TAX ISSUES FOR ACOs AND OTHER NEW PAYMENT METHODOLOGIES. AHLA TAX ISSUES October 15-16, By John R. Holdenried Baird Holm LLP

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1 TAX ISSUES FOR ACOs AND OTHER NEW PAYMENT METHODOLOGIES AHLA TAX ISSUES October 15-16, 2012 By John R. Holdenried Baird Holm LLP I. Background on New Medicare Payment Methodologies A. Shared Savings Payments ACO Model. 1. Program limited to entities that qualify as accountable care organizations. Requires a mechanism for shared governance and a formal legal structure to receive and distribute payments for shared savings among providers. 2. Providers receive traditional Medicare payments, but if ACO meets quality performance standards and financial per capita targets, then the ACO will receive a percentage of the shared savings to be distributed among participating providers. 3. Potential tax issues a. Organization, capitalization, governance, and operation of ACO. b. Distribution of shared savings payments among participating providers. c. UBI status of ACO payments B. Pioneer ACO Model. 1. Separate from shared savings program under ACO model. C. Bundled Payment Initiative. 1. Announced by CMS on August 23, Separate from the National Pilot Program required by PPACA. Based on the authority of the Center for Medicare & Medicaid Innovation.

2 2. Rather than separate payments to each provider for services they furnish to a beneficiary for a single illness or course of treatment, CMS will link payments for multiple services patients receive during an episode of care. 3. Goal is to align incentives for providers (hospitals, post acute care providers, physicians, and other practitioners). 4. Four potential models: a. Model 1. Episode of care limited to inpatient stay. Hospital and physicians are paid a discounted rate based on traditional reimbursement. If payments are less than a target rate, then hospital and the physicians share in the gain. b. Model 2. Episode of care includes the inpatient stay and post-acute care (either a minimum of 30 or 90 days). Providers are paid a discounted rate based on traditional reimbursement. If payments are less than a target rate, then providers share in the gain. c. Model 3. Episode of care limited to the post-acute care (a minimum of 30 days following discharge). Providers are paid a discounted rate based on traditional reimbursement. If payments are less than a target rate, then providers share in the gain. d. Model 4. Episode of care limited to the inpatient stay. Hospital is paid a bundled amount to encompass all services during the inpatient stay. Hospital responsible to pay all physicians and other practitioners out of the bundled payment. 5. Status. CMS announced on September 6, 2012 that it has been reviewing applications and will be convening technical panels and will be contacting applicants in October with further questions. 6. Potential tax issues: a. Organization, capitalization, governance, and operation of entity receiving the payments under the first three models. b. Payment of the providers from the episodic payment. c. UBI status of the episodic payments. 2

3 D. National Pilot Program on Payment Bundling. 1. PPACA authorizes a pilot program to focus on eight medical conditions selected by the Secretary. Required by January 1, Covers an episode of care, defined to include 3 days prior to admission to a hospital and extending through 30 days following discharge. 3. Payment is expected to include bundled payments and bids from entities for episodes of care. 4. Potential tax issues likely to include same issues as under the Bundled Payment Initiative. II. Capitalization Needs of ACOs. A. Commentators. Several commentators have noted the significant capital and infrastructure necessary for the development of an ACO. As one commentator stated: So and I think it will be almost impossible to start ACOs quickly if each potential collaboration among otherwise independent providers has to come up with the same formula for sharing those upfront costs. I wouldn't begin to know how to do it. See transcript of hearings before FTC, CMS and the OIG, October 5, B. AHA/McManis Study. On May 13, 2011, the American Hospital Association (AHA) released a McManis study that looked at the startup investment required to establish and sustain an ACO. The study found that the costs of the necessary elements to successfully manage the care of a defined population is considerably higher $11.6 to $26.1 million than the $1.8 million estimated by CMS in its proposed rule for start-up and one year of ongoing operations. The AHA sent a letter to Donald Berwick, Administrator of CMS, to highlight these findings. 1. This study identifies a total of 23 different capabilities that must be developed across four categories to achieve the desired transformation in care delivery: network development and management care coordination, quality improvement and utilization management clinical information systems data analytics 3

4 2. The information gathered from four case studies was used to create two hypothetical examples to estimate the start-up and ongoing costs of establishing an ACO. The first represents a single free-standing hospital, 80 primary care physicians and 250 specialists. The second example includes a five-hospital (1,200 bed) system, 250 primary care physicians and 500 specialists. 3. The study was based on a series of case studies of organizations that have already taken steps to manage the care of a defined population in a manner similar to that of an ACO. This work was completed prior to the release of the proposed rule; therefore it does not include estimates of the costs of meeting requirements specific to the Medicare Shared Savings Program. III. Background on Tax Issues for Alternative Delivery Systems. The analysis of PPACA changing payment methodologies should be considered in the context of prior IRS standards for alternative payment mechanisms and delivery systems. A. HMOs. 1. General Standard. To qualify for exemption an HMO must either meet a community benefit standard (under Section 501(c)(3)) or social welfare standard (under Section 501(c)(4)), and must avoid disqualification under Section 501(m) (c)(4). Although in Sound Health Ass n v. Commissioner, 71 TC 158 (1978), acq C.B. 2, an HMO was found to qualify under Section 501(c)(3), the more common qualification is under Section 501(c)(4). See Geisinger Health Plan v. Commissioner, 985 F.2d 1210 (3d Cir. 1993); IHC Health Plan, Inc. v. Commissioner, 82 T.C.M. (CCH) 593 (2001); IHC Group, Inc. v. Commissioner, 82 T.C.M. (CCH) 606 (2001); IHC Care, Inc. v. Commissioner, 82 T.C.M. (CCH) 617 (2001). But see Vision Service Plan v. U.S., 96 AFTR 2d (RIA) (E.D. Calif. 2005), aff d unpublished, 101 AFTR 2d (RIA 656 (9th Cir. 2008) (holding that an HMO was not described in Section 501(c)(4) because it operated for the benefit of its members rather than to promote social welfare, and it carried on a business with the public for profit). 3. Section 501(m). Section 501(m), enacted in 1986, provides that an organization described in Section 501(c)(3) or (4) can be exempt only if no substantial part of its activities consists of providing commercial type insurance. Section 501(m)(3) expressly excludes from the term commercial-type insurance 4

5 provided substantially below cost to a class of charitable recipients and incidental health insurance provided by an HMO of a kind customarily provided by such organization. The IRS does not interpret this exclusion of incidental health insurance as a blanket exception for HMOs from the Section 501(m) commercial-type insurance proscription. The IRS expects a qualifying HMO to minimize its risk either by employing (or otherwise contracting on a fixed fee basis with) physicians providing a substantial proportion of the services being provided or utilizing a non-staff model that can shift a substantial part of the risk to the health care providers (such as capitated fees or discounted fee-for-service with substantial withholds). See Lawrence M. Brauer, Mary Jo Salins & Robert Fontenrose, Update on Health Care, FY 2002 CPE Text. 4. Medicaid-only HMOs. Such an entity may qualify for 501(c)(3) by virtue of the relief of poverty standard if it arranges for the provision of health services to its members, consisting exclusively of persons eligible under Medicaid, a comparable state program, or persons having special health care needs, and if it promotes the health of the community by actively engaging in programs that provide related health care services to its members. 5. Arranger Model. An arranger-model HMO may theoretically qualify under 501(c)(3) under the promotion of health rationale, but only if it can demonstrate that its activities benefit the community as a whole in addition to its subscribers, or alternatively as an integral part of a health care system. a. IHC Health Plans makes exemption under promotion of health difficult if not impossible. b. IHC Health Plans interprets the integral part test very narrowly. The court concluded that the HMOs were not an integral part of the health care system s operations because they contracted with independent contractor physicians (rather than solely with employed physicians at affiliated hospitals) to provide physician care for subscribers. IHC Health Plans, Inc. v. Commissioner, 325 F.3d 1188 (10th Cir. 2003). 6. Analogy to ACO. While an ACO is fundamentally different from an HMO, many of the IRS concerns about community benefit and the arranger model seem to similarly apply to ACOs. 5

6 B. Independent Practice Association (IPA). 1. Background on IPA. An IPA is typically a membership organization of physicians that arranges for the delivery of health services through written agreements negotiated with HMOs. The IPA serve as a bargaining agent for its members in dealing with HMO's, and to perform the administrative claims services required by the agreements negotiated with the HMOs. In Rev. Rul , C.B. 75, the IPA was paid a capitation amount by each HMO based on the number of HMO subscribers entitled to receive medical services, and the IPA in turn paid physicians on a fee for service basis subject to a withhold. The IRS held that the IPA operates in a manner similar to organizations carried on for profit, and its primary beneficiaries are its member-physicians rather than the community as a whole. Thus, the IPA didn t qualify for tax exemption under Section 501(c)(4). See also General Counsel Memorandum (Sep. 9, 1982). 2. Analogy to ACO. The role of an ACO in delivering services, potentially on a capitated or other risk basis to private payors, can be analogous to that of an IPA. C. Preferred Provider Organizations. 1. Background on PPOs. General Counsel Memorandum (November 6, 1989) sets forth the IRS thinking regarding PPOs. It concludes that the typical provider-sponsored PPO, one that is sponsored, for example, by a hospital and a group of physicians practicing there, probably would not qualify for tax exemption due to excessive benefit accruing to the sponsoring physicians. The GCM suggested that most PPOs would be subject to the same analysis as IPAs under Rev. Rul Analogy to ACO. The role of a joint venture ACO between a hospital and a group of physicians practicing there can be analogous to that of a PPO. D. RHIOs. 1. Background. Since 2009, the IRS has recognized regional health information organizations (RHIOs) as eligible for exemption. These are organizations formed and operated to facilitate the exchange of electronic health records among hospitals, physicians, and others in the health care system. The IRS has determined that their exempt purpose is the lessening of the burdens of government, based on the 6

7 legislative history of the American Recovery and Reinvestment Act of 2009, which is designed to promote health information technology development and information exchange. By enacting the new law, Congress recognized that facilitating health information exchange and technology is important to improving the delivery of health care and reducing the costs of health care delivery and administration. See IRS frequently asked questions at 2. Analogy to ACO. It can be argued that ACOs serve a similar role in that they have been authorized by Congress to improve accountability for care of Medicare beneficiaries, improve coordination of care, and encourage inivestments in infrastructure and redesigned care processes for high quality and efficient service delivery, thereby lessening the burdens of government. IV. Comparison to Physician Hospital Organization (PHO) Guidance A. CPE Articles. The closest analogy to ACO-type entities arises under IRS principles applicable to PHOs. Two IRS CPE articles address PHOs in some depth: 1. Charles F. Kaiser, Phyllis D. Haney, and T.J. Sullivan, Integrated Delivery Systems And Joint Venture Dissolutions Update, FY 1995 CPE Text, and 2. Charles F. Kaiser & T.J. Sullivan, Integrated Delivery Systems and Health Care Update, FY 1996 CPE Text. B. Background on PHOs. The CPE articles describe a PHO as essentially an independent practice association with a hospital participant. Thus, it may include an exempt hospital and a medical group, an individual practice association, or individual physicians who practice at or are affiliated with the hospital. The PHO typically owns no facilities or equipment and is not itself a provider of health care services. Its primary functions are to plan and implement a coordinated, cost-effective health-care delivery system that assures all needed medical treatments and resources are available and avoids duplication of services. The PHO serves as a vehicle through which hospitals and physicians jointly market their services to and contract with third party payers, such as managed care plans, insurance companies, and employers. It may also provide some administrative services related to third party payer contracts. The PHO does not exercise control over the operations of the hospital or the physicians, which retain their separate existence. 7

8 C. Not Eligible for Exemption. The CPE articles conclude that a PHO generally will not qualify for exemption under IRC 501(c)(3) because negotiating managed care contracts for the member-physicians furthers their private interests more than incidentally. D. Unique Kansas Model. The 1995 CPE article refers to exemption granted to a PHO affiliated with the University of Kansas Medical School. Unlike most PHOs, which confer substantial private benefit on the participating physicians, this PHO was controlled by the related Section 501(c)(3) organizations with which it is affiliated. Its mission is not simply to negotiate contracts for the delivery of hospital and medical services, but to supply a continuum of patients with diverse medical problems to the faculty and teaching hospital in order to perform their exempt function of educating the medical students. As a result, this PHO provides essential services to and is operated for the benefit of a group of related tax exempt organizations with which it is affiliated and not for the benefit of private interests. Therefore, this PHO qualifies as an organization described in IRC 501(c)(3). E. Hospital Affiliate Model. Notwithstanding the Kansas ruling, the IRS concludes that even if a PHO is a subsidiary controlled by the exempt hospital, it would generally not qualify under IRC 501(c)(3). It would not meet the integral part test because of the requirement that the integral part provide services that are essential to the exempt parent. Although the PHO provides services that benefit the hospital, negotiating managed care contracts for the member-physicians, a substantial if not primary activity, is not an essential service to a hospital. F. Participation by Exempt Hospital. In the CPE articles, the IRS concluded that PHOs that do not themselves qualify as tax-exempt organizations may nevertheless have tax-exempt hospitals as members. Under certain circumstances, a tax-exempt hospital may participate in a PHO without jeopardizing its exempt status. This requires structure and operation that avoids impermissible private benefit. 1. The articles state that the governing body may represent the participants, but that the tax-exempt hospital participant should ensure that its interests are adequately represented on the governing body so that the PHO is not operated in a manner that is inconsistent with the hospital's exempt status (e.g., with a veto power over actions of the PHO which may adversely affect its exempt status). 2. The articles specifically note that while tax-exempt hospital capitalization of a PHO should be commensurate with the benefits expected to be received by the hospital and its 8

9 community from the hospital's participation in the PHO, absolute parity between investment and control may not be required, though the opportunity to control the organization is one of the benefits of participation and may evince a hospital's intention to protect its investment. The article notes that properly structured loans and preferred stock arrangements, where reasonable, may provide some flexibility to the general expectation that capitalization be proportional. G. Participation Example. The 1995 CPE article cites a typical example, in which a hospital's ruling request states that NP Health Care Organization, Inc. ("NP") is formed as a non-profit membership organization. NP is controlled equally by the hospital and 275 physicians of the hospital's 300 person medical staff ("NP Physicians"). 1. The ruling request states that NP provides no health care services. Its sole function is to contract with payers for the provision of health care services to their covered individuals. The ruling request further states that NP in effect serves as a joint marketing arrangement, the expenses of which are intended to be paid by the hospital member and the NP Physician members in proportion to the benefit derived by each. NP is capitalized equally between the hospital and NP Physicians. 2. Whether a hospital's participation in a PHO jeopardizes its exempt status under IRC 501(c)(3) is determined by the IRS requirements for investments and joint ventures. Exemption will be jeopardized if the PHO is a vehicle for the hospital to share its net income with the medical staff. This would occur if the hospital's control or profit share in the PHO is smaller than its share of the capital contribution, as the member physicians would receive benefits disproportionately greater than their risk. To be consistent with exempt status under IRC 501(c)(3), the expenses of the arrangement should be paid by the hospital and the aggregate physician members in proportion to the benefit derived by each to assure that only incidental private benefit is conferred on the physician members, who otherwise would have no financial risk. 3. Another situation in which a PHO could jeopardize the exempt status of a participating hospital is where the PHO is a vehicle for sharing capitated payments with the physicians and the physicians are being paid more than reasonable compensation for their services or the hospital otherwise receives less than a fair portion of income. This situation would result in inurement or private benefit depending on whether any participating 9

10 physicians are insiders of the hospital subject to the inurement prohibition. 4. The 1995 CPE refers to G.C.M (May 19, 1988) and the factors that the Service will scrutinize when an exempt organization is involved in a partnership with physicians, and concludes that these factors are also useful in determining if a hospital's participation in a PHO adversely affects its exempt status. The factors are: Is there a disproportionate allocation of profit or loss in favor of the for-profit partner? Is there a nominal or insufficient capital contribution by the for-profit partner? Are new equipment or services brought into the partnership or is the service or equipment already available in the area? Is existing hospital equipment or facilities sold or leased to the partnership? Is any service being provided by the hospital at less than fair market value? Does a for-profit limited partner have significant influence and control over operations? Does the exempt organization bear all risk or liability for the partnership losses? Are commercially unreasonable loans made to the partnership (low interest or inadequate security)? H. Unrelated Business Income Tax ("UBIT") Considerations For Hospitals in PHO Arrangements. The 1995 CPE observes that a hospital that participates in a PHO through a partnership or joint venture, will generally be subject to unrelated business income tax on income it derives from the arrangement. Except for rare and unusual circumstances, the income of a separately incorporated PHO will be taxable at the corporate level and will not be attributable to the hospital. 1. The example in the Reg (b) is applicable to income derived from a PHO. Similar to the pharmaceutical sales to hospital patients in the example, income from PHO services performed for the benefit of hospital and its patients would 10

11 normally be considered related and would not be subject to UBIT. 2. PHO services provided to patients in the member physicians' private practices do not serve the hospital's exempt purposes and generate unrelated business income. I. PLR (Released ; dated ) 1 PHO type organization (although not called by that name) formed to help tax-exempt hospital and its medical staff participate in provider networks and contract with commercial payors. 2. Held: a. Not exempt because not organized and operated exclusively for charitable purposes b. Functions similar to IPA (per Rev. Rul ) c. Not exempt as integral part 3. Some activities (quality and care management) were similar to those of an ACO. V. Accountable Care Organization IRS Guidance A. Potential EO Ownership Roles in ACO 1. No ownership interest 2. Joint venture with physicians/other private parties to function as an ACO 3. Joint venture with other EOs to function as an ACO 4. Sole owner of ACO B. Potential Contractual Relationship with ACO. 1. A contract participant, sharing in MSSP 2. Contracted to provide management, support, administrative services 3. Lender, developer 11

12 C. ACOs So Far 1. Pioneer ACOs. On December 19, 2011, CMS announced the 32 organizations initially selected for inclusion in the Pioneer ACO program. While only a brief description of each organization is provided, it appears that 20 of the 32 have significant ownership and participation by tax-exempt hospitals, while the other 12 appear to be owned by physicians or independent practice associations of physicians. Of the 20 with hospital involvement, several appear to be wholly owned by the tax-exempt hospital system, while others appear to be joint ventures of hospital systems and physicians. 2. ACOs. a. On April 11, 2012, CMS announced the 27 organizations initially selected for inclusion in the ACO shared savings program. Again, while only a brief description of each organization is provided, it appears that only 4 of the 27 appear to have significant ownership and participation by hospitals. Rather, they appear to be physician or physician organization owned (and in a few cases FQHC owned). b. On July 9, 2012, CMS announced an additional 89 organizations selected for inclusion. Based on the brief descriptions provided, it appears that 47 are physician or physician organization-owned, 36 are hospital-physician ventures, 4 are hospital-owned, and 2 are FQHC-owned. D. Exemption Can an ACO itself qualify for tax exemption? 1. IRS Notice (released on March 31, 2011) does not directly address tax exemption for an ACO because the IRS anticipates that tax-exempt organizations will be participating in an ACO with private parties in the form of membership in a nonprofit membership corporation or limited liability company, shares in a corporation, or partnership interests. 2. In some cases, however, the ACO might be solely owned by an exempt hospital or a group of exempt hospitals or their taxexempt affiliates. 3. IRS Fact Sheet states that an organization engaged exclusively in the Medicare shared savings program will qualify for exemption under Section 501(c)(3) provided that it meets all the requirements for exemption. 12

13 4. IRS Fact Sheet also states that an organization that also engages in activities other than the Medicare shared savings program can qualify for exemption if it engages exclusively in activities that accomplish one or more charitable purposes and meets all of the other requirements for taxexemption under 501(c)(3). This seems to require that it engage exclusively in Shared Savings Program and non- Shared Savings Program activities that accomplish charitable purposes. E. Will Participation in ACO affect an Exempt Hospital s Tax Status? 1. IRS Expectations. IRS Notice states that payments must be structured to avoid inurement or private benefit. It then goes on to state that the IRS expects that there will not be inurement or private benefit where: a. The terms of participation (including its share of MSSP payments or losses and expenses) are set forth in advance in a written agreement negotiated at arms - length. IRS Fact Sheet clarifies that it is sufficient that the agreement set out the methodology for sharing rather than the precise share or exact amount. b. CMS has accepted the ACO into the Medicare Shared Savings Program. IRS Fact Sheet clarifies that termination of participation under the Medicare Shared Savings Program does not necessarily jeopardize continued exemption, but that non-medicare activities would then need to support exemption. c. The exempt organization s share of economic benefits from the ACO is proportional to the benefits or contributions it has made to the ACO. If the exempt organization receives an ownership interest, the ownership interest received is proportional and equal in value to its capital contributions, and all ACO returns of capital, allocations, and distributions are made in proportion to its ownership interest. IRS Fact Sheet clarifies that not all ACOs need to be proportional as in the example above. It states that this factor takes into account all contributions made by the charitable organization and other ACO participants to the ACO, in whatever form (cash, property, services), and all economic benefits received by ACO participants 13

14 (including shares of Shared Savings payments and any ownership interests). d. The exempt organization s share of ACO losses does not exceed the share of ACO economic benefits to which the organization is entitled. e. All contracts and transactions entered into by the exempt organization with the ACO and the ACO s participants, and by the ACO with the ACO s participants and any other parties, are at fair market value. Notwithstanding this expectation, the IRS seems to indicate that whether prohibited inurement or private benefit has occurred must be analyzed on a case-by-case basis. IRS Fact Sheet clarifies that no particular factor must be satisfied in all circumstances to prevent inurement or impermissible private benefit. 2. Jointly Owned ACO. In the case of an ACO jointly owned by exempt hospitals and for profit entities, there is considerable IRS and judicial guidance on joint ventures generally. a. Generally these standards require that the venture be organized and operated to carry out a charitable purpose (promotion of health), that the exempt organization have the power to control the venture at least as to powers to assure the carrying out of such charitable purposes and to prevent private benefit, and that the exempt organization s investment, risk, and return be proportionate. b. Rev. Rul concluded that a university continued to qualify for tax exemption with a appointed board based on other indicia of control. c. IRS Fact Sheet concludes that the exempt organization does not necessarily need to control the venture. The IRS observes that the CMS regulation and oversight of the ACO will be sufficient to ensure that the ACO s participation in the Shared Savings Program furthers the charitable purpose of lessening the burdens of government. However, the IRS cautions that participants in ACOs treated as partnerships that plan to engage in activities other than participation in the 14

15 Shared Savings Program should consult IRS guidance regarding joint ventures. d. Valuation issues will include capitalization, governance, profit share, expense allocation, compensation of physicians for services (e.g., developing care pathways), and distribution of savings. 3. Wholly Owned ACO. In some cases, hospitals may choose to be the sole owners of the ACO, but provide for appointment of physicians to the board. a. Private benefit issues identified by the IRS must be evaluated, even when the ACO is not an exempt organization. b. Valuation issues will still exist related to compensation of physicians for services, distributions of savings to physicians, and reasonable compensation. F. Activities Other than Medicare. 1. The IRS Notice recognizes that most ACOs will likely conduct other activities unrelated to MSSP, e.g., similar programs with private payors. The Notice indicates that negotiating with payors on behalf of unrelated parties is not a charitable activity, but that similar programs with Medicaid may further charitable purposes of relieving the poor and distressed or the underprivileged. Comments were requested, particularly as to safeguards necessary as in the Medicare program, such as regulatory requirements, and government oversight. 2. This will be a critical issue in further IRS guidance due to the need for ACOs to direct their attention to all care of its providers not just the care of Medicare patients. 3. It can be argued that the ACO for commercial patients also serves charitable purposes both because this promotes the health of the community and because it also contributes to lessening the burdens of government. 4. IRS Fact Sheet confirms that activities other than Medicare will be analyzed under traditional IRS principles including whether they: a. further an exempt purpose described in 501(c)(3) b. are attributed to the tax-exempt participant 15

16 c. represent an insubstantial part of the participant s total activities, and d. do not result in inurement of the tax-exempt participant s net earnings or in the participant conferring impermissible private benefit. 5. Can non-medicare activities further an exempt purpose? a. IRS Fact Sheet continues to refer only to programs such as those for Medicaid or indigent populations as furthering an exempt purpose. It specifically observes that not every activity that promotes health supports exemption under Section 501(c)(3). G. Application to Pioneer ACOs. The IRS guidance is specific to ACOs participating in the Medicare shared savings program. The Pioneer ACO program is separate and distinct. However, the Center for Medicare & Medicaid Innovation Request for Applications for the Pioneer ACO program contains a comparison of the Shared Savings Program and the Pioneer ACO. As to the Pioneer ACO, it states: Pioneer ACO Model will apply rules consistent with the guidance issued by FTC, DOJ, and IRS. Similarly, the frequently asked questions for the Pioneer ACO states: During the selection process, the Pioneer ACO Model will apply rules consistent with the guidance issued in March 2011 by the FTC, DOJ, and IRS. H. Application to Bundled Payment Initiative. CMS FAQs describe potential for Secretary to exercise statutory waiver authority for fraud and abuse laws. No separate guidance regarding IRS. VI. UBI Issues. A. UBI Status of ACO Payments to EO. 1. IRS Notice states that it expects that absent inurement or private benefits, shared savings payments from the ACO to the exempt organization will be substantially related to the performance of the charitable purpose of lessening the burdens of government so long as the ACO meets all the CMS eligibility requirements. In such circumstances, the ACO will not generate unrelated business income. 2. IRS Fact Sheet confirms that absent inurement or impermissible private benefit, any Shared Savings payments received by a tax-exempt participant from an ACO would derive from activities that are substantially related to the performance 16

17 of the charitable purpose of lessening the burdens of government. B. Capitated HMO/Insurance Payments. 1. PLR (6/15/98). As discussed in the Update on Health Care, 2001 EO CPE Text, the IRS determined that capitated HMO payments received by an exempt clinic from an HMO for the provision of physician services to the HMO s enrollees, whether performed by the clinic s employed or contracted physicians, were not unrelated business income to the clinic. The IRS concluded that the clinic s exempt purposes included the provision of heath care services to the community, and that the provision of health care services by the clinic s employed and contracted physicians to HMO s enrollees, in return for the receipt of fees from the HMO, was substantially related to the clinic s exempt purposes. 2. PLR (11/06/2000). Hospital affiliate contracts with insurance companies and HMOs on a global risk contracting basis. One contract was limited to services of affiliated exempt hospitals and physician entities. A second also included unaffiliated specialty care physicians. An affiliate then contracts on a capitated basis with each of the providers, including the specialist, except for low volume specialists who were paid on a discounted fee basis. Thus, most of the risk is shifted to the providers. The hospital affiliate also agreed to share risk with the insurance company for other services such as pharmacy, transplant, and out of area services based on a budget. The payments were received on behalf of affiliated hospitals and physicians and other specialty care physicians. In the case of one of the affiliated hospitals, there is a three way contract with a for-profit physician cliniic. The IRS concluded that the payments would not affect the entity s exmpt status and would not result in UBIT. This included the global capitated payments, the subordinated captiated payments, and the discounted fee for service payments to unaffiliated providers. 3. ACO Payments. In the ACO context, hospitals and other exempt providers will receive additional payments or face reductions from payors (Medicare, Medicaid, and private payors) for the services they provide, based on the quality and cost effectiveness of the services. If anything, the limited risk associated with such payments for health care services seems more consistent with a finding that such payments are substantially related to the provider s exempt purposes. In 17

18 both cases, the provider receives something other than traditional fee for service. In the PLRs, it s a capitated payment; in the ACO context and in private payor arrangements, it s a bonus or potentially a reduction in payment based on quality and cost effectiveness. The applicability of the PLRs should not be dependent on the nature of the payor. It s simply a recognition that tax-exempt providers can be paid in various ways for their services, and that the methodology doesn t change the character of the income. Applied here, this concept means that providers should be able to enter into arrangements with private insurers for payment arrangements similar to the Medicare Shared Savings Payments, and that such payments will not generate UBI. C. Profit Distributions. 1. The UBI status of ACO profit distributions is more likely to relate back to the exempt/non-exempt nature of the ACO activity. 2. Medicare/Medicaid allocations likely to be exempt. 3. Distributions from other activities likely to be subject to UBI. D. Payments for Management Services. 1. Likely relates back to exempt/non-exempt nature of ACO activities. 2. Medicare/Medicaid portion likely to be exempt. 3. Other portion likely to be UBI. VII. Comparison to Physician Electronic Health Record (EHR) Subsidy. A. CMS and OIG Action. In Section 1128B(b)(3)(E) of the Social Security Act, Congress authorized and directed the OIG to develop an anti-kickback safe harbor for the subsidy of physician EHR and in section 1860D-4(e)(6) of the Social Security Act, Congress authorized CMS to develop a Stark exception. Inherent in that legislation was a determination that in the absence of such incentives, physicians would not make such conversion and the national policy goals for electronic health records could not be achieved. As a result, CMS and the OIG jointly issued new anti-kickback safe harbors and Stark exceptions that permitted hospital payments to physicians for such software. 71 Fed. Reg (August 8, 2006); 71 Fed. Reg (August 8, 2006). In announcing that safe harbor on August 8, 2006, 18

19 CMS noted the concern about fraud and abuse, but that it was important to strike a balance between fraud and abuse concerns. They stated: However, we recognize that certain arrangements for the transfer of health information technology between parties with actual or potential referral relationships may further the important national policy of promoting widespread adoption of health information technology to improve patient safety, quality of care, and efficiency in the delivery of health care. 71 Fed. Reg B. IRS Action. After this was released, there remained significant concern about the effect of such subsidies on tax-exemption. Without IRS guidance, the CMS exception and the OIG safe harbor would leave exempt organizations with substantial risk in proceeding. The IRS followed with a Memorandum dated May 11, 2007 (Internal Revenue Service Memorandum, Hospitals Providing Financial Assistance to Staff Physicians Involving Electronic Health Records), May 11, 2007, available at: concluding that such physician incentives would not constitute inurement or impermissible private benefit if the benefits met the standards set out by CMS and the OIG and so long as three other standards were met: 1. There must be agreements with the hospital and its physicians requiring compliance with the CMS and OIG standards on a continuing basis, 2. The hospital must be able to access such medical records, to the extent permitted by law, and 3. The subsidy must be provided to all of its medical staff physicians and any difference in the level of subsidy must vary based on applying criteria related to meeting the healthcare needs of the community. C. Analogy to ACO. Clearly, there is physician benefit in tax-exempt hospitals providing subsidies to private physicians to acquire such capability. However, that benefit was viewed as incidental to the broader national policy goals. 1. Legislative Action. Section 1899(f) of the Social Security Act, as added by the Affordable Care Act (ACA) is similar to the EHR legislative mandate in that it authorizes the Secretary to waive certain fraud and abuse laws as necessary to carry out the MSSP. Similarly, Section 1115A(d)(1) of the Act, as added 19

20 by section 3021 of the ACA, authorizes the Secretary to waive the same fraud and abuse laws, among others, as necessary solely for the purposes of carrying out the provisions of section 1115A of the Act with respect to the testing of certain innovative payment and service delivery models by the Center for Medicare and Medicaid Innovation. The resulting waivers promulgated by CMS and the OIG on April 7, Fed. Reg (April 7, 2011) were, much like the IRS Notice, limited in scope to the distribution of MSSP. DOCS/