AHLA. B. What s Up with Rev. Proc Brenda S. Horn Ice Miller LLP Indianapolis, IN. Elizabeth M. Mills Proskauer Rose LLP Chicago, IL

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1 AHLA B. What s Up with Rev. Proc Brenda S. Horn Ice Miller LLP Indianapolis, IN Elizabeth M. Mills Proskauer Rose LLP Chicago, IL Tax Issues for Health Care Organizations October 19-21, 2014

What s Up With Rev. Proc. 97-13 Brenda S. Horn Ice Miller LLP Elizabeth M.

Yes, if you represent a Section 501(c)(3) organization with outstanding tax-exempt bonds Yes, if you represent a state or local government

2 What s Up With Rev. Proc Brenda S. Horn Ice Miller LLP Elizabeth M. Mills Proskauer Rose LLP Tax Issues for Health Care Organizations October 19-21, Do you care about Rev. Proc ? Yes, if you represent a Section 501(c)(3) organization with outstanding tax-exempt bonds Yes, if you represent a state or local government owned hospital with outstanding tax-exempt bonds (or Build America Bonds) Yes, if you represent entities which seek to enter into a service contract with any of the foregoing (You want to be able to argue with bond counsel!) 1 1

3 Why do you care about Rev. Proc ? Use of Facilities financed with tax-exempt bond proceeds (or BABS) by non-exempt entities is limited and failure to comply causes loss of tax exemption Policy Reason: This private use or non-exempt use would give a non-exempt entity (not entitled to such use) the benefits of the tax-exempt bonds (or BABS) Section 501(c)(3) organization - 5% private use limits (reduced by COI) and $15m cap - Exempt entities are Section 501c(3) organizations or state and local government entities State or local government owned hospital 10% private use limits and $15m cap Exempt entities are state and local government entities 2 Service contracts may result in private use Private use of bond financed property may result from a lease, a sale, use in an unrelated trade or business, use under a research contract, use in a joint venture or a partnership In all of the foregoing (except for the research contract), there is no way to structure the use to avoid private use. In contrast, a service contract may be structured so that it does not result in private use of the bond financed facilities of Section 501(c)(3) or state and local governmental health care providers 3 2

agreements (ER, anesthesiology, radiology, pathology) medical director agreements on-call agreements teaching agreements laundry service agreements food service agreements management agreements 4

4 What service contracts may result in private use? Arrangements under which services are provided in bondfinanced property or use bond-financed property Unwritten arrangements as well as written contracts Examples in healthcare professional services agreements (ER, anesthesiology, radiology, pathology) medical director agreements on-call agreements teaching agreements laundry service agreements food service agreements management agreements 4 What service contracts do not result in private use? Employment agreements Agreements for services that are solely incidental to the primary function of the facility E.g., janitorial, hospital billing, office equipment repair The granting of medical staff privileges, without more Agreements with other 501(c)(3) organizations where the exempt service provider's activity is related to its exempt purposes Service contracts in which only payment is reimbursement of payments by the service provider to unrelated third parties Certain short term contracts 5 3

5 Rev. Proc Safe Harbors for service contracts Rev. Proc , as modified by Rev. Proc , sets forth the circumstances under which the IRS will ordinarily issue a ruling that a service contract does not create private use The safe harbor has become the de facto rule because they are all bond counsel and others have to go on Numerous Private Letter Rulings have been issued on this topic in the last 10 years Safe Harbor Revenue Procedures for service contracts have served as guidelines since the early 1980s, with periodic updates but no significant update since 1997, long overdue NABL and ABA have submitted comments suggesting changes 6 General Rev. Proc provisions Must fall within one of five defined combinations of term length and compensation arrangements Compensation is not based on net profits (can be based on revenue or expenses, but not both) Compensation is fair market value Generally cannot contract with non exempt related parties Frame of reference for compensation: everything that flows to the service provider as a result of the service, including patient fees, is treated as compensation 7 Except for amounts paid to unrelated parties Note: this means a contract for services can implicate even when not exclusive and the hospital makes no payment to physician 4

6 Rev. Proc Safe Harbors Method of Compensation At least 95% Fixed Fee At least 80% Fixed Fee At least 50% Fixed Fee or 100% Capitation Fee or Combination 100% Per Unit Fee or Combination Fixed Fee/Per Unit Fee (includes separate billing arrangements) % of Revenue or Expense or Combination of % and a Per Unit Fee --- Only for start-up & for services provided to 3 rd parties Maximum Contract Term Lesser of 80% of useful life of facility and 15 years Lesser of 80% of useful life of facility and 10 years Right to Terminate Contract without Penalty After: N/A N/A 5 years 3 years 3 years 2 years 2 years 1 year Long-term contracts Two of the five categories are rarely seen in health care arrangements Up to 15-year term permitted if at least 95 percent of each year's compensation is fixed Up to 10-year term permitted if at least 80 percent of each year's compensation is fixed The problem with these categories is that fixed means fixed at the time the contract is entered into (subject only to adjustment with an external index) In other words, when you sign the agreement you must know what the compensation will be in year 8, subject to e.g. CPI adjustments 9 5

Percentage contracts Compensation may be based on a percentage of revenues or expenses Term limit: 2 years, with exempt organization able to terminate without penalty or cause effective the end of

7 Percentage contracts Compensation may be based on a percentage of revenues or expenses Term limit: 2 years, with exempt organization able to terminate without penalty or cause effective the end of the first year Permissible only in limited circumstances Facility start-up period Contracts under which service provider primarily provides services to third parties (e.g. radiology services to patients) but in this situation would usually prefer to characterize as per-unit contract with longer term 10 Per-unit fee Compensation is based on per-unit fee Or combination of per-unit fee and periodic fixed fee No incentive compensation allowed Patient fees billed separately by physicians are generally treated as per-unit fees Exempt organization fee approval needed? Comments suggest clarification that approval not needed Contract can have term of up to three years, terminable by exempt organization without penalty or cause effective at the end of the second year Notice requirement for two-year termination must be reasonable 11 6

Fifty percent fixed fee Contract can have term of up to five years, terminable by exempt organization without penalty or cause at the end of the third year Notice requirement for three-year

8 Fifty percent fixed fee Contract can have term of up to five years, terminable by exempt organization without penalty or cause at the end of the third year Notice requirement for three-year termination must be reasonable This is really a 3-year contract At least 50 percent of each year s compensation is a fixed fee Again fixed means determinable, except for external indices, at the beginning of the contract Comments suggest permitting adjustments to a periodic fixed fee based on measurable factors that are not within the control of the service provider or the qualified user 12 Fifty percent fixed fee (Cont d) The other 50 percent can be based on revenues or expenses (but not both), as well as incentive amounts based on nonfinancial indicators For example, quality indicators? Comments suggest making clear that incentive payment can be based on non-financial indicators 13 7

Contract may not comply with 97-13, regardless of term or compensation provisions, because it is with a non-exempt subsidiary Comments suggest eliminating this restriction 14 Common arrangements that

9 Common arrangements that cause concerns under the Safe Harbors Hospital parent owns all the stock of a for profit physician practice entity. Hospital contracts with the practice entity to staff ER, interpret EKGs, or act as medical director. Contract may not comply with 97-13, regardless of term or compensation provisions, because it is with a non-exempt subsidiary Comments suggest eliminating this restriction 14 Common arrangements that cause concerns under the Safe Harbors Hospital enters into contract for food service with nonexempt entity, compensation is based on a monthly fixed fee and incentive payments. The incentive payment will be 5% of any revenue above a budgeted target and 5% of any cost savings below a budgeted expense target Incentive is based on both revenues and expenses, which may run afoul of net profits prohibition Comments suggest clarification that certain types of compensation that include both revenue and expense measures are not based on net profits 15 8

10 Common arrangements that cause concerns under the Safe Harbors Hospital enters into contract with nonexempt entity to manage outpatient services; compensation is a fixed fee and reimbursement of cost of employees of manager (salary and benefits, computed as percentage of salary) Common arrangement; but is the benefit calculation truly pass-through? Comments suggest clarifying this point 16 Common arrangements that cause concerns under the Safe Harbors Hospital constructs new bond-financed outpatient cancer center and needs a commitment from a private oncology group that it will staff the center when construction is completed in 1-2 years If hospital and group enter into 3-year per-unit agreement now, must that 3-year, 2-year-out term start now? If so, not much of a commitment from group Comments suggest providing that measurement of term begins on commencement of operations 17 9

11 Common arrangements that cause concerns under the Safe Harbors Radiologists have exclusive contract, receive $50,000 annual medical director payment as well as the right to bill and collect professional fees, and receive incentive payments for meeting quality and service indicators. Emergency physicians want compensation consisting of professional fees but with guaranteed annual minimum and want minimum to vary based on number of newly recruited physicians How to analyze these? Only solution may be fifty percent fixed fee, which puts risks on both hospital and physician (with greater risks for longer contracts) 18 Proposed changes to Rev. Proc Contractual relationships in healthcare have changed dramatically since 1997, some being driven by other federal agencies Private Use scrutiny has escalated with the imposition of the Schedule K reporting requirements, the IRS focus on post issuance compliance and increased IRS tax exempt bond audits focused on private use In 2012, National Association of Bond Lawyers and American Bar Association each submitted proposed changes at the request of the Internal Revenue Service. Changes to Rev. Proc remain on the IRS Work Plan but timing has not been communicated

12 Proposed changes to Rev. Proc Expand the list of incidental services excluded from Combine the two-, three- and five-year safe harbors into a single three-year safe harbor For contracts terminable without penalty or cause, measure the term as the stated notice period for termination (i.e., if contract terminable on 180 days notice at any time, term of contract should be 180 days) Eliminate the requirement that the qualified user be able to terminate the contract without penalty or cause If the requirement that the contract be terminable without penalty or cause is retained, it should be clarified Remove the 80% useful life requirement for the 10 and 15 year safe harbors 20 Proposed changes to Rev. Proc Clarify that per-unit fee safe harbor arrangements either need not include the schedule of fees, or need not include the schedule of fees for negotiated third partyagreements Clarify that participation in an ACO or bundled payment program does not give rise to private business use Analyze multiple arrangements with one service provider separately (not as a single contract) if the compensation for each arrangement is separately determined and each can be separately terminated 21 11

AHLA. C. Tax-Exempt Financing Basics for Section 501(c)(3) Organizations. L. Todd Gibson Squire Sanders (US) LLP Cleveland, OH

AHLA. C. Tax-Exempt Financing Basics for Section 501(c)(3) Organizations. L. Todd Gibson Squire Sanders (US) LLP Cleveland, OH AHLA C. Tax-Exempt Financing Basics for Section 501(c)(3) Organizations L. Todd Gibson Squire Sanders (US) LLP Cleveland, OH Julie K. Seymour Ungaretti & Harris LLP Chicago, IL Tax Issues for Health Care