ACO not entitled to exemption under section 501(c)(4)

ARTICLE | May 30, 2023

Authored by RSM US LLP

Executive summary: IRS wins Tax Court case denying section 501(c)(4) exemption to an accountable care organization

The U.S. Tax Court issued a memorandum opinion upholding the IRS’s determination that Memorial Health Accountable Care Organization (MHACO) does not qualify for tax exempt status under section 501(c)(4).

ACO not entitled to exemption under section 501(c)(4)

Background

MHACO was organized as a nonprofit corporation by Memorial Hermann Health System, the section 501(c)(3) parent entity of a tax-exempt health system. MHACO coordinates care for both Medicare and commercially insured patients. Medical providers contract with MHACO to coordinate and provide care for patients in exchange for a share of the payments that petitioner receives under its shared savings programs, which include both the Medicare Shared Savings Program (MSSP) and non-MSSP programs negotiated with commercial insurers.

Under the shared savings programs, MHACO receives a financial distribution if the assigned patients’ health care improves, based on agreed upon metrics, while costs decrease. The financial distribution is referred to as a shared savings payment, which generally is a percentage of the cost savings of beneficiaries’ healthcare. Under the commercial agreements, performance is measured, at least in part, based on cost savings to the commercial payors and the reduced cost of care directly benefits the commercial payors. In addition, the healthcare providers participating in MHACO also receive a portion of the shared savings payments as an incentive to participate in MHACO.

MHACO filed for tax-exempt status, seeking recognition as an organization described in section 501(c)(4). The application represented that MHACO seeks “to improve the health and social welfare of vulnerable patient populations of its parent…[Its] activities are focused on patients with complex or chronic conditions and who otherwise may have challenges navigating the healthcare system effectively.” Upon review, the IRS denied MHACO’s application for exempt status under section 501(c)(4) because the non-MSSP programs do not serve the public and primarily benefit the commercial insurers and healthcare providers with which MHACO contracts.

Tax Court’s opinion

Organizations exempt under section 501(c)(4) must be operated exclusively for the promotion of social welfare, which requires that the organization be primarily engaged in promoting the common good and general welfare of the people of the community. The Tax Court held that MHACO’s non-MSSP activities primarily benefit its commercial payor and healthcare provider participants rather than the public.

The Court found no evidence that MHACO coordinated with the State of Texas to administer healthcare to its Greater Houston community and did not otherwise show that its non-MSSP activities promote the common good and general welfare of the community. Rather, the Court found that MHACO’s non-MSSP activities provide no more than incidental benefits to the general public.

Accordingly, the court agreed with the IRS’s position that MHACO’s non-MSSP activities constitute a substantial nonexempt purpose, precluding MHACO from obtaining exemption as an organization described in section 501(c)(4).