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In a final adverse determination letter (PLR 201615022), the IRS has ruled that an organization (ORG) established as an accountable care organization (ACO) to assist an associated health care system, as well as participating unaffiliated physicians, to achieve goals set forth by the Affordable Care Act (ACA) fails to qualify for recognition of exemption under Section 501(c)(3) due to its substantial non-charitable activities.

Facts and background

ORG was incorporated as a nonprofit corporation to support "System," a public charity healthcare corporation recognized as exempt under Section 501(c)(3). Specifically, ORG was formed to assist System in achieving clinical care integration, coordination and accountability. ORG filed an application for recognition of exemption under Section 501(c)(3) and for public charity status under Section 509(a)(3) as a supporting organization to the System. ORG stated that it is an ACO, but that it does not participate in the Medicare Shared Savings Program (MSSP).¹

ORG does not directly provide healthcare services to the public, but instead dedicates itself to the furtherance of the "Triple Aim" health care reform goals established by the ACA: (1) reducing the cost of care for individuals, (2) improving patient access to and quality of care, and (3) improving population health and patient experience. ORG has formed an integrative network of healthcare providers, both System-affiliated and unaffiliated independent providers.

ORG is developing performance measures and data infrastructure to assess care delivery of participating providers. It also is developing incentives to motivate improvements by participating providers in achieving Triple Aim goals. In addition, ORG acts as representative for all participating providers in the negotiation and execution of certain agreements with third-party payers. These agreements link rewards and penalties for participants to their achievement of performance measures to incentivize changes in participant behavior in furtherance of the Triple Aim goals.

Ruling and analysis

To qualify for recognition of exemption under Section 501(c)(3) and the accompanying regulations, an organization must be both organized and operated exclusively for one or more specified charitable purposes. Organizations may engage in activities that do not further an exempt purpose to an incidental degree without jeopardizing tax exemption, but any single substantial nonexempt purpose destroys an organization's exemption.

While lessening the burdens of government is a specified exempt charitable purpose, there must be an objective manifestation that the government considers the activities to be its burden. The IRS noted that the ACA encourages ACOs and established the MSSP (to be conducted through ACOs) to promote quality improvements. Accordingly, the IRS stated in Notice 2011-20 that participation of an ACO in an MSSP will generally further the charitable purpose of lessening the burdens of government. In PLR 201615022, however, the IRS explained that there is no objective manifestation in the ACA providing that the government considers non-MSSP activities by ACOs to be its burden — regardless of whether such ACOs are pursuing Triple Aim goals. Unlike ACOs participating in MSSPs, the IRS noted, there is no government oversight of ORG's activities.

Promoting health is also a recognized charitable purpose, but not all activities that promote health further charitable purposes under Section 501(c)(3). While the Triple Aim goals set forth by the ACA and adopted by ORG generally promote health, the IRS concluded that not all its activities advancing those goals are necessarily in furtherance of charitable purposes under Section 501(c)(3).

Furthermore, the IRS determined, based on ORG's application materials, that the negotiation of payer agreements — including on behalf of participating physicians that are not affiliated with System — is a substantial part of ORG's activities. The IRS stated that negotiating with private health insurers on behalf of unrelated providers is not a charitable activity, regardless of whether the activity is aimed at achieving cost savings in health care delivery. Moreover, the IRS concluded that the negotiation of these agreements offers more than an incidental private benefit to non-System affiliated providers. The IRS ruled that this substantial nonexempt purpose prevents ORG's recognition of exemption under Section 501(c)(3), regardless of any other charitable activities it may conduct.

Finally, even if ORG did qualify for Section 501(c)(3) exemption recognition, the IRS stated that it would not qualify for public charity status as a supporting organization under Section 509(a)(3), because it provides networking and contracting activities on behalf of non-System healthcare providers, which activities do not exclusively benefit System.

Implications

This IRS denial letter is the first public guidance the IRS has issued regarding non-MSSP ACOs. In PLR 201615022, the IRS found that an ACO providing services to non-MSSP providers neither lessens the burdens of government nor promotes the health of the community to further charitable purposes under Section 501(c)(3).

A number of tax-exempt health care organizations have already instituted non-MSSP ACO programs as part of their operations, taking the position that such ACO activity furthers the goals of the ACA and therefore furthers their tax-exempt charitable purposes. The IRS denial letter suggests potential difficulty with this position and may provide an obstacle for non-MSSP ACOs seeking Section 501(c)(3) tax-exempt status. Further, it signals that the IRS might view similarly structured activities as being unrelated trade or business activity or potentially threating the exempt status of an organization that runs such a program as part of its activities or through a partnership. Tax-exempt organizations participating or considering participating in non-MSSP ACOs, should review those activities in light of PLR 201615022. Improper structuring of an ACO's or health care organization's independent physician contracts could jeopardize the tax-exempt status of the ACO, result in prohibited private benefit or inurement to participating providers, and/or result in unrelated business taxable income from ACO activity.

The IRS had previously released guidance on which tax-exempt organizations can rely when participating in MSSP ACOs. In Notice 2011-20, the IRS discussed its expectations for how existing tax guidance would apply to tax-exempt organizations participating in the MSSP through ACOs. See Tax Alert 2011-589{}. Additionally, in November 2011, CMS released final regulations on the MSSP and ACOs. The IRS concurrently released a fact sheet with guidance for tax-exempt organizations participating in the MSSP through ACOs. See Tax Alert 2011-1806{}.

It remains unclear whether and when furthering the "Triple Aim" goals of the ACA would further tax-exempt charitable purposes; whether an ACO with a dual-use purpose (participating in MSSP as well as negotiating contracts between independent physicians and commercial payers) or a health care system-related ACO that served only providers within the system could qualify for exemption under Section 501(c)(3).

Please contact your EY tax practitioner for further information.

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RELATED RESOURCES

— For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.

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ENDNOTES

¹ The ACA directed the Department of Health and Human Services (HHS) to establish the MSSP to promote accountability for care of Medicare beneficiaries, improve the coordination of Medicare fee-for-service items and services, and encourage investment in infrastructure and redesigned care processes for high quality and efficient service delivery. Groups of health care service providers and suppliers that have established a mechanism for shared governance and that meet certain criteria specified by HHS are eligible to participate as ACOs under the program.