In April 2016, the Internal Revenue Service (the “Service”) issued a final determination denying a nonprofit corporation (the “Network”) tax exempt status under Section 501(c)(3) of the Internal Revenue Code (the “Code”). The private letter ruling involved a tax-exempt health system (the “System”) that formed the Network to operate an accountable care organization (“ACO”) that did not participate in the Medicare Shared Savings Program (“MSSP”). Rather, the Network was formed and operated as a non-MSSP clinically integrated network. The Network was intended to develop and implement financial incentives to participating providers by tying payments to the providers’ collective success at (i) reducing the cost of healthcare for individuals; (ii) improving patient access and quality of care; and (iii) improving population health and patient experience. These goals were measured by the Network’s analysis of clinical information and a patient satisfaction tool.
Participation in the Network was open to providers employed by the tax-exempt System, providers in private practice that held medical staff privileges with the System, and providers in private practice that were not affiliated with the System. The Network also represented all of those participating providers (including those in private practice) in certain negotiations with third-party payers.
The Service concluded that the Network was not organized exclusively for a charitable purpose, and therefore denied tax exempt status to the Network. Although the promotion of health is recognized as a charitable purpose, the Service explained that not every activity that promotes health furthers a charitable purpose under Section 501(c)(3) of the Code. The Service concluded that although the aforementioned goals of the Network were intended to promote health, those goals were not “coextensive” with charitable purposes under Section 501(c)(3). The Service expressed concern that a substantial portion of the Network’s activities involved negotiating with third-party payers on behalf of non-System affiliated physicians and groups. The Service determined that those activities were primarily beneficial to private interests, and only of incidental benefit to the community.
In concluding that the Network was not organized exclusively for a charitable purpose, the Service distinguished commercial ACO’s from MSSP ACO’s. Specifically, the Service reasoned that MSSP ACO’s have a charitable purpose insofar as they serve Medicare patients and therefore lessen burdens on government, which is a recognized charitable purpose. The Service determined that there was not a similar charitable purpose in the commercial ACO in question in the private letter ruling.
Although the ruling denied tax exempt status to the Network, the System’s own tax exempt status was not affected by the ruling. The Service has previously observed that ACO’s (whether MSSP ACO’s or commercial ACO’s) can be structured in different entity forms under state law and that each entity form may come with its own tax consequences. The ruling confirms that tax-exempt organizations that participate in commercial ACO’s should continue to carefully consider:
- the selection of a commercial ACO’s entity type and intended income tax classification;
- whether ACO’s or similar joint ventures may qualify for tax-exempt status;
- whether commercial ACO’s or similar joint ventures will generate unrelated business income; and
- whether commercial ACO’s or similar joint ventures, if they represent a substantial enough portion of a tax exempt organizations’ operations, could even jeopardize those organizations’ tax exempt status.
 The Service has previously provided guidance for ACO’s that participate in the MSSP, see Treas. Notice 2011-20, available at https://www.irs.gov/pub/irs-drop/n-11-20.pdf, as well as informal guidance for ACO’s that do not participate in the MSSP. See Fact Sheet: “Tax-Exempt Organizations Participating in the Medicare Shared Savings Program through Accountable Care Organizations”, Q&A 11-15, available at https://www.irs.gov/uac/tax-exempt-organizations-participating-in-the-medicare-shared-savings-program-through-accountable-care-organizations.
 Approximately one-half of the Network’s participating providers were in private practice or were affiliated with hospitals or health systems other than the System.
 On May 16, The American Hospital Association submitted comments to the Service requesting that the Service make additional guidance regarding the availability of tax exempt status for commercial ACO’s a priority. The comments are available at http://www.aha.org/advocacy-issues/letter/2016/160516-let-hatton-koskinen-mazur.pdf.