Fifth Circuit affirms Tax Court’s denial of accountable care organization’s tax-exempt status

In detail

Background

MHACO, a nonprofit corporation formed under Texas law and located in Houston, participates as an ACO in the MSSP established under the Patient Protection and Affordable Care Act. MSSP ACOs are groups of health care providers that collaborate to manage and coordinate care for Medicare beneficiaries. Some ACOs similarly may manage and coordinate care for Medicaid beneficiaries or patients covered by commercial insurance.

Approximately 10% of MHACO’s patients are part of the MSSP, approximately 9% are covered by Medicare Advantage Plans administered by commercial insurers, and the remaining approximately 81% are covered by employer-sponsored health plans through commercial insurers. MHACO provides no services for people without insurance. 

Although the percentage of MHACO’s annual revenue derived from MSSP varies, MHACO maintains that MSSP activities have generated approximately 65% of its revenue since its formation in 2012. 

Fifth Circuit decision

On appeal, MHACO argued that:

• the Tax Court applied the wrong legal standard to the question of whether MHACO qualifies as a Section 501(c)(4) organization,
• the Tax Court’s review of the IRS’s Section 501(c)(4) determination extended beyond its appropriate scope, and
• the Tax Court improperly concluded that MHACO’s non-MSSP activities disqualify it from exemption under Section 501(c)(4).

Legal standard

The Tax Court applied a “substantial nonexempt purpose” test set forth in Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 279, 283 (1945), to determine whether MHACO qualifies as an organization “operated exclusively for the promotion of social welfare.” MHACO argued that the Tax Court instead should have applied the “primary purpose” test found in regulations under Section 501(c)(4), which provides that an organization is eligible for exemption under Section 501(c)(4) if it is “primarily engaged in promoting in some way the common good and general welfare of the people of the community.”

The Fifth Circuit rejected MHACO’s argument that the Tax Court applied the wrong test, finding that since Sections 501(c)(3) and 501(c)(4) both use the crucial phrase “operated exclusively,” the Better Business Bureau standard applies under both provisions. Accordingly, the court declined to disturb the Tax Court’s judgment on the grounds that it applied the incorrect legal standard.

Scope of review

MHACO next argued that the Tax Court exceeded the proper scope of review of the IRS’s Section 501(c)(4) determination. MHACO read the IRS’s final adverse determination letter as rejecting the substantial nonexempt purpose test, as the letter said an organization exempt under Section 501(c)(4) “may engage in substantial non-exempt activities since the test for exemption...is one of primary activities.” MHACO argued that the Tax Court should not have upheld the IRS’s determination based on the substantial nonexempt purpose test. The Fifth Circuit concluded that the IRS’s reasoning in the letter was consistent with the Tax Court’s reasoning and found that the Tax Court’s inquiry did not exceed its proper scope.

Qualification under Section 501(c)(4)

MHACO further argued that the Tax Court improperly concluded that MHACO is not “operated exclusively for the promotion of social welfare” within the meaning of Section 501(c)(4). It contended that its operations are intended to increase the quality and lower the cost of health care for the greater Houston community and that any benefits accruing to insurance companies, private payors, and private providers are merely incidental. The Fifth Circuit disagreed, finding that MHACO’s care-coordination services are not offered to the greater Houston community, but rather to people with health insurance.

MHACO contended that its private insurance contracts provide it with “otherwise inaccessible patient-level data” used to “judge the success of the community benefits it aims to deliver.” However, the Fifth Circuit found that MHACO uses this data only to benefit its members and that its members-only benefits system counsels against a conclusion that it is “operated exclusively for the promotion of social welfare.

The Fifth Circuit also found that even if MHACO’s coordinated-care services did benefit social welfare beyond its membership pool, the magnitude of MHACO’s commercial activities still would exclude it from tax exemption under Section 501(c)(4). The court noted that approximately 80% of MHACO’s patient population is covered by employer-sponsored health plans through commercial insurers and most of its operations pertain to creating cost savings that turn into revenue for insurance companies, private providers, and private payors. Accordingly, the court concluded that MHACO does not assist the entirety of Houston given its lack of addressing uninsured people who lack Medicare. 

Further, in reaching its conclusion, the court did not accept MHACO’s argument that since 65% of its revenue over its lifetime is from MSSP, most of the medical savings MHACO has generated have been in the public health sector through the MSSP. Rather, the court indicated it thought that the patient population breakdowns may provide a more reliable indicator of the MHACO’s purpose (particularly because contractual differences likely account for at least some of the differences in MSSP and non-MSSP revenue). In addition, the court noted that in any event the fact that more than a third of MHACO’s revenue comes from its non-MSSP contracts further supports the argument that its commercial activities are a substantial non-exempt purpose.

As such, the Fifth Circuit found that MHACO’s direct benefits accrue exclusively to its members, the vast majority of whom are not a part of MSSP. Based on the evidence, the court concluded that it is not clear that MHACO’s services even indirectly benefit the broader community. For these reasons, it held that the Tax Court did not clearly err when it determined MHACO is not “operated exclusively for the promotion of social welfare.