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Not All ACOs are Charitable: IRS Rejects Tax-Exemption for Commercial ACO

April 29, 2016

On April 8, 2016, the Internal Revenue Service (IRS) released a private letter ruling (PLR) rejecting the application of an accountable care organization (ACO) for tax-exemption under Section 501(c)(3) of the Internal Revenue Code (Code) because it was a commercial ACO outside of the Medicare Shared Savings Program (MSSP). While this PLR does not set precedent, it does raise questions about whether or not an ACO outside of the MSSP can qualify for exemption.

The PLR is the first ruling from the IRS involving activities of an ACO outside of the MSSP since 2011 when the Service released Fact Sheet FS-2011-11 (Fact Sheet). The Fact Sheet advised that an ACO engaged exclusively in MSSP activities will qualify for tax-exempt status if it meets all other status requirements under Section 501(c)(3) of the Code. Generally, a tax-exempt organization must be organized and operated exclusively for the organization’s exempt purposes that benefit the community rather than individual interests. The Fact Sheet indicated that ACOs organized as joint ventures with private parties would not create unrelated business income if that ACO operated exclusively in the MSSP, because MSSP activities furthered charitable purposes by reducing the burden on federal health care programs. While the Fact Sheet also indicated that certain non-MSSP related activities might similarly further the charitable purposes of an ACO in some circumstances, the IRS did not include ACO contracts with commercial payers among its examples. For further details about the Fact Sheet, please see HDJN’s Client Advisory, Tax-Exemption for Your ACO? Watch Out for PHO and IPA Pitfalls (December 19, 2011).

In the PLR issued earlier this month, the IRS did not consider the applicant ACO’s population health benefits of its contracts with commercial payers to be sufficient charitable activities to support tax exemption. The applicant ACO was organized as a corporation to support a not-for-profit health system. The ACO engaged exclusively with commercial payers outside of MSSP in creating a clinically integrated network comprised of physicians employed through the health system, affiliated independent groups, and outside physicians. The ACO’s goals were aligned with the “Triple-Aim” of the Affordable Care Act (ACA) for the purposes of (i) reducing costs, (ii) improving access and quality of care, and (iii) improving population health and patient experience. Even though the ACO generally promoted community health, the IRS considered the purpose of the organization to benefit individual interests within the ACO and the clinically integrated network rather than to benefit the community.

The PLR raises concerns that MSSP ACOs with some commercial contracts may not qualify for tax exempt status or may trigger unrelated business income tax for the non-MSSP activity. This could potentially affect tax-exempt organizations participating in an ACO as a partner in a joint venture or as a member in a limited liability company. In the PLR, the IRS did not give any indication as to how it might weigh the private benefits of commercial activities against the community benefits of MSSP activities for MSSP ACOs also engaged with commercial payers. The PLR also questioned if an ACO is involved in a charitable activity when engaged in contracting activities on behalf of physicians in the clinically integrated network who were not employees of or affiliated through medical staff membership with the not-for-profit health system that the ACO was established to support.

Exempt health systems should review their ACO arrangements to gain a firm understanding of the tax risks associated with non-MSSP ACO activities. If you have any questions about IRS guidance in the recent PLR or need assistance in reviewing the structure of your ACO, please contact Mike Newby or Jim Daniel.

Authored By:

Ethan D. Dunn
Ethan D. Dunn

The information contained in this advisory is for general educational purposes only. It is presented with the understanding that neither the author nor Hancock, Daniel, Johnson & Nagle, PC, is offering any legal or other professional services. Since the law in many areas is complex and can change rapidly, this information may not apply to a given factual situation and can become outdated. Individuals desiring legal advice should consult legal counsel for up-to-date and fact-specific advice. Under no circumstances will the author or Hancock, Daniel, Johnson & Nagle, PC be liable for any direct, indirect, or consequential damages resulting from the use of this material.