On April 8, 2016, the IRS released a private letter ruling denying tax-exempt status under Code section 501(c)(3) to an accountable care organization (“ACO”) that was not participating in the Medicare Shared Savings Program (“MSSP”).  PLR 201615022 (the “2016 PLR”) is the IRS’s first public written guidance on the tax-exempt status of ACO activities since 2011.

Since the MSSP became operational in 2012, it has been supported by a multi-agency effort to provide participants’ assurance that the application of existing laws and regulations governing tax-exempt status and permissible practices under the fraud and abuse laws would not be used against them. Recently, there has been increasing debate about whether the protected status that federal agencies have provided MSSP participants should also apply to ACOs in the private sector.  In fact, the Centers for Medicare & Medicaid Services and the Department of Health & Human Services’ Office of the Inspector General addressed this issue in their joint issuance of the final rule discussing the waivers of fraud and abuse laws for MSSP ACO arrangements in October 2015.  Now, with the 2016 PLR, the IRS has added its own views on the outer limits of protections for tax-exempt entities that create ACOs outside the MSSP.

The ACO at issue in the 2016 PLR was formed by a tax-exempt healthcare system to achieve clinical care integration, coordination, and accountability among employed and independent physicians practicing throughout the system’s affiliated facilities. Approximately half of the physicians participating with the ACO are members the health care system’s affiliated facilities, while the other half are in independent practices or affiliates of other hospitals and regional health systems.  The ACO acts as the representative for all participating providers, including the non-system affiliated physicians, in the negotiation and execution of agreements with third party payers.  Although the ACO does not participate in the MSSP, its mission focuses on the furtherance of the three health care reform goals established by the Patient Protection and Affordance Care Act (“PPACA”): reducing health care costs, improving patient access to and the quality of care, and improving population health and patient experience.

Nevertheless, the IRS denied tax-exempt status to the ACO, rejecting several arguments that the ACO made in favor of its tax-exempt status.

First, in order to qualify for section 501(c)(3) tax-exempt status, an entity must be organized and operated exclusively for charitable or certain other limited purposes, and no part of its net earnings may inure to the benefit of any private individual. The IRS held that the ACO at issue failed both of these tests.

Second, as stated by the IRS under Notice 2011-20, an ACO meeting certain requirements and whose only activity is participating in the MSSP should qualify as a tax-exempt entity .  In this case, the IRS agrees that the ACO’s participation in the MSSP would be charitable for purposes of section 501(c)(3) because the ACO would be “lessening the burdens of government,” a recognized charitable purpose.  While Notice 2011-20 does not provide guidance on the tax-exempt status of non-MSSP ACOs, commentators have argued that PPACA essentially makes all healthcare a burden of the government.  Thus, an entity focused on achieving the three aims of the PPACA is arguably reducing the burdens of government.  The IRS rejected this argument in the 2016 PLR, on the basis that PPACA “does not provide an objective manifestation that the government considers non-MSSP related ACO activities to be its burden, regardless of their furtherance of the PPACA’s overall . . . goals.”

The IRS further held that the ACO at issue in the 2016 PLR was not analogous to certain other health-related organizations that have been held to be tax-exempt (including a professional review standards organization) because it was not established pursuant to statute, managed by government officials, or funded by government grants.

Moreover, the IRS found that the ACO’s negotiation of agreements with third party payers was providing more than an incidental private benefit to non-system-affiliated providers.

The ACO will have the opportunity to protest the IRS’s determination, including at IRS Appeals and potentially in litigation.