Can non-MSSP ACOs qualify for Tax-Exempt Status?

The Internal Revenue Service (IRS) recently affirmed its decision to deny 501(c)(3) tax-exempt status to an accountable care organization (ACO) that did not participate in the Medicare Shared Savings Program (MSSP). The IRS initially denied the ACO’s request for tax exempt status in a determination letter dated August 25, 2014. While neither the determination letter nor subsequent appeal is precedential, they provide valuable guidance for ACOs operating as tax-exempt organizations or pursuing tax-exempt status.

The ACO was formed by an existing exempt 501(c)(3) organization (System). The ACO’s purported purpose was furthering the triple aim health care reform goals (Triple Aim Goals) established by the Patient Protection and Affordable Care Act (PPACA), i.e. reducing healthcare costs, improving patient access to and the quality of medical care, and improving population health and patient experience. The ACO strove to further the Triple Aim Goals by acting as the representative for its providers in the negotiation and execution of agreements with third-party payers. The ACO’s providers included physicians employed by System, independent practice groups whose physicians were employed by System, and providers unaffiliated with System. Approximately half of the physicians participating in the ACO worked for independent practices or independent hospitals unaffiliated with System.

The IRS denied the ACO tax exempt status on two separate grounds. First, the IRS determined that the ACO was not operated exclusively for exempt purposes within the meaning of the Internal Revenue Code. The IRS then determined that the ACO was also not operated primarily for a public purpose.

Operated Exclusively for Exempt Purposes:

In order to qualify for 501(c)(3) status, an organization must be organized and operated exclusively for an exempt purpose. An organization is regarded as being operated exclusively for one or more exempt purposes, if it engages primarily in activities that accomplish an exempt purpose. An organization is not operated exclusively for an exempt purpose if more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Two exempt purposes recognized by the IRS are lessening the burdens of government and the promotion of health.  In its determination letter, the IRS applied both exempt purposes to the ACO, before determining that the ACO was not operated exclusively for an exempt purpose.

Lessening the Burdens of Government:

In order for an activity to lessen the burdens of government, there must be an objective manifestation that government considers the activity to be its burden. Provisions of the PPACA encourage and support ACO cost sharing arrangements. In its determination letter, the IRS acknowledged that participation in the MSSP by an ACO will generally further the exempt purpose of lessening the burdens of government. The IRS continued, however, that the government has not provided an objective manifestation that it considers the activities of ACOs that do not participate in the MSSP to be its burden, regardless of their furtherance of the Triple Aim Goals. Accordingly, the IRS determined that the ACO’s activities did not further the exempt purpose of lessening the burdens of government.

This conclusion suggests that ACOs that do not participate in the MSSP may not be able to qualify for tax-exempt status by lessening the burdens of government. Such non-MSSP ACOs may be able to lessen the burdens of government through other means, however, furthering the Triple Aim Goals of the PPACA alone appears to be insufficient. ACOs who intend to further the Triple Aim Goals, should either participate in the MSSP or establish an exempt purpose other than lessening the burdens of government.

Promoting Health:

The promotion of health has long been recognized as an exempt purpose. However, not every activity that promotes health furthers exemption under Code Section 501(c)(3). For example, selling prescription pharmaceuticals promotes health, but is not a tax-exempt activity. In its determination letter, the IRS provided that while the Triple Aim Goals generally promote health, not all activities that that support the Triple Aim Goals further the promotion of health for purposes of Code Section 501(c)(3). The ACO’s primary activity was negotiating with private insurers on behalf of its providers, many of which were unrelated to the ACO. The IRS determined that the link between negotiating with private insurers and promoting health was insufficient. Accordingly, the IRS concluded that the ACO was not operated exclusively in furtherance of the exempt purpose of promoting health.

This conclusion provides two insights. First, it indicates that an ACO whose purpose is furthering the Triple Aim Goals can qualify as being operated exclusively for the exempt purpose promoting health. This is a valuable insight for ACOs that would prefer not to participate in the MSSP, but would like to receive tax-exempt status. Second, the IRS’ determination letter indicates that negotiating with private insurers likely is not sufficiently connected to promoting health. Accordingly, the activities of ACOs that do that participate in the MSSP will require a closer nexus to promoting health, in order for such ACOs to qualify as tax-exempt organizations.

Benefiting a Public Purpose:

In addition to being organized and operated exclusively for exempt purposes, organizations seeking tax-exempt status must be organized and operated primarily for a public purpose. Organizations that primarily serve private interests instead of public interests are not eligible for tax-exempt status. Notwithstanding the foregoing, limited private benefits are permissible, when a benefit to the public cannot be achieved without necessarily benefiting private individuals and the private benefits are insubstantial to the public benefit conferred by the activity. In its determination letter, the IRS determined that the ACO conferred an impermissible private benefit.

As discussed above, the ACO’s primary activity was negotiating with private insurers on behalf of its providers. The IRS determined that the ACO’s negotiations only indirectly benefitted the community, compared to the benefit conferred to the ACO’s providers. Further, the IRS determined that the ACO’s activities were not the only means of conferring the benefit to the community. Accordingly, the IRS determined that the ACO conferred an impermissible private benefit to its providers. This example stands is reminder, that the primary benefit of an organization’s activities must flow to the public and not private interests, in order for the organization to receive tax-exempt status.

Conclusion:

The IRS’ determination letter and holding on appeal provide three valuable lessons for ACO’s operating as tax-exempt organizations or pursuing tax-exempt status. First, in the opinion of the IRS, the activities of ACOs that do not participate in the MSSP do not further the exempt purpose of lessening the burdens of government. Second, while the Triple Aim Goals generally promote health, not all activities that support the Triple Aim Goals adequately further the promotion of health. For example, negotiation with private insurers on behalf of healthcare providers is not sufficiently tied to promoting health. Third, regardless of whether an ACO is organized and operated exclusively for an exempt purpose, the primary benefit an ACO’s activities must flow to the public and not private interests.

1st Circuit Court of Appeals Upholds Tax Refund In False Claims Act Case

The United States Court of Appeals for the First Circuit upheld the district court’s decision allowing Fresenius Medical Care Holdings, Inc. (f/k/a National Medical Care, Inc.) to deduct $95 Million from a $385 Million dollar civil settlement under the False Claims Act (“FCA”).  Accordingly, the First Circuit affirmed the district court’s tax refund judgment in favor of Fresenius in the amount of $50,420,512 (Fresenius Medical Care Holdings, Inc. v. United States, August 13, 2014, Case No. 13-2144).

The First Circuit held that, in determining the tax treatment of a FCA civil settlement, the court may consider factors beyond the presence or absence of a tax characterization agreement.  In reaching its decision, the Court applied generally accepted principles of tax law to depart from earlier contrary authority in Talley Industries Inc. v. Commissioner, 116 F.3d 392 (9th Cir. 1997).

Because Fresenius and the government did not agree on the tax characterization of the FCA civil settlement, the critical consideration in determining deductibility was the extent to which the disputed settlement payment was compensatory as opposed to punitive.  The Court acknowledged that no deduction may be made for fines or penalties paid to the government for legal violations, whereas compensatory damages paid to the government, which are deductible, do not constitute a fine or penalty.  26 U.S.C. §162(f).

The First Circuit rejected the government’s argument and interpretation of Talley, in part, based on the notion that substance prevails over form in tax characterizations of transactions between private parties, and that amounts paid or received in settlement should receive the same tax treatment, to the extent practicable, as would have applied had the dispute been litigated to judgment.

Judge Selya, who is known for using uncommon words and phrases to draw an intersection between jurisprudence and interesting prose, authored the Fresenius opinion for the First Circuit and he did not disappoint.  The opinion, makes use of several intriguing words and phrases, such as:  gallimaufry, explicated, ordained, asseverates, asseveration, talismanic, ferocity, expedient, indistinct beacon, inters, the graveyard of forgotten canons, perforce, infelicitous asymmetry, judicial fiat, paint the lily, remonstrance, calumnizes, patina of plausibility, pari passu, and praxis.

For additional information regarding the False Claims Act, please contact Adam Snyder.