Accountable Care Organizations (ACOs)—groups of health care providers jointly responsible for the overall care and cost of Medicare fee-for-service beneficiaries assigned to them—are one of the structures recommended under the Patient Protection and Affordable Care Act of 2010 (PPACA)1 to achieve the nation’s goals of increasing the quality and efficiency of health care and “bending the curve” of increases in costs.

ACO participants are compensated based on the applicable Medicare fee schedule but have an opportunity to share in savings resulting from the ACO’s more efficient use of resources. PPACA provides little detail on ACOs and imposes no mandatory organizational structure to obtain that goal.

The legislation does, however, explicitly anticipate ACOs that are joint-venture arrangements between hospitals and physicians.2 An ACO could be a joint venture organized through contractual arrangements among the ACO participants. Alternatively, it could operate under a formal, fully integrated entity structure, such as a limited liability company, with the participants all members of the company.

Regardless of the ACO’s structure, hospitals and other health care organizations that are exempt from federal income tax under Section 501(c)(3) of the Internal Revenue Code face special challenges. Those challenges include issues of whether the hospital’s participation creates prohibited “private benefit” or “private inurement” to nonexempt persons, including physicians who are highly compensated.

Private benefit occurs when private interests are served rather than the public good; private inurement involves a benefit to “insiders” in excess of the fair-market value of goods or services provided to the exempt organization by the insider.

Restrictions on a tax-exempt hospital or other health care organization resulting from its exempt status may include the following:

  • Control. An exempt-organization participant will need to have control of the ACO, or other rights sufficient to ensure the ACO is operated in furtherance of the exempt organization’s exempt purposes.
  • Transactions with insiders. Benefit to an insider in excess of fair-market value resulting from transactions with the ACO, such as provision of services or sale of goods, must be avoided to prevent risk to the exempt status of the exempt organization and to avoid penalties for excess benefits to the insider under the intermediate sanctions rules.
  • Compensation. Compensation to insiders, physicians, and other key employees and contractors must be reasonable and should be supported by comparable salary data from other organizations.
  • Profit allocation. Profits, including shared savings, must be allocated in a manner that avoids private inurement and private benefit.
  • Ownership interests. The ownership interests in an ACO entity must be divided among the participants in the ACO in relation to the value of their contributions so as not to benefit a for-profit participant.
  • Services provided by exempt organization. If an exempt organization provides services to the ACO, it must be paid fair-market value compensation in order to avoid private benefit to the for-profit ACO participants.
  • Loans by exempt organization. Loans made by an exempt organization to the ACO must be at commercially reasonable terms.
  • Unrelated business income. Although the provision of health care services will not generally result in unrelated business income to an exempt health care organization, activities of an ACO in certain situations could constitute an unrelated trade or business, e.g., operation of a laboratory or cafeteria by the ACO for nonpatients.
  • Liability. The exempt organization should organize an ACO under a structure that limits liability to its other assets, such as through a limited liability company.
  • Exempt-bond financing. For facilities that are financed with exempt bonds, care should be taken if the facility plans to lease exempt-bond-financed space to the ACO, or if such entity plans to provide administrative services to the ACO. The provision of either space or administrative services may be problematic for the exempt organization, even if the ACO is providing medical services.


These legal barriers are not new, and experienced counsel can generally sculpt a structure that allows the tax-exempt organization to remain within the Internal Revenue Service’s rules and still participate in an ACO joint venture with physicians that makes economic sense and promotes the public policy goals of PPACA.

It will be important early on, however, to communicate to the physician and other taxable participants that the hospital has limits on its discretion to contribute to the venture or to cede control. The process will proceed much more quickly and amicably if unrealistic expectations are not created, which then have to be corrected.