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Memorandum |
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To: |
NAACOS |
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From: |
Bruce M. Fried, Jeremy D. Sherer
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Date: |
June 10, 2016
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Subject: |
IRS ACO Ruling |
On April 8th, 2016, the Internal Revenue Service (“IRS”) issued Private Letter Ruling 201615022 (“the PLR”), in which it denied an exemption application for an accountable care organization (“ACO”) outside of the Medicare Shared Savings Program (“MSSP”) that was seeking tax exempt status under Internal Revenue Code (“IRC”) § 501(c)(3). This is the first public guidance from the IRS regarding a non-MSSP (or commercial) ACO and calls into question whether such ACO’s can qualify for tax-exempt status due to substantial non-charitable activities. The facts provided by the taxpayer did not persuade the IRS that the private benefit to physicians from integrated contracting and population health analytics were only incidental to the community benefits of pursuing better health care for patients at a reduced cost. However, this is a single IRS denial letter issued to a taxpayer that interprets and applies the tax laws to the taxpayer’s specific set of facts. Therefore, the decision is not precedential for other taxpayers and only the ACO that the PLR is issued to is bound by the IRS’ decision. Nevertheless, it is important for ACOs to understand this ruling and its potential implications. With this in mind, we explain the ruling and its significance for NAACOS and its members below.
1. Background on Tax Exemption
IRC § 501(c)(3) provides that an organization may be exempt from tax if it is “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes” and no part of the net earnings inures to the benefit of any private shareholder or individual. All charities are subdivided between public charities and private foundations. IRC § 509(a)(3) allows an organization to qualify for public charity status as a supporting organization when the organization is organized and operated solely “for the benefit of, to perform the functions of, or to carry out the purposes of one or more specified publicly supported organizations.”[1]
The promotion of health has long been recognized as a charitable purpose.[2] However, not all activities that promote health support tax exempt status for an organization.[3] As the Supreme Court noted in Better Business Bureau of Washington, D.C. vs. United States,[4] the existence of any single nonexempt purpose that is substantial in nature will nullify the exempt status of an organization, no matter how many other exempt purposes the organization has or how important they are. Essentially, an organization will not be regarded as tax exempt if more than an insubstantial part of its activities are not in furtherance of a tax exempt purpose.
2. Past IRS Guidance on ACOs and Tax Exemption
While the PLR is the first one related to the tax exempt status of non-MSSP ACOs, it is not the first publication by the IRS related to ACOs and tax exemption. After CMS released the final regulations describing the MSSP and ACOs in 2011, the IRS issued a notice summarizing how it expected existing IRS guidance to apply to tax exempt organizations, such as non-profit hospitals, participating in the MSSP through ACO’s.[5] In addition, the IRS issued a fact sheet (the “Fact Sheet”) that provides additional information for charitable organizations that may participate in the MSSP.[6]
Among other things in the Fact Sheet, the IRS addressed whether there were circumstances where ACO’s could participate in non-MSSP activities that further a charitable purpose. There are situations where the answer is yes. Non-MSSP activities that further a charitable purpose, such as relieving the poor and distressed or underprivileged by working with Medicaid plans, might further the organization’s purpose and not jeopardize the ACO’s tax exemption.[7] Similarly, where an ACO’s non-MSSP, or, more broadly, non-charitable, activities represent only an insubstantial part of the ACO’s total activities, the ACO’s tax exempt status will not be in jeopardy.[8] There are, however, activities that may not further or be substantially related to an exempt purpose. For instance, “negotiating with private health insurers on behalf of unrelated parties generally is not a charitable activity, regardless of whether the agreement negotiated involves a program aimed at achieving cost savings in health care delivery.”[9]
3. Analysis of PLR
The ACO in the PLR (the “Organization”) was incorporated as a nonprofit corporation to support the interests and purposes of a health system recognized as tax exempt under § 501(c)(3) (the “Health System”).[10] The Organization was formed to promote clinical care integration, coordination and accountability among employed and independent physicians practicing throughout the Health System. The Organization did not participate in the MSSP.
The Organization did not directly provide medical care or health services to the public, but instead dedicated its time and resources to furthering the goals established by the Patient Protection and Affordable Care Act (the “ACA”), namely, reducing the cost of care for individuals, improving patient access to the quality of care, and improving population health and patient experience.[11]
In furtherance of the Organization’s goals, it performed the following activities:
a. Not Operated for Tax-Exempt Purposes.
To qualify for tax exemption under § 501(c)(3), the Organization must be both organized and operated exclusively for one or more specified charitable purposes. In the PLR, the IRS concluded that the Organization was not operated exclusively for charitable purposes for the following reasons.
Just as the promotion of health is an accepted charitable purpose, the IRS has recognized that by participating in the MSSP, an ACO generally furthers the charitable purpose of lessening the burden on government.[12] However, in a non-MSSP ACO, there is no government oversight and, therefore, there is no objective manifestation that the government considers non-MSSP activities to be its burden. In reaching the conclusion that the Organization did not qualify for tax exempt status, the IRS found that the Organization did not lessen the burden on government. Negotiations with third party payers outside of the MSSP was not a government burden and is generally not a charitable activity. The IRS spoke precisely to this issue in Notice 2011-20 providing this activity as an example of one that generally is not a charitable activity.
As stated above, promoting health is a recognized charitable purpose, but not all activities that promote health further charitable purposes under § 501(c)(3). The ACA sets forth goals for improving patient care and the Organization dedicated time and resources to adopting these goals. The IRS concluded that not all of the activities advancing the ACA goals were necessarily in furtherance of charitable purposes.
b. Considerable Benefit for Non-Exempt Purpose.
The IRS also focused in the PLR on the fact that the Organization negotiated with private health insurers on behalf of a group of providers including both providers affiliated with the tax-exempt Health System and non-Health System affiliated providers, and that doing so created a significant benefit for the non-Health System affiliated providers.[13] Negotiating on behalf of non-Health System affiliated providers, the IRS concluded, is not a charitable activity, even if it is intended to achieve cost savings in health care delivery.[14] Ultimately, the IRS concluded that this benefit comprised a substantial part of the Organization’s activities and confers an impermissible private benefit to participants not affiliated with the Health System.[15]
c. Public Charity Status
The IRS determined that the Organization’s activities were not exclusively for the benefit of the Health System. Therefore, the IRS found that even if the Organization qualified for tax exemption under § 501(c)(3) it would not qualify as a supporting organization.
4. Conclusion
This ruling is significant because it is the first public guidance from the IRS on non-MSSP ACOs and raises concerns about tax-exempt status for any nonprofit ACO (or tax exempt organization participating in an ACO) that engages in non-MSSP activities. However, this ruling does not change the position of the IRS in Notice 2011-20 and the IRS Fact Sheet that an ACO engaged exclusively in non-MSSP activities can qualify as a tax exempt entity. In the PLR, the IRS denied tax exempt status to the Organization because the activities of a non-MSSP ACO do not lessen the burdens of government or promote the health of the community to further charitable purposes. It is clear that the IRS will not grant tax exempt status to an ACO engaged in primarily non-MSSP activities. The one area where the IRS position is unclear with respect to granting tax exemption is when there is a mix of MSSP and non-MSSP activities performed by the ACO. In such a case, it seems likely that the IRS will thoroughly review the facts and circumstances of the particular taxpayer to determine whether the primary purpose is charitable.
[1] I.R.S. Priv. Ltr. Rul. 201615022 at 3 (Jan. 15, 2016).
[2] See Revenue Ruling 69-545, 1969-2 C.B. 117.
[3] For example, even though a pharmacy selling prescription pharmaceuticals promotes health, the pharmacy cannot quality for recognition of exemption under § 501(c)(3) on only that basis.
[6] IRS FS 2011-11 (Oct. 20, 2011).
[10] PLRs are made public after all information has been removed that could identify the taxpayer. Therefore, PLR 201615022 does not include any identifying information of the Organization or the Health System.
[11] I.R.S. Priv. Ltr. Rul. 201615022 at 2.