ACOs and Tax-Exempt Financing
On October 24, 2014, the IRS released Notice 2014-67 which provides guidance for tax-exempt entities participating in ACOs as related to outstanding tax-exempt bonds. Particularly, the Notice provides (i) guidance relative to such an entity’s participation in an ACO; and (ii) a new private use safe harbor for management and service agreements.
As background, the Internal Revenue Code provides that the interest on bonds issued by governmental or 501(c)(3) organizations may be exempt from gross income if, in addition to satisfying other requirements, not more than 10 percent of the proceeds for governmental entities, or 5 percent for 501(c)(3) organizations, are used in a private business use. According to the IRS, both actual and beneficial use of tax-exempt financed property by a private party such as a medical practice or for-profit service provider may qualify as a private business use. As a result, traditional service agreements between medical practices and other arrangements to manage various segments of a hospital’s business may be considered management agreements and could cause a hospital’s financings to fail the private business use test. Revenue Procedure 97-13 provides various safe harbors for management and services agreements that, if satisfied, will result in an agreement not being considered private business use.
The Medicare Shared Savings Program (MSSP) is intended to bring together various health care service providers to coordinate care with regard to a defined patient population with the goal of reducing the costs of care for that population to the Medicare program. As a result, many hospitals have joined together with other service providers to form Accountable Care Organizations (ACOs) to participate in the MSSP. It has been unclear whether participation in ACOs would or could lead to private business of a hospital’s facilities or whether contracts between a hospital and service providers that contain ACO-related incentives could satisfy a Rev. Proc. 97-13 safe harbor.
Participation in ACOs
In Notice 2014-67, the IRS definitively states that participation in an ACO that includes for-profit parties by a hospital that has outstanding tax-exempt bonds must be structured so as to not result in private business use of the hospital or threaten the hospital’s tax-exempt status. Implicit in this statement is the presumption that participation in an ACO by a tax-exempt hospital may result in private business use of its tax-exempt financed facilities if the ACO includes for-profit parties, which they almost always do. The Notice provides that participation in an ACO will not in and of itself result in private business use so long as:
- The terms of the hospital’s participation in the MSSP through the ACO are set in advance in a written agreement negotiated at arms’ length.
- CMS accepts the ACO into the MSSP, and the ACO has not been terminated from the MSSP.
- The hospital’s share of profits and losses from the ACO are proportional to its economic interest in the ACO.
- If the hospital has an ownership interest in the ACO, its ownership interest must be proportional to its capital contributions.
- All contracts and transactions entered into by the hospital with the ACO and the ACO’s other participants must be at fair market value.
- Property financed with tax-exempt bonds may not be transferred to the ACO unless the ACO is itself an exempt organization.
This guidance, while helpful, continues to leave open the question as to how and whether hospitals that have taken advantage of the various fraud and abuse safe harbors and exceptions when creating ACOs satisfy the conditions set forth in the Notice. The Notice also does not address participation by tax-exempt organizations in ACOs that do not participate in the MSSP or that engage in other commercial ACO activity in addition to participation in the MSSP.
New Rev. Proc. 97-13 Safe Harbor
In addition to providing guidance on the participation of hospitals with outstanding tax-exempt bonds in ACOs, Notice 2014-67 also created an additional safe harbor for management contracts under Revenue Procedure 97-13. The newly created safe harbor is quite broad and going forward should be helpful to tax-exempt hospitals. The new safe harbor provides that an agreement will not be considered a management agreement, and thus will not constitute private business use, if:
- It is for a term of no longer than 5 years.
- The compensation is based upon a stated amount; periodic fixed fee; a capitation fee; a per-unit fee; or a combination of the preceding. The compensation for services also may include a percentage of gross revenues, adjusted gross revenues or expenses of the facility (but not revenues and expenses).
The new safe harbor provides a wide array of permissible compensation structures where other Rev. Proc. 97-13 exceptions contain specific compensation structure limitations that vary based upon the term of the agreement. Also, the new safe harbor specifically does not require that the agreement be terminable by the hospital prior to the end of the 5-year term. The early termination rights required by many of the other Rev. Proc. 97-13 safe harbors are often a contentious subject when negotiating agreements with service providers.
Finally, Notice 2014-67 provides further clarification that a “productivity reward” will not cause compensation to be based on “net profits” if (i) the productivity award is based on the quality of services provided rather than increases in revenues or decreases in expenses of the hospital; and (ii) the amount of the productivity reward is a stated dollar amount, a periodic fixed fee, or a tiered system of stated dollar amounts or periodic fixed fees with respect to the achievement of certain applicable measures. This definitional clarification is intended to provide additional guidance to entities that desire to structure compensation incentives around the goals espoused in the MSSP program.
Notice 2014-67 provides useful guidance to tax-exempt organizations that have outstanding tax-exempt debt that should be followed as those entities participate in ACOs. It also provides an important new private use safe harbor that is substantially less restrictive than existing Rev. Proc. 97-13 safe harbors. The IRS is specifically requesting comments on the issues discussed in Notice 2014-67 and is accepting comments until January 22, 2015. Hopefully the comments will result in additional clarification interpreting the interaction between participation in an ACO and the various fraud and abuse safe harbors upon which many tax-exempt organizations relied when initially creating and participating in ACOs.