n-11-20.pdf

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NOTICE 2011-20

The Internal Revenue Service (IRS) is considering the application of the
provisions of the Internal Revenue Code (Code) governing tax-exempt
organizations to hospitals or other health care organizations that are recognized
as organizations described in § 501(c)(3) of the Code (referred to herein as
“tax-exempt organizations”) participating in the Medicare Shared Savings
Program (MSSP) described in § 3022 of the Patient Protection and Affordable
Care Act, Pub. L. 111-148, 124 Stat. 119 (Affordable Care Act), enacted March
23, 2010. Accordingly, the IRS is soliciting comments as to whether existing
guidance relating to the Code provisions governing tax-exempt organizations is
sufficient for those tax-exempt organizations planning to participate in the MSSP
through an “accountable care organization” (ACO) and, if not, what additional
guidance is needed. The IRS is also soliciting comments concerning whether
guidance is needed regarding the tax implications for tax-exempt organizations
participating in activities unrelated to the MSSP, including shared savings
arrangements with commercial health insurance payers, through ACOs.

BACKGROUND ON ACOS AND THE MSSP

Section 3022 of the Affordable Care Act amends Title XVIII of the Social Security
Act (SSA) (42 U.S.C. 1395 et seq.) by adding a new § 1899, which directs the
Secretary of the Department of Health and Human Services (HHS) to establish a
Medicare shared savings program that promotes accountability for care of
Medicare beneficiaries, improves the coordination of Medicare fee-for-service
items and services, and encourages investment in infrastructure and redesigned
care processes for high quality and efficient service delivery. Under § 1899(b)(1)
of the SSA, groups of health care service providers and suppliers that have
established a mechanism for shared governance and that meet criteria specified
by HHS are eligible to participate as ACOs under the program.

Section 1899(b)(1) of the SSA provides examples of groups of service providers
and suppliers that may form an ACO, including (i) physicians and other health
care practitioners (ACO professionals) in a group practice, (ii) a network of
individual practices, (iii) a partnership or joint venture arrangement between
hospitals and ACO professionals, and (iv) a hospital employing ACO
professionals. ACOs eligible to participate in the MSSP will manage and
coordinate care for their assigned Medicare fee-for-service beneficiaries. Health
care service providers and suppliers participating in an ACO will continue to
receive Medicare fee-for-service payments in the same manner as such
payments would otherwise be made. In addition, an ACO that meets quality
performance standards established by HHS and demonstrates that it has
achieved savings against an appropriate benchmark of expected average per
capita Medicare fee-for-service expenditures will be eligible to receive payments
for Medicare shared savings (MSSP payments) under § 1899(d)(2) of the SSA.

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Section 1899(i) of the SSA also authorizes the use of other payment models that
the HHS Secretary determines will improve the quality and efficiency of items
and services for Medicare.

Section 1899(b)(2) of the SSA establishes the following requirements for an ACO
to participate in the program:

(1) The ACO shall be willing to become accountable for the quality,
cost, and overall care of the Medicare fee-for-service beneficiaries
assigned to it.
(2) The ACO shall enter into an agreement with the HHS Secretary to
participate in the program for not less than a 3-year period (the
MSSP agreement period).
(3) The ACO shall have a formal legal structure that would allow the
organization to receive and distribute payments for shared savings
under § 1899(d)(2) to participating providers of services and
suppliers.
(4) The ACO shall include primary care ACO professionals that are
sufficient for the number of Medicare fee-for-service beneficiaries
assigned to the ACO under § 1899(c). At a minimum, the ACO
shall have at least 5,000 such beneficiaries assigned to it under
§ 1899(c) in order to be eligible to participate in the MSSP.
(5) The ACO shall provide the HHS Secretary with such information
regarding ACO professionals participating in the ACO as the
Secretary determines necessary to support the assignment of
Medicare fee-for-service beneficiaries to an ACO, the
implementation of quality and the other reporting requirements
under § 1899(b)(3), and the determination of payments for shared
savings under § 1899(d)(2).
(6) The ACO shall have in place a leadership and management
structure that includes clinical and administrative systems.
(7) The ACO shall define processes to promote evidence-based
medicine and patient engagement, report on quality and cost
measures, and coordinate care, such as through the use of
telehealth, remote patient monitoring, and other such enabling
technologies.
(8) The ACO shall demonstrate to the HHS Secretary that it meets
patient-centeredness criteria specified by the Secretary, such as
the use of patient and caregiver assessments or the use of
individualized care plans.

Section 1899(b)(3) of the SSA requires the HHS Secretary to establish quality
performance standards to assess the quality of care furnished by ACOs and
requires ACOs to report data, in a form and manner specified by the HHS
Secretary, on measures the Secretary determines necessary to evaluate the
quality of care furnished by the ACO. Section 1899(d)(3) of the SSA requires the

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HHS Secretary to monitor ACOs for avoidance of at-risk patients. If the HHS
Secretary determines that an ACO has taken steps to avoid at-risk patients to
reduce the likelihood of increasing costs to the ACO, the Secretary may impose
appropriate sanctions, including termination from the MSSP.

On March 31, 2011, the Centers for Medicare & Medicaid Services (CMS), the
agency within HHS that administers the Medicare program, released a Notice of
Proposed Rulemaking (NPRM) addressing § 1899 of the SSA and soliciting
comments. The NPRM contains specific, proposed eligibility criteria (including
patient and program safeguards) that entities would have to meet to qualify as
ACOs under the MSSP, and describes proposed quality measures, reporting
requirements, and monitoring by CMS. Consistent with the eligibility
requirements under §1899(b), the NPRM proposes requiring an ACO to be an
organization that is recognized under applicable State law and that has a
governing body with adequate authority to execute the statutory functions of an
ACO. The NPRM also proposes requiring an ACO’s governing body to include
ACO participants (or their designated representatives) and to include Medicare
patients who are served by the ACO and do not have a financial connection to
the ACO.

In the NPRM, CMS proposes to require potential ACOs seeking to participate in
the MSSP to submit written applications to CMS and to describe in their
applications how they plan to use and distribute any MSSP payments, and how
that plan would contribute to achieving the specific goals of the MSSP and the
general aims of better care for individuals, better health for populations, and
lower growth in expenditures. The NPRM proposes that CMS would evaluate the
ACO’s proposal in determining its eligibility to participate in the program.

The NPRM further proposes that CMS will monitor and assess the performance
of ACOs and their participants by making site visits, analyzing beneficiary and
provider complaints, conducting audits, and analyzing specific financial and
quality measurement data reported by the ACO, as well as aggregated annual
and quarterly reports. CMS will use these methods to monitor such matters as
the ACOs’ avoidance of at-risk beneficiaries and its compliance with quality
performance standards and eligibility requirements.

In addition, the NPRM proposes to require participating ACOs to comply with
public reporting and transparency requirements. For example, each participating
ACO would be required to publicly report information about its participating
providers of services and suppliers, leadership, quality performance, and shared
savings, including MSSP payments (if any) received by the ACO and the total
proportion of shared savings distributed among ACO participants and the total
proportion used to support quality performance and program goals.

Finally, consistent with the language in § 1899(i) of the SSA that authorizes the
use of alternative payment models, the NPRM proposes a “two-sided model,”

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under which participating ACOs would not only be eligible to share in cost
savings at higher rates but would also have to repay losses resulting from
spending that exceeds a benchmark of expected average per capita Medicare
fee-for-service expenditures (MSSP losses). ACOs will be able to elect to
participate in the two-sided model during the first two years of their initial MSSP
agreement period, with all ACOs operating under the two-sided model by the
third year of their initial MSSP agreement period, and during any subsequent
MSSP agreement period.

LAW

Exemption under § 501(c)(3) of the Code

Section 501(c)(3) of the Code provides, in part, for the exemption from federal
income tax of corporations organized and operated exclusively for charitable,
scientific, or educational purposes, provided no part of the organization's net
earnings inures to the benefit of any private shareholder or individual.

Treas. Reg. § 1.501(c)(3)-1(c)(1) states that an organization will be regarded as
operated exclusively for one or more exempt purposes only if it engages primarily
in activities that accomplish one or more of such exempt purposes specified in
§ 501(c)(3). An organization will not be so regarded if more than an insubstantial
part of its activities is not in furtherance of an exempt purpose.

Treas. Reg. § 1.501(c)(3)-1(c)(2) states that an organization is not operated
exclusively for charitable purposes if its net earnings inure in whole or in part to
the benefit of private shareholders or individuals. Courts have interpreted the
term “net earnings” as referring to an “advantage, profit, fruit, privilege, gain [or]
interest” derived from the organization. Harding Hospital v. United States
,
505 F.2d 1068, 1072 (6th Cir. 1964); Retired Teachers Legal Defense Fund v.
Commissioner, 78 T.C. 280, 286 (1982).

Treas. Reg. § 1.501(a)-1(c) defines “private shareholder or individual” as
referring to persons having a personal and private interest in the activities of the
organization. Such persons are commonly referred to as “insiders.”

Treas. Reg. § 1.501(c)(3)-1(d)(1)(ii) states that an organization is not organized
exclusively for any of the purposes specified in § 501(c)(3) unless it serves
public, rather than private interests. Thus, an organization applying for tax
exemption under § 501(c)(3) must establish that it is not organized or operated
for the benefit of private interests.

Treas. Reg. § 1.501(c)(3)-1(d)(2) provides that the term “charitable” is used in
§ 501(c)(3) in its generally accepted legal sense and includes such purposes as
relief of the poor and distressed or of the underprivileged; advancement of

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religion; advancement of education or science; and lessening of the burdens of
Government. A determination of whether an organization is lessening the
burdens of government requires consideration of whether the organization’s
activities are ones that a government unit considers to be its burden, and
whether such activities actually lessen that burden, based on all the facts and
circumstances. See
Rev. Rul. 85-1 (organization that assists a county’s law
enforcement agencies in policing illegal narcotics traffic lessens burdens of
government); Rev. Rul. 85-2 (organization that provides legal counsel and
training to volunteers who serve as guardians ad litum in a juvenile court
dependency program lessens the burdens of government).

Rev. Rul. 81-276, 1981-2 C.B. 128, describes a professional standards review
organization established pursuant to a federal statute to review health care
practitioners' and institutions' provision of health care services and items for
which payment is made under Medicare and Medicaid, and determine whether
the quality of services met professionally recognized standards of care. The IRS
ruled that by taking on the government's burden of reviewing the quality of
services provided under Medicare and Medicaid, the organization lessened the
burdens of government within the meaning of Treas. Reg. § 1.501(c)(3)-1(d)(2).
Any benefit to members of the medical profession from such activities was
incidental to the benefit the organization provided in lessening the burdens of
government. Therefore, the organization qualified for exemption under
§ 501(c)(3) of the Code.

The “promotion of health has long been recognized as a charitable purpose.”
Rev. Rul. 98-15, 1998-1 C.B. 718; see also
Rev. Rul. 69-545, 1969-2 C.B. 117
(noting that “[i]n the general law of charity, the promotion of health is considered
to be a charitable purpose”). However, not every activity that promotes health
supports tax exemption under § 501(c)(3). For example, selling prescription
pharmaceuticals promotes health, but pharmacies cannot qualify for recognition
of exemption under § 501(c)(3) on that basis alone. Federation Pharmacy
Services, Inc. v. Commissioner, 72 T.C. 687 (1979), aff'd, 625 F.2d 804 (8th
Cir.1980); see also
IHC Health Plans Inc. v. Commissioner, 325 F.3d 1188, 1197
(10th Cir. 2003) (noting that “engaging in an activity that promotes health,
standing alone, offers an insufficient indicium of an organization's purpose,” as
“[n]umerous for-profit enterprises offer products or services that promote health”).
Furthermore, “an institution for the promotion of health is not a charitable
institution if it is privately owned and is run for the profit of the owners.”
Rev. Rul. 98-15.

In Rev. Rul. 98-15, the IRS recognized that the activities of a limited liability
company (LLC) “treated as a partnership for federal income tax purposes are
considered to be the activities of a nonprofit organization that is an owner of the
LLC when evaluating whether the nonprofit organization is operated exclusively
for exempt purposes within the meaning of § 501(c)(3).” See also Rev. Rul.
2004-51, 2004-1 C.B. 974 (noting that the activities of an LLC treated as a

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partnership for tax purposes are attributed to a university that owns 50 percent of
the LLC for purposes of determining whether the university “operates exclusively
for educational purposes and therefore continues to qualify for exemption under
§ 501(c)(3)”).

Tax on Unrelated Business Income

Section 511(a) of the Code, in part, provides for the imposition of tax on the
unrelated business taxable income (as defined in § 512) of organizations
described in § 501(c)(3).

Section 512(a)(1) of the Code defines “unrelated business taxable income” as
the gross income derived by any organization from any unrelated trade or
business (as defined in § 513) regularly carried on by it less the deductions
allowed, both computed with the modifications provided in § 512(b).

Section 512(c) of the Code provides that, if a trade or business regularly carried
on by a partnership of which an organization is a member is an unrelated trade or
business with respect to the organization, in computing its unrelated business
taxable income, the organization shall, subject to the exceptions, additions, and
limitations contained in § 512(b), include its share (whether or not distributed) of
the gross income of the partnership from the unrelated trade or business and its
share of the partnership deductions directly connected with the gross income.

Section 513(a) of the Code defines the term “unrelated trade or business” as any
trade or business the conduct of which is not substantially related (aside from the
need of the organization for income or funds or the use it makes of the profits
derived) to the exercise or performance by the organization of its charitable,
educational, or other purpose or function constituting the basis for its exemption
under § 501.

Treas. Reg. § 1.513-1(d)(2) provides that a trade or business is “related” to an
organization's exempt purposes only if the conduct of the business activities has
a causal relationship to the achievement of exempt purposes (other than through
the production of income). A trade or business is “substantially related” for
purposes of § 513, only if the causal relationship is a substantial one. Thus, to
be substantially related, the activity “must contribute importantly to the
accomplishment of [exempt] purposes.” Treas. Reg. § 1.513-1(d)(2).

Rev. Rul. 2004-51 describes a § 501(c)(3) university that, together with a video
technology company, formed an LLC with the sole purpose of offering teacher
training seminars at off-campus locations using interactive video technology.
The university and the company each held a 50 percent ownership interest in the
LLC, which was proportionate to the value of their respective capital contributions
to the LLC. In addition, the governing documents of the LLC provided that (1) all
returns of capital, allocations and distributions were to be made in proportion to

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the members' respective ownership interests; (2) the LLC would be managed by
a governing board comprised of three directors chosen by the university and
three directors chosen by the company; (3) the university had the exclusive right
to approve the curriculum, training materials, and instructors, and to determine
the standards for successful completion of the seminars; and (4) the terms of all
contracts and transactions entered into by the LLC with the university and the
company and any other parties had to be at arm's length and all contract and
transaction prices had to be at fair market value. The IRS noted that because
the LLC was treated as a partnership for federal tax purposes, its activities were
attributed to the university for purposes of determining whether the university was
engaged in an unrelated trade or business. Under these facts and
circumstances, the IRS ruled that the university's activities conducted through the
LLC constituted a trade or business that was substantially related to the exercise
and performance of the university's exempt purposes.

DISCUSSION

Participation in the MSSP Through ACOs by Tax-Exempt Organizations

The IRS anticipates that tax-exempt organizations typically will be participating in
the MSSP through an ACO along with private parties, including some that might
be considered insiders with respect to the tax-exempt organization. The IRS
further anticipates that a tax-exempt organization’s participation may take a
variety of forms, including membership in a nonprofit membership corporation,
ownership of shares in a corporation, ownership of a partnership interest in a
partnership (or a membership interest in an LLC), and contractual arrangements
with the ACO and/or its other participants.

To avoid adverse tax consequences, the tax-exempt organization must ensure
that its participation in the MSSP through an ACO is structured so as not to result
in its net earnings inuring to the benefit of its insiders or in its being operated for
the benefit of private parties participating in the ACO. The IRS must determine
whether prohibited inurement or impermissible private benefit has occurred on a
case-by-case basis, based on all the facts and circumstances. Because of CMS
regulation and oversight of the MSSP, as a general matter, the IRS expects that
it will not consider a tax-exempt organization’s participation in the MSSP through
an ACO to result in inurement or impermissible private benefit to the private party
ACO participants where:

• The terms of the tax-exempt organization’s participation in the MSSP
through the ACO (including its share of MSSP payments or losses and
expenses) are set forth in advance in a written agreement negotiated at
arm’s length.
• CMS has accepted the ACO into, and has not terminated the ACO from,
the MSSP.

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• The tax-exempt organization's share of economic benefits derived from
the ACO (including its share of MSSP payments) is proportional to the
benefits or contributions the tax-exempt organization provides to the ACO.
If the tax-exempt organization receives an ownership interest in the ACO,
the ownership interest received is proportional and equal in value to its
capital contributions to the ACO and all ACO returns of capital, allocations
and distributions are made in proportion to ownership interests.
• The tax-exempt organization's share of the ACO's losses (including its
share of MSSP losses) does not exceed the share of ACO economic
benefits to which the tax-exempt organization is entitled.
• All contracts and transactions entered into by the tax-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.

An additional issue raised by the participation of tax exempt organizations in
ACOs is whether the share of the MSSP payments received by a tax-exempt
organization will be subject to unrelated business income tax (UBIT) under § 511.
Whether the MSSP payments will be subject to UBIT depends on whether the
activities generating the MSSP payments are substantially related to the exercise
or performance of the tax-exempt organization’s charitable purposes constituting
the basis for its exemption under § 501.

The IRS expects that, absent inurement or impermissible private benefit, any
MSSP payments received by a tax-exempt organization from an ACO would
derive from activities that are substantially related to the performance of the
charitable purpose of lessening the burdens of government within the meaning of
Treas. Reg. § 1.501(c)(3)-1(d)(2), as long as the ACO meets all of the eligibility
requirements established by CMS for participation in the MSSP. See, e.g.
, Rev.
Rul. 81-276 (recognizing that the federal government considers the provision of
Medicare to be its burden). Congress established the MSSP to be conducted
through ACOs in order to promote quality improvements and cost savings,
thereby lessening the government’s burden associated with providing Medicare
benefits.

The IRS is soliciting comments regarding what additional guidance, if any, is
needed to facilitate participation by tax-exempt organizations in the MSSP
through ACOs. If additional guidance is needed, the IRS is soliciting comments
regarding what criteria or requirements should be analyzed in determining
whether participation by a tax-exempt organization in the MSSP through an ACO
is consistent with tax-exempt status under § 501(c)(3) and whether the tax-
exempt organization is receiving unrelated business income.

ACO’s Conduct of Activities Unrelated to the MSSP

The IRS understands that some tax-exempt organizations might participate in
ACOs conducting activities unrelated to the MSSP, including entering into and

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operating under shared savings arrangements with other types of health
insurance payers (non-MSSP activities). The IRS anticipates that, in contrast to
activities conducted as part of the MSSP, many non-MSSP activities conducted
by or through an ACO are unlikely to lessen the burdens of government within
the meaning of Treas. Reg. § 1.501(c)(3)-1(d)(2). For example, negotiating with
private health insurers on behalf of unrelated parties generally is not a charitable
activity, regardless of whether the agreement negotiated involves a program
aimed at achieving cost savings in health care delivery. However, the IRS
recognizes that certain non-MSSP activities may further or be substantially
related to an exempt purpose. For example, the NPRM released by CMS
anticipates that ACOs may also participate in shared savings arrangements with
Medicaid, which may further the charitable purpose of relieving the poor and
distressed or the underprivileged. See
Treas. Reg. § 1.501(c)(3)-1(d)(2). This
notice does not address whether and under what circumstances a tax-exempt
organization’s participation in non-MSSP activities through an ACO will be
consistent with an organization’s tax-exemption under § 501(c)(3) or not result in
UBIT. However, the IRS requests comments regarding what guidance, if any, is
necessary or appropriate regarding a tax-exempt organization’s participation in
non-MSSP activities through an ACO.

Specifically, the IRS requests comments regarding how a tax-exempt
organization’s participation in particular non-MSSP activities through an ACO
further or are substantially related to an exempt purpose. Comments should
describe the activities a tax-exempt organization might expect to participate in
through an ACO and address under what rationale participation in such non-
MSSP activities might further exempt purposes and also what criteria,
requirements, and safeguards would ensure the furtherance of these exempt
purposes. In particular, comments should address how a participating tax-
exempt organization will ensure that non-MSSP activities further exempt
purposes in the absence of safeguards similar to those present in the MSSP,
such as (1) any regulatory requirements imposing quality performance and other
standards on the non-MSSP activities and (2) any oversight and monitoring of
the non-MSSP activities by a government agency such as CMS.

Comments should also take into account two principles under existing law. First,
although the promotion of health has been recognized as a charitable purpose,
not every activity that promotes health supports tax exemption under § 501(c)(3).
See
IHC Health Plans, 325 F.3d at 1197; Fed’n Pharmacy Serv., 72 T.C. at 691-
92; Rev. Rul. 98-15. Second, if a tax-exempt organization is a partner (or
member, in the case of an LLC) of an ACO treated as a partnership for federal
tax purposes, the ACO’s activities will be attributed to the tax-exempt
organization for purposes of determining both whether the organization operates
exclusively for exempt purposes and whether it is engaged in an unrelated trade
or business. See, e.g.
, Rev. Rul. 2004-51; Rev. Rul. 98-15.

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REQUEST FOR PUBLIC COMMENT

Public comments should be submitted in writing on or before May 31, 2011.
Comments should be sent to the following address:

Internal Revenue Service
SE:T:EO:RA:G (Notice 2011-20)
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Comments may be hand delivered to:

SE:T:EO:RA:G (Notice 2011-20)
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Comments may also be sent electronically to
notice.comments@irscounsel.treas.gov
. Please include “Notice 2011-20” in the
subject line.

All comments will be available for public inspection.

DRAFTING INFORMATION

The principal author of this notice is Mackenzie McNaughton of
Exempt Organizations, Tax Exempt and Government Entities Division. For
further information regarding this notice contact Mackenzie McNaughton at
(202) 283-9484 (not a toll-free call).