June 2, 2023
Tax Court holds that accountable care organization does not qualify as tax-exempt
The Tax Court (Court) held in a memorandum opinion (Memorial Hermann Accountable Care Org. v. Commissioner (T.C. Memo. 2023-62)) that an accountable care organization (ACO) does not qualify as tax-exempt under IRC Section 501(c)(4) because its activities primarily benefit commercial healthcare plan insurers (commercial payors) and providers, and do not primarily promote the common good and general welfare of the public.
Memorial Hermann Accountable Care Organization (MHACO), which is organized and controlled by an IRC Section 501(c)(3) nonprofit organization, coordinates care for participating patients, who are assigned to MHACO by either the Centers for Medicare & Medicaid Services (CMS) or a commercial payor that participates in MHACO. As of 2019, 18% of MHACO's patient participants were Medicare beneficiaries and the rest received health coverage from commercial payors. MHACO contracts with its sister organization to provide a physician network for the care of its patient participants. Patients do not pay fees to MHACO and are not limited to seeing its providers.
MHACO participates in the Medicare Shared Savings Program (MSSP), which is governed by CMS for Medicare beneficiaries. Participating ACOs receive a financial distribution (known as a shared savings payment) from CMS if the beneficiaries' health care improves while costs decrease. The participating ACOs then share these savings with their participating healthcare providers.
MHACO also participates in shared savings programs with commercial payors. As in the MSSP, MHACO and the healthcare providers receive payments when certain cost savings metrics are met.
MHACO applied to the IRS to be exempted as an IRC Section 501(c)(4) organization that seeks to improve the health and social welfare of vulnerable patient populations. The IRS denied the application on the grounds that MHACO's activities related to its non-MSSP programs, which primarily benefit the MHACO's participating insurance companies and health care providers, not the public.
After exhausting its administrative remedies, MHACO filed a petition with the Court.
To qualify as an IRC Section 501(c)(4) organization, an entity must show that (1) it is a civic organization, (2) it is not organized for profit, (3) it is operated exclusively for the promotion of social welfare, and (4) none of its net earnings benefit private shareholders or individuals.
The IRS argued that MHACO does not operate exclusively for the promotion of social welfare because it operates primarily for the benefit of commercial payors and healthcare providers.
The Court agreed, concluding that MHACO did not qualify as an IRC Section 501(c)(4) organization because its non-MSSP activities — which comprise the majority of its activities — primarily benefit its commercial payor and healthcare provider participants, not the public, and therefore constitute a substantial nonexempt purpose. "There is no evidence that petitioner has coordinated with the State of Texas to administer healthcare to the Greater Houston community, and petitioner has not otherwise shown that its non-MSSP activities promote the common good and general welfare of the community," according to the Court. Providing health care alone is not sufficient to qualify for exemption under IRC Section 501(c)(4), the Court noted.
The Tax Court, like the IRS, focused more on the benefits that participating healthcare providers and commercial payors derived from MHACO's activities than on how improvements in health care quality and cost savings from MHACO's activities could benefit the public. In doing so, the Tax Court did not analyze whether and to what extent MHACO's activities furthered its tax-exempt purposes. Rather, the Tax Court summarily concluded that any such public benefit was "incidental to the benefits received by the commercial payors and healthcare providers." Consequently, it is not clear from this ruling how an ACO could qualify for tax-exempt status under IRC Section 501(c)(4), other than by participating exclusively in the MSSP shared savings program (or an equivalent Medicare-only program), which would also qualify the ACO for tax exemption under IRC Section 501(c)(3).
While denying the ACO's exemption on the basis that it operates primarily for the benefit of private healthcare providers and commercial payors and operated for a "substantial non-exempt purpose," the Tax Court did not define what constitutes "primarily" or "substantial." Some organizations and practitioners have taken the position that "primarily" in the IRC Section 501(c)(4) context means greater than 50%, but this is not clear from prior rulings or the Tax Court's ruling.
MHACO could appeal the Tax Court's ruling to a federal appellate court, which could then affirm, overturn or modify the Tax Court's decision, and provide more specific guidance on how an ACO could qualify for IRC Section 501(c)(4) status. In the meantime, the IRS will follow the Tax Court's ruling in evaluating whether ACO entities qualify for tax exemption under IRC Section 501(c)(4), whether on examination or in a determination application. The IRS likely will also use this standard in evaluating whether ACO activities of tax-exempt healthcare entities constitute an unrelated trade or business activity that could generate unrelated business taxable income (UBTI). A tax-exempt healthcare organization should consider engaging only in MSSP shared savings programs and/or equivalent Medicare-only or Medicaid-only shared savings ACO programs. At this time, the IRS would not agree that participation in an ACO program, whether Medicare-only or otherwise, promotes social welfare by improving health care quality and reducing costs.
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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor