Bringing Hospital Tax Exemption into the Modern Era: Why ACO - PDF document

Bringing Hospital Tax Exemption into the Modern Era: Why ACO Activities Should Be Tax-Exempt By Catherine E. Livingston and Gerald M. Griffjth, Jones Day 36 AHLA Connections July 2015

Accountable care organizations and clinically integrated considered as furthering charitable or educational purposes. networks (ACOs) are a key health care innovation designed to However, providing ancillary services that support direct produce better care at lower cost for the community. Whether patient care, like management, fjscal, and administrative formed to participate in the Medicare Shared Savings Program services, to other health care entities for a fee is generally (MSSP) or to coordinate clinical activities involving other considered to further an exempt purpose only if the other payers, ACOs seek to align fjnancial incentives so that they entities are related to the service provider or structurally and fjnancially integrated with the service provider. 11 Tiere is a reward hospitals, physicians, and other providers for working together to serve a defjned population. Participation in ACOs very limited exception for providing certain services specifj- has grown substantially over the past fjve years. 1 Tie ability cally identifjed in Section 501(e) (e.g., billing and collection, of tax-exempt hospitals and health systems to participate in laboratory services, data processing) to hospital facilities with 100 or fewer beds at or below cost. 12 Tie provision of “commer- ACOs depends on whether participation allows the hospital or health system to further charitable purposes within the cial-type insurance” also is treated as an unrelated trade or meaning of Section 501(c)(3), 2 without generating more than business unless an exception applies. 13 incidental private benefjt. Failure to meet that standard can Tie IRS takes the position that a health care activity, have severe consequences, including unrelated business whether or not it involves services to patients, fails to further a charitable purpose if it is conducted in a commercial fashion. 14 income tax (UBIT), loss of exemption for interest on bonds that fjnance hospital facilities, and loss of tax-exempt status. Tie parameters of what causes an activity to be too commer- To date, the Internal Revenue Service (IRS) has confjrmed cial are unclear and have never been captured in published only that participation in a ACO that is limited to MSSP is guidance. consistent with the requirements for exemption as a Section A nonprofjt hospital will not qualify as a Section 501(c) 501(c)(3) organization. 3 Tie IRS has held open the possibility (3) organization if a substantial portion of its activities benefjt that non-MSSP ACO activities also can further charitable private parties, like physicians, unless the private benefjt purposes and avoid producing impermissible private benefjt, 4 conferred is both qualitatively and quantitatively incidental to but it has not described the criteria applicable to participation accomplishment of the hospital’s charitable purpose. A private in non-MSSP ACOs. Tiis leaves tax-exempt hospitals in a diffj- benefjt is quantitatively incidental if it is reasonably necessary to achieve the broader public benefjt, 15 and it is qualitatively cult position. Tiey appreciate the importance of joining with other providers to address the fundamental problems of health incidental if it is insubstantial in amount compared to the public benefjt. 16 Paying reasonable compensation for services care economics that jeopardize access to quality, afgordable generally results in only on incidental private benefjt. 17 health care, but the current state of IRS guidance raises ques- tions about the consequences of participation in non-MSSP Activities that a tax-exempt hospital conducts through ACO activities. its participation in a partnership or LLC that is treated like a partnership for tax purposes (i.e., a joint venture) must meet Requirements for Hospital Tax Exemption the same standards for tax exemption as activities a hospital conducts directly. 18 If the joint venture’s activities do not To qualify as a Section 501(c)(3) organization, a nonprofjt hospital must be organized and operated exclusively for chari- further exempt purposes, or if the tax-exempt participant lacks table, scientifjc, educational, or other exempt purposes. Since suffjcient controls to ensure that the joint venture furthers 1969, the IRS has taken the position that a nonprofjt hospital charitable purposes and provides no more than incidental is furthering a charitable purpose if it engages in promotion private benefjt, then participation in the joint venture may of health for the benefjt of the community as a whole. 5 Section generate unrelated business income. If the joint venture consti- 501(c)(3) hospitals are required to have a written fjnancial tutes a substantial portion of the participant’s activities, those assistance policy, but neither the statute nor the regulations activities could jeopardize its tax exemption. Tie IRS has not specify criteria for whom, if anyone, must be ofgered fjnancial issued any published guidance on what constitutes substantial assistance under the policy. 6 IRS guidance has long considered activities for this purpose, though existing guidance in other the provision of health care services to patients as a trade or areas focuses on the percentage of the organization’s revenues and expenses associated with the activity. 19 business that furthers charitable purposes, but the provision of services to members of the public who are not otherwise Many tax-exempt hospitals also are fjnanced in part with receiving clinical care at the hospital (e.g., laboratory, phar- the proceeds of tax-exempt bonds. To preserve the exemption macy, or imaging services) is generally considered to be an for the interest on their bonds, hospitals must not allow more unrelated trade or business unless the services are otherwise than de minimis levels of private use, which includes use in scarce or unavailable in the community. 7 Under this guidance, the trade or business of a private party (such as a for-profjt lowering cost and improving quality of care is irrelevant in physician group) or use in an unrelated trade or business of the hospital. 20 Arrangements that otherwise may result in private determining 501(c)(3) eligibility and the focus instead is on whether the hospital provides hands-on care. use can be protected by structuring them to fjt within estab- Activities that regulate or coordinate the delivery of lished safe harbors based primarily on the term, termination rights, and compensation methodology. 21 Although the latest health care, such as operating a professional standards review organization, 8 a health planning agency, 9 or a regional health safe harbor guidance from the IRS includes specifjc provi- data system, 10 but do not involve direct patient care also are sions tailored to MSSP ACOs, it does not address the threshold healthlawyers.org 37 healthlawyers.org 37