IRS Releases Guidance on Private Business Use, and ACOs and Management Contracts 

Public Finance and Health Law Alert

November 4, 2014

On October 25, 2014, the Internal Revenue Service (the IRS) released Notice 2014-67 that provides interim guidance on (i) participation in the Medicare Shared Savings Program through an accountable care organization (ACO) and (ii) certain management contract provisions, as each relate to limitations on private business use of facilities financed by tax-exempt bonds issued for governmental entities and 501(c)(3) organizations.

Accountable Care Organizations

Many hospitals and other medical facilities owned by governmental entities and organizations described in section 501(c)(3) of the Internal Revenue Code of 1986, as amended are financed through tax-exempt bonds. There are significant restrictions on the amount of “private business use” (i.e., generally use by a for profit entity) that can be made of such tax-exempt bond financed facilities. Under the Patient Protection and Affordable Care Act, many hospitals and other health care organizations are incentivized to enter into ACOs to allow them to participate in the Medicare Shared Savings Program. As most ACOs involve participation of for profit entities together with 501(c)(3) organizations (and sometimes governmental entities), various groups, including the National Association of Bond Lawyers and the IRS Advisory Committee on Tax Exempt and Government Entities, have raised concerns that participation in an ACO could give rise to prohibited private business use of tax-exempt bond financed facilities owned by ACO participants through the terms of the contract with the ACO.

To respond to these concerns, Notice 2014-67 states that participation in an ACO by a governmental entity or 501(c)(3) organization (each a “qualified user”) in and of itself will not give rise to private business use if:

  • The terms of the qualified user's participation in the Medicare Shared Savings Program through the ACO (including its share of Medicare Shared Savings Program payments or losses and expenses) are set forth in advance in a written agreement negotiated at arm's length.
  • The Centers for Medicare & Medicaid Services have accepted the ACO into, and have not terminated the ACO from, the Medicare Shared Savings Program.
  • The qualified user's share of economic benefits derived from the ACO (including its share of Medicare Shared Savings Program 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 must be made in proportion to ownership interests.
  • The qualified user's share of the ACO's losses (including its share of Medicare Shared Savings Program 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.
  • 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 either a governmental person or a 501(c)(3) organization, as applicable to the tax-exempt bonds in question.

Notice 2014-67 is consistent with IRS Notice 2011-20 which the IRS issued in March 2011 regarding the participation of 501(c)(3) organizations in ACOs generally (whether or not the organization’s facilities are financed with tax-exempt bonds). In that previous notice, the IRS stated that it will not consider a 501(c)(3) organization’s participation in an ACO to result in private inurement or impermissible private benefit to the private party ACO participants if certain conditions are met. These conditions are the same as the first five conditions listed in Notice 2014-67.

Management Contract Rules

In order to avoid private business use, there are also limitations on the types of management contracts that a qualified user may enter into with respect to facilities financed by tax-exempt bonds. Generally, a management contract may not be based on net profits from the facility. IRS Revenue Procedure 97-13 sets forth more specific safe harbors for types of management contracts that avoid private business use; generally, the longer the term of a contract, the less variable compensation is permitted, and variable compensation that takes into account both revenues and expenses is also generally not permitted. Notice 2014-67 (i) provides for a specific safe harbor for productivity awards (geared towards the Medicare Shared Savings Program) and (ii) expands the safe harbor for certain five-year contracts.

Productivity Awards

Notice 2014-67 states that a productivity award will not give rise to compensation based on net profits if: (i) the eligibility for the productivity award is based on the quality of the services provided under the management contract (for example, the achievement of Medicare Shared Savings Program quality performance standards or meeting data reporting requirements), rather than increases in revenues or decreases in expenses of the facility; and (ii) the amount of the productivity award is a stated dollar amount, a periodic fixed fee or a tiered system of stated dollar amounts, or periodic fixed fees based solely on the level of performance achieved with respect to the applicable measure.

Certain Five Year Contracts

Notice 2014-67 adds to the types of permissible contracts a safe harbor for five-year contracts where all of the compensation for services is based on a stated amount, a periodic fixed fee, a capitation fee, a per-unit fee, or a combination of the preceding. The compensation for services also may include a percentage of gross revenues, adjusted gross revenues, or expenses of the facility (but not both revenues and expenses). This adds considerable flexibility to the current safe harbors that limited per unit fees to three-year contracts and only allowed compensation based on percentage of revenues or expenses in two-year contracts for limited types of services. Also, under the new safe harbor, the five-year contract does not have to be terminable by the qualified user prior to the end of the term; the existing five-year contract safe harbor requires that the contract be terminable after three years by the qualified user.


Notice 2014-67 states that the guidance regarding participation in an ACO applies to tax-exempt bonds issued on or after January 22, 2015, and that the guidance regarding management contracts applies to contracts entered into, materially modified or extended (other than by renewal) on or after January 22, 2015, but may be applied to earlier bonds or contracts.

Additional Guidance

The IRS has been working to update the management contract rules in Revenue Procedure 97-13. Notice 2014-67 states that it is interim guidance, and that the IRS may address additional issues regarding private business use and participation in an ACO in such additional guidance.


R. Christopher Raphaely

Co-Chair, Health Care

(215) 665-2099

Related Practices

Related Industries

For questions about the IRS's interim guidance on participation in the Medicare Shared Savings Program thought an accountable care organization, contact Jonathan Lichtenstein, a member of the firm's Public & Project Finance Group at (215) 665-2769 or or Christopher Raphaely, co-chair of the firm's Health Law Group, at (215) 665-2099 or