IRS Denies Tax Exemption to Commercial Accountable Care Organization
On April 8, 2016, the IRS released a final adverse exemption determination with respect to an accountable care organization (ACO) formed by an unnamed nonprofit health care system. The adverse determination confirms and elaborates on the view, first strongly implied by the IRS in Notice 2011-20, that ACOs not participating in CMS’s Medicare Shared Savings Program (MSSP) will face an uphill battle in qualifying for exemption from federal income tax.
ACOs do not provide health care services; rather, they integrate, coordinate and foster accountability for patient care among like-minded health care providers in the ACO’s network. ACOs apply patient data collection and analytic tools, evidence-based medicine principles, and information sharing to improve individual patient outcomes and population health, and to reduce the cost of care. The Affordable Care Act established the MSSP to encourage health care providers to form ACOs, and offer them the incentive of sharing in any Medicare program cost savings achieved through the MSSP. Recognizing the potential benefits, health systems have established a significant number of ACOs in recent years, some to participate only in the MSSP, others in arrangements with commercial insurance companies, and in some cases, both.
The ACO at issue in the recent IRS adverse determination was a strictly “commercial” ACO, meaning that it was formed to negotiate with commercial payers and did not participate in the MSSP. Health care provider participants in the ACO included physicians employed by the health system and its affiliates, and also included independent, community-based providers who were unaffiliated with the health system. These unaffiliated providers comprised approximately half of the ACO’s participants. Aside from data collection and analysis, the ACO acted as the contracting agent for all participating providers in the negotiation and execution of certain agreements with third-party commercial payers, linking rewards and penalties to the achievement of certain quality goals and performance measures.
In applying existing federal tax exemption law and authorities to the ACO, the IRS first noted that the exempt charitable purpose of lessening the burden of government, which it found helpful in Notice 2011-20, is not applicable to ACOs operating outside of the MSSP. The IRS also noted that, while the promotion of health generally may be an exempt charitable purpose, not all activities that promote health necessarily further exempt charitable purposes. In particular, the IRS noted that the ACO’s negotiation with private health insurers on behalf of unrelated health care providers does not further a charitable purpose because it provides primary benefits to the unrelated health care providers and only indirect benefits to the public as a whole. The IRS position is, essentially, that this ACO benefits the private interests of the physicians more than incidentally, which precludes exemption.
While the analysis in the adverse determination letter should have no effect on ACOs formed solely to participate in the MSSP, tax-exempt health systems are well-advised to carefully consider the structure of their commercial ACOs and the potential tax ramifications. In particular, the adverse determination seems to indicate that an ACO’s participation in the MSSP is a key factor in determining the ACO’s tax-exempt status. The IRS also appears to be indicating that non-MSSP ACOs comprised of large numbers of providers unaffiliated with the health system may preclude tax-exempt status. Further, outside of the exemption determination context, the analysis relating to whether commercial ACO activities further an exempt charitable purpose is likely to have implications in the context of unrelated business taxable income and, possibly, tax-exempt bond financing.
This adverse determination could lead some providers to choose so-called “dual purpose” ACOs, formed to participate in both the MSSP and commercial ACO arrangements, which could raise potential Antitrust and MSSP regulatory concerns.
 See Priv. Ltr. Rul. 201615022 (Apr. 8, 2016).
 2011-16 I.R.B. 652.