disregarded for tax purposes.
The IRS also discussed in the Fact Sheet participation by charitable organizations in an ACO, which was the main subject of Notice 2011-20. The IRS reiterated that if a charitable organization participates in the Shared Savings Program through an ACO with private parties, the organization must ensure that it continues to meet the requirements for tax exemption. Thus, its participation may not result in private inurement, nor may it result in impermissible private benefit. The determination of whether private inurement or impermissible private benefit has occurred in a given ACO program will be based on the facts and circumstances present.
The IRS notes that general tax rules relating to charitable organizations continue to apply when they participate in an ACO. Also, charitable organizations can still rely upon Notice 2011-20, even though the CMS final rules for the MSSP are different than the proposed rules.
Participation in Shared Savings Program Activities
On the topic of Shared Savings Program activities, the IRS reinforces its position in Notice 2011-20 that a charitable organization can participate in a Shared Savings Program through an ACO, and that such participation generally will further the charitable purpose of lessening the burdens of government, which is a long-recognized basis for qualification for charitable tax-exempt status. This is consistent with an increasing tendency by the IRS in recent years to rely upon the rationale of lessening the burdens of government as a basis for finding that participation in CMS programs is consistent with tax-exempt status.
An issue that has been the prime focus for the IRS in reviewing exempt organization participation in joint ventures is the amount of control that the tax-exempt participants have in the venture. In this Fact Sheet, the IRS states that it is not necessary in all cases for the tax-exempt participants in an ACO that is treated as a partnership to have control over the ACO in order to ensure that their participation furthers their charitable purposes. The IRS indicates that control is relevant; however, in the case of an ACO that has been accepted into the Shared Savings Program, the IRS relies upon CMS’ regulation and oversight of the ACO for ensuring that the ACO’s participation in the MSSP furthers the charitable purpose of lessening the burdens of government.
The IRS states that a tax-exempt participant’s share of an ACO’s shared savings payment will generally not be subject to the unrelated business income tax. The IRS concludes that shared savings payments would derive from activities that are substantially related to the performance of the charitable purpose of lessening the burdens of government.
Participation in Non-Shared Savings Program Activities
One of the less optimistic aspects of the IRS’ earlier Notice 2011-20 was with respect to the conduct of activities by an ACO that are unrelated to the Shared Savings Program, e.g., activities with Medicaid and private payors. In the earlier notice, the IRS had suggested that such activity may not be consistent with charitable operation. In this Fact Sheet, the IRS states that in some circumstances, an ACO can conduct activities unrelated to the Shared Savings Program without jeopardizing the tax-exempt status of its participants. The determination of the effect of such activities would be analyzed under the general tax rules applicable to charitable organizations and would depend on all of the facts and circumstances. The IRS provided that relevant facts and circumstances for consideration would include whether the non-SSP activities:
- Further a charitable purpose
- Are attributed to the tax-exempt participant
- Represent an insubstantial part of the participants’ overall activities
- Do not result in private inurement or impermissible private benefit
The IRS expands on this point in the Fact Sheet by expressly stating that in its view, certain non-Shared Savings Program activities may still further a charitable purpose. It cites as an example an ACO’s activities related to serving Medicaid or indigent populations as achieving a charitable purpose of relieving the poor and distressed or the underprivileged. The IRS further instructs exempt organizations participating in a partnership joint venture style-ACO to consult its prior guidance regarding such joint ventures, specifically, Rev. Rul. 2004-51 and Rev. Rul. 98-15. The IRS acknowledges that not every activity undertaken by an ACO will always further charitable purposes. It notes further that if an ACO conducts non-Shared Savings Program activities that do not further a charitable purpose, this will not necessarily jeopardize the tax-exempt status of its participants. This would depend on the relevant facts and circumstances and the answer to the traditional IRS question of whether there is present a single non-exempt purpose that is substantial in nature with regard to the activities. Likewise, the ACO’s non-Shared Savings Program activities, in the IRS’ view, will not always generate unrelated business taxable income for its tax-exempt participants. If the non-Shared Savings Program activities are substantially related to the tax-exempt participants’ charitable purposes, the activities would not generate unrelated income.
ACO Entity Qualification for Tax-Exempt Status
Importantly, the IRS addresses a core issue in the Fact Sheet that was not addressed in Notice 2011-20, that is, whether an ACO entity that is engaged exclusively in Shared Savings Program activities can itself qualify for tax-exemption as a charitable organization under Section 501(c)(3) of the Internal Revenue Code. The IRS answers that question in the affirmative. As long as the organization meets all of the requirements for tax-exemption under Section 501(c)(3), including that it engage exclusively in activities that accomplish charitable purposes, it will qualify for exempt status. Thus, the IRS concludes that an ACO engaged exclusively in Shared Savings Program activities could qualify for tax-exemption as a charitable organization as long as the ACO also meets the other requirements for tax-exemption under Section 501(c)(3). It points out also that an ACO treated as a partnership, or that is disregarded for federal tax purposes, is not eligible to apply for tax-exempt status under Section 501(c)(3) in accordance with the IRS’ oft-cited position. The IRS states that even if an ACO is engaged in both Shared Savings Program and non-Shared Savings Program activities, it could still qualify for tax-exemption under Section 501(c)(3) as long as it engages exclusively in activities that accomplish one or more charitable purposes, and meets all of the other requirements for tax-exemption under Section 501(c)(3).
This analysis as to the ability of ACO entities to qualify for exemption is more encouraging than might have been expected from the IRS. The IRS had seemed to be staking out the position that ACOs are like physician-hospital organizations or individual practice associations, and the IRS has historically not been hospitable to attempts by such entities to secure recognition of their charitable tax-exempt status. To avoid a similar characterization that an ACO is simply a commercial contracting entity, would-be charitable ACOs will need to stress their participation in the MSSP, their exclusive undertaking of charitable activities, and the lessening the burdens of government rationale to ensure a favorable result when they apply for recognition of tax-exempt status from the IRS.
Clarification of Prior Guidance
Finally, the IRS takes the opportunity in the Fact Sheet to clarify the application of its prior analysis in Notice 2011-20. In that Notice, the IRS set forth five factors that an exempt organization should comply with to avoid private inurement or impermissible private benefit when participating in an ACO. These factors are:
- Whether the terms of the tax-exempt organization’s participation in the SSP through the ACO are set forth in advance in a written agreement negotiated at arms’ length.
- Whether CMS has accepted the ACO into, and has not terminated the ACO, from the Shared Savings Program.
- Whether the tax-exempt organization’s benefits that it derives from the ACO are proportional to the benefits it provides to the ACO. In addition, if the exempt organization receives an ownership interest, that interest must be proportional and equal in value to its capital contributions to the ACO, and all returns of capital, allocations, and distributions must be made in proportion to ownership interest.
- The exempt organization’s share of ACO losses does not exceed its share of economic benefits.
- All contracts entered into by the exempt organization with the ACO and its participants are at fair market value.
In the Fact Sheet, the IRS characterizes the five factors as though they were a safe harbor, to be considered in its facts and circumstances analysis. However, it is not required for a charitable organization to always satisfy all five factors in its participation in the ACO in order to avoid private inurement or impermissible private benefit.
Consistent with the more flexible approach taken by the IRS in the new Fact Sheet, the IRS also offers the following tips as to the agreement between the ACO and the tax-exempt participant: a written agreement does not have to specify a charitable organization’s precise share or exact amount of any shared savings payments distributed by the ACO; statement of the methodology to be used would be sufficient. Also, termination of an ACO from the Shared Savings Program does not automatically jeopardize the status of a tax-exempt participant. And finally, it is not necessarily required for any ownership interest in an ACO to be directly proportional to capital contributions, and an ACO does not always have to distribute shared savings payments in proportion to such ownership interests.
The Fact Sheet concludes with a commentary by the IRS on its 2007 IRS Memorandum relating to electronic health records (EHR). The IRS states that this Memorandum also applies to a charitable organization participating in the Shared Savings Program through an ACO. The IRS will continue to follow this Memorandum with respect to all charitable hospitals that have an EHR program with physicians, including those participating in an ACO.
The IRS is to be commended for expanding its prior guidance on participation in ACOs by tax-exempt organizations and for taking the same, more relaxed approach adopted by CMS in its final ACO rules in order to make participation in the Shared Savings Program more palatable and less risky for charitable hospitals, providers, and suppliers. This Fact Sheet confirms the IRS’ current attitude towards participation in new CMS programs: if it’s good enough for them, it’s good enough for us, as long as you meet all the usual requirements for tax-exempt entities as well.