On October 24, 2014, the IRS published Notice 2014-67, which expands the Revenue Procedure 97-13 safe harbors regarding management contracts and further provides interim guidance related to a health care organization’s participation in the Medicare Shared Savings Program (MSSP) through an Accountable Care Organization (ACO). The Internal Revenue Code of 1986 and Treasury Regulations impose restrictions on facilities financed by tax exempt government bonds or bonds issued for the benefit of nonprofit 501(c)(3) organizations regarding private business use (referred to as a “qualified user”). Because many 501(c)(3) hospitals are qualified users, the IRS guidance regarding private business use impacts the structure of arrangements between hospitals and their physician partners.
Private business use can occur if a qualified user enters into a management contract or other type of exclusive service contract with a for-profit party (a “non-qualified user”). Rev. Proc. 97-13 sets forth certain safe harbors for these types of management contracts, which can include exclusive service contracts. When structured consistent with the requirements of one of the safe harbors, these contracts will not result in private business use of the qualified user’s facilities. Generally, the safe harbors focus on the term length, including the right of the qualified user to terminate the agreement at will and without penalty, as well as the compensation paid to the non-qualified user, including restrictions on payments based on a share of net profits.
New safe harbor for management contracts
The new safe harbor significantly increases the flexibility of a qualified user, including a 501(c)(3) hospital, to enter into management contracts for a term of five years, without requiring a termination right by the qualified user prior to the end of the five-year term. There is also no limitation on the variable component of the compensation arrangement. Management contracts with a five-year term can include compensation structured as a percentage of gross revenues, adjusted gross revenues or expenses of the facility (but not revenues and expenses), or otherwise as a combination of a stated amount, periodic fixed fee, a capitation fee or a per-unit service fee. Productivity rewards based on achieving predetermined quality of service metrics (e.g., ACO payments to participants through participation in a MSSP arrangement) can be structured in a tiered system of stated dollar amounts or periodic fixed fees. This new safe harbor applies to management contracts entered into, materially modified, or extended (other than pursuant to a renewal option) on or after Jan. 22, 2015 and may be applied to contracts entered into before Jan. 22, 2015.
Interim guidance on ACO participation in the Medicare Shared Savings Program
The Medicare Shared Savings Program encourages ACO’s to reduce costs while still achieving certain quality benchmarks established by the Centers for Medicare and Medicaid Services (“CMS”) by paying the ACOs a payment equal to a certain percentage of the cost savings to the Medicare program. This guidance clarifies that a qualified user’s, including a 501(c)(3) hospital’s, participation in an ACO with other for-profit entities, such as physicians, other health care providers and suppliers, and insurers, will not result in private business use if all of the following requirements are met:
- the terms of the qualified user’s participation (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;
- the qualified user’s share of economic benefits derived from the ACO (including its share of MSSP payments) is proportional to the benefits or contributions the qualified user provides to the ACO – if the qualified user receives an ownership interest in the ACO, the ownership interest received must be 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 qualified user’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 qualified user is entitled;
- all contracts and transactions entered into by the qualified user 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; and
- the qualified user does not contribute or otherwise transfer the property financed with tax-exempt bonds to the ACO unless the ACO is an entity that is a qualified user.