By: Philip Hackney 
Sometimes, well probably every time, when I teach about hospitals qualifying as tax-exempt charitable organizations I tell the joke from the movie Airplane that goes like this:
Rumack: You’d better tell the Captain we’ve got to land as soon as we can. This woman has to be gotten to a hospital.
Elaine Dickinson: A hospital? What is it?
Rumack: It’s a big building with patients, but that’s not important right now.
The point of this joke is an important one to me. It helps to illuminate the fact that the “promotion of health” as a charitable purpose is focused heavily on a space and an activity combined. Generally for the promotion of health to qualify as a charitable purpose there must be a physical building where doctors and nurses relieve the suffering of the afflicted. Not just any promotion of health suffices. Running a cheap pharmacy just does not cut it. Providing sperm to the women of your choice for free, even though it may effect health, simply does not cut it either (don’t ask, just read the opinion). What about health insurance? Generally, because of section 501(m) of the Code, health insurance does not qualify. However, health maintenance organizations (HMOs) that sell health services in exchange for a monthly fee that also own a building where they treat patients can qualify.
That brings us to a recent IRS denial of the application for charitable status of an organization operated as an “accountable care organization” (“ACO”), a creature of Obamacare. Congress created ACOs as a means of trying to maintain or enhance the quality of patient care while keeping costs low. In the Medicare Shared Savings Program various medical service providers such as hospitals, doctors and other providers can organize together to form an ACO. Medicare assigns that ACO a certain patient population. If the ACO is able to come up with savings for a particular procedure, Medicare would pay the ACO that saved that money half of the money saved.
Although the IRS had devised ways to allow hospitals to participate with private parties in ACOs, and the IRS had concluded that an ACO that solely served MSSP programs could be considered tax exempt entities because these ACOs could be considered to be lessening the burdens of government, the IRS has never found the same as to ACOs that are primarily engaged in serving private insurers. Part of the IRS’s reasoning for allowing those ACOs that serve MSSPs is that the government actually imposes significant rules on the operations of these ACOs, and performs oversight. If the ACO fails in any of the measures established, the government can remove the ACOs status as an ACO. In a January PLR released in April, the IRS denied the application of an ACO that does not serve an MSSP at all. It only serves an insurance company. The letter states: “You indicate that you are an Accountable Care Organization (“ACO”). You indicate that you do not participate in the MSSP.” Furthermore, and tellingly, the IRS states that this ACO does not “engage in the direct delivery of medical care or provide health services to the general public.”
The NYTimes released a story a couple of weeks ago with hospital and managed care interested parties arguing that the IRS ruling was not consistent with the tenor of the Affordable Care Act. By enacting the ACA, the government was trying to reduce the cost of health care while maintaining quality of care; the supporters claim that this new ruling stands in the way of that progress on health care cost and quality. This appears to be a strong lobbying effort on the part of that industry to force the IRS’s hand to accept tax exemption for these new creatures. While I appreciate that there is some subtlety on this one, I think the IRS is right here, and that it should stick to its guns. I approach this fairly simply as a line drawing exercise within the charitable sector. Generally health insurance is not considered to be a charitable activity and Congress has explicitly adopted this position. Without more direct guidance from Congress I think the IRS’s hands are tied here.
It is worthwhile noting that initially Blue Cross qualified for tax exemption. However, in the 1980s, Congress enacted section 501(m) mentioned above that states that a charitable organization or social welfare organization can so qualify “only if no substantial part of its activities consists of providing commercial-type insurance.” Since that time we have introduced into our country a series of different types of health care insurance such as health maintenance organization (HMOs) and Preferred Provider Organizations (PPOs) and the IRS has had to determine whether those organizations qualified for tax exemption or not primarily under a theory that they are engaged in the promotion of health.
Health care organizations typically seek tax exemption for two primary reasons: the ability to issue tax exempt bonds and the ability to hold property that is exempt from state and local taxes. In the health insurance context though it is harder to know. It seems that there may be some interest in tax exemption for other reasons such as for investment purposes. Once they receive annual payments they must invest those funds. If they can invest them tax free they are likely better off. This seems the most likely want in the ACO case. If anyone happens to know the most salient reason for an HMO or ACO in this case to seek tax exemption, I would be interested in your thoughts.
In the end, I think the IRS is almost surely right in its decision on this one. Court cases and IRS guidance provide that arranging for the delivery of care without actually operating the building with patients in it is deadly to exemption. Because I have great skepticism about the need for tax exemption in the cases of hospitals in the first place, and I have a tough time understanding why the operation of a financial arrangement to make health care available should be considered some charitable good, I am perfectly fine with this line drawing. I don’t think that every new policy we try out in health care that we think might cut costs should be thrown into the charitable mold. If the managed care folks can get Congress to pass legislation granting charitable status, fine, but until then, I think the IRS should stick to its guns. If an ACO is operated explicitly under guidance and supervision of the Centers for Medicare & Medicaid Services, fine – charitable status should be granted. However, without some other substantial factor involved, such as the relief of poverty, an organization involved in the provision of care in some way needs a building with patients in it to be charitable.
The Surly Subgroup 