On October 20, IRS issued FS 2011-11 containing questions and answers regarding Notice 2011-20, 2011-16 I.R.B 652 that summarized how the IRS expected existing guidance might apply to Section 501(c)(3) hospitals that participate in Accountable Care Organizations (ACOs) created under the Patient Protection and Affordable Care Act.

In Notice 2011-20, dated March 23, 2010, the IRS asked for comments regarding the participation of tax-exempt hospitals in the Medicare Shared Savings Program (MSSP) designed to promote the formation of ACOs to coordinate and improve care for Medicare beneficiaries beginning January 2012. See McGuireWoods’ Healthcare Reform webpage for further discussion of the law and issues regarding ACOs. Also see Nonprofit Healthcare: What Does the Future Hold?

While Notice 2011-20 appeared to assure tax-exempt participants that properly structured ACOs and organizations that meet Centers for Medicare & Medicaid Services (CMS) criteria will not jeopardize their tax-exempt status or generate unrelated business income tax (UBIT), other statements in the Notice indicated that the IRS will evaluate ACO arrangements on a case-by-case basis. A number of questions were raised regarding the IRS position and requirements for continued 501(c)(3) tax-exempt status of nonprofit hospitals and whether other healthcare providers could engage in the program and be tax exempt. In response to these questions the IRS provided the following guidance.

New IRS Guidance

  • Must an ACO be structured as a particular type of legal entity (for example, a corporation or partnership) to participate in the Shared Savings Program ?
    •  No. The CMS final regulations do not require an ACO to be any particular type of legal entity. The CMS final regulations generally require an ACO to be organized as a legal entity separate from its participants.
  • How does the structure of the ACO affect the tax consequences for its tax-exempt participants?
    •  An ACO structured as a corporation for federal tax purposes generally will be treated as a separate taxable entity from its participants. See Moline Properties, Inc. v. Commissioner, 319 U.S.436 (1943). On the other hand, if an ACO is structured as a partnership for federal tax purposes, its activities will generally be attributed to its partners. See, e.g., Rev. Rul. 2004-51; Rev. Rul. 98-15. An ACO structured as an LLC generally may choose to be treated as a corporation or as a partnership or an entity that is disregarded for tax purposes.
  •  Can charitable organizations participate in the Shared Savings Program through an ACO?
    • Yes. If charitable organizations participate in the Shared Savings Program through an ACO along with private parties, the charitable organization must be sure that it continues to meet the requirements for tax exemption, to avoid adverse tax consequences. The IRS will determine whether prohibited inurement or impermissible private benefit has occurred based on all the facts and circumstances.
  • Can charitable organizations still rely on Notice 2011-20 even though the CMS final regulations are different from the proposed regulations?
    • Yes. Although the CMS final regulations differ from the proposed regulations in some respects, the discussion in Notice 2011-20 continues to reflect IRS expectations regarding the application of existing IRS guidance to charitable organizations participating in the Shared Savings Program through ACOs.
  •  Can a charitable organization’s participation in the Shared Savings Program through an ACO further charitable purposes?
    • Yes. As noted in Notice 2011-20, the IRS expects that participation in the Shared Savings Program (Shared Savings Program activities) through an ACO generally will further the charitable purpose of lessening the burdens of government within the meaning of Treas. Reg. § 1.501(c)(3)-1(d)(2).
  •  Must the tax-exempt participant(s) in an ACO treated as a partnership have control over the ACO in order to ensure that the ACO’s participation in the Shared Savings Program furthers a charitable purpose?
    • Not necessarily. An ACO treated as a partnership can further the tax-exempt participants’ charitable purposes. However, in the case of an ACO that has been accepted into (and not terminated from) the Shared Savings Program, the IRS expects that CMS’s regulation and oversight of the ACO will be sufficient to ensure that the ACO’s participation in the Shared Savings Program furthers the charitable purpose of lessening the burdens of government. Tax‑exempt participants in ACOs treated as partnerships that plan to engage in activities other than participation in the Shared Savings Program should consult IRS guidance regarding joint ventures.
  • . Will a tax-exempt participant’s share of an ACO’s Shared Savings payments be subject to the UBIT?
    • Generally, no. The IRS expects that, absent inurement or impermissible private benefit, any Shared Savings payments received by a tax-exempt participant from an ACO would derive from activities that are substantially related to the performance of the charitable purpose of lessening the burdens of government.
  •  Can an ACO conduct activities unrelated to the Shared Savings Program (non-Shared Savings Program activities) without jeopardizing the status of its tax-exempt participants ?
  • Yes, in some circumstances. Whether an ACO’s conduct of non-Shared Savings Program activities will jeopardize the status of a tax-exempt participant is analyzed under the general tax rules applicable to charitable organizations and will depend on all of the facts and circumstances. Some facts and circumstances to be considered include whether the non-Shared Savings Program activities:
    • further an exempt purpose described in § 501(c)(3),
    • are attributed to the tax-exempt participant,
    • represent an insubstantial part of the participant’s total activities and
    • do not result in inurement of the tax-exempt participant’s net earnings or in the participant conferring impermissible private benefit.
  •  Are there circumstances in which an ACO’s non-Shared Savings Program activities can further a charitable purpose?
    • Yes. The IRS recognizes that certain non-Shared Savings Program activities may further a charitable purpose. For example, an ACO’s activities related to serving Medicaid or indigent populations might further the charitable purpose of relieving the poor and distressed or the underprivileged. However, if an ACO is treated as a partnership, the ACO and its tax-exempt participants should consult IRS guidance regarding joint ventures — specifically, Rev. Rul. 2004-51 and Rev. Rul. 98-15 — for examples of partnerships conducting activities that further a charitable purpose of a tax-exempt participant.
  • Will every activity undertaken by an ACO, including non-Shared Savings Program activities, always further charitable purposes?
    •  No. Although activities that promote health further charitable purposes in some circumstances, not every activity that promotes health supports tax exemption under § 501(c)(3). See, e.g., Federation Pharmacy Services, Inc. v. Commissioner, 72 T.C. 687, 691-92 (1979), aff’d, 625 F.2d 804 (8th Cir. 1980).
  • If an ACO conducts non-Shared Savings Program activities that do not further a charitable purpose, will the status of its tax-exempt participants be in jeopardy?
    • Not necessarily. The answer will depend upon all of the relevant facts and circumstances. For example, an ACO’s conduct of activities that do not further a charitable purpose will not jeopardize the tax-exempt status of one of its participants if the ACO’s activities are not attributed to that participant. Even if the ACO’s activities are attributed to a tax-exempt participant (for example, because the ACO is treated as a partnership for tax purposes), the participant’s tax-exempt status will not be jeopardized if the ACO’s non-charitable activities represent no more than an insubstantial part of the participant’s total activities. On the other hand, the presence of a single, nonexempt purpose, if substantial in nature, may jeopardize a participant’s tax-exempt status. See Better Business Bureau of Washington, DC v. United States, 326 279 (1945).
  • Will an ACO’s non-Shared Savings Program activities always generate unrelated business income (UBI) for its tax-exempt participants?
    • No. The IRS recognizes that certain non-Shared Savings Program activities may be substantially related to the exercise or performance of a charitable purpose. Generally, non-Shared Savings Program activities that are substantially related to a tax-exempt participant’s charitable purposes will not generate UBI for that participant.
  • Can an ACO engaged exclusively in Shared Savings Program activities qualify for tax-exemption under § 501(c)(3)?
    • Yes, provided that it meets all of the requirements for tax-exemption under § 501(c)(3). Note, however, that an ACO that is treated as a partnership or is disregarded for federal tax purposes is not eligible to apply for tax-exempt status under § 501(c)(3).
  •  Can an ACO engaged in both the Shared Savings Program and non-Shared Savings Program activities qualify for tax-exemption under § 501(c)(3)?
    • Yes, provided it engages exclusively in activities that accomplish one or more charitable purposes and meets all of the other requirements for tax-exemption under § 501(c)(3).
  •  Must a charitable organization always satisfy all five factors described in Notice 2011-20 to avoid inurement or impermissible private benefit?
  • No. A charitable organization participating in an ACO must ensure that its participation does not result in inurement or impermissible private benefit. The IRS expects that it will not consider a charitable organization’s participation in the Shared Savings Program through an ACO to result in inurement or impermissible private benefit to the private party ACO participants where the ACO has been structured in accordance with five factors:
    • Factor 1. The terms of the tax-exempt organization’s participation in the Shared Savings Program through the ACO (including its share of Shared Savings or Losses and expenses) are set forth in advance in a written agreement negotiated at arm’s length.
    • Factor 2. CMS has accepted the ACO into, and has not terminated the ACO from, the Shared Savings Program.
    • Factor 3. The tax-exempt organization’s share of economic benefits derived from the ACO (including its share of Shared Savings payments) is proportional to the benefits or contributions the tax-exempt organization provides to the ACO.
    • Factor 4. The tax-exempt organization’s share of the ACO’s losses (including its share of Shared Losses) does not exceed the share of ACO economic benefits to which the tax-exempt organization is entitled.
    • Factor 5. All contracts and transactions entered into by the tax-exempt organization 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

However, no particular factor must be satisfied in all circumstances to prevent inurement or impermissible private benefit.

  • For purposes of Factor 1, does the written agreement need to specify the charitable organization’s precise share or exact amount of any Shared Savings payments distributed by the ACO?
    • No. It is sufficient for the written agreement to set forth the methodology for determining an ACO’s allocation of Shared Savings payments to the tax-exempt participant and the other Medicare-enrolled providers and suppliers participating in the Shared Savings Program through the ACO.
  • For purposes of Factor 2, will termination of an ACO from the Shared Savings Program automatically jeopardize the status of a tax-exempt participant?
    • No. Whether an ACO’s termination from the Shared Savings Program jeopardizes the status of a tax-exempt participant will depend on all relevant facts and circumstances. Relevant facts include whether the ACO’s activities after termination further a charitable purpose and whether the ACO’s activities are attributed to the tax‑exempt participant (for example, where the ACO is treated as a partnership). After the termination, all of the ACO’s activities will be non-Shared Savings Program activities.
  •  For purposes of Factor 3, must any ownership interests in an ACO be directly proportional to capital contributions, and must an ACO always distribute Shared Savings payments in proportion to such ownership interests?
    • Not necessarily. Factor 3 looks to the totality of circumstances; the tax-exempt participant’s share of economic benefits derived from the ACO (including its share of Shared Savings payments) is proportional to the benefits or contributions the tax-exempt participant provides to the ACO. Factor 3 takes into account all contributions made by the charitable organization and other ACO participants to the ACO, in whatever form (cash, property, services), and all economic benefits received by ACO participants (including shares of Shared Savings payments and any ownership interests).

The new guidance provided by the IRS is very helpful in clarifying Notice 2011-20. While it remains to be seen whether nonprofit hospitals and physician groups will enter into an ACO because of the cost of establishment and its rather limited term of existence, new CMS rules have replaced the three-year agreement rule for providers with a rolling application process and financing.

In addition to the IRS guidance, the Centers for Medicare and Medicaid Services issued a Final Rule on ACOs, Notice CMS-1345-F in 42CFR part 425. The Federal Trade Commission and the Department of Justice also issued an antitrust policy statement providing guidance to health providers.