The National Association of Bond Lawyers is urging the Treasury Department and Internal Revenue Service to provide guidance ensuring that, if governments and nonprofit hospitals that use tax-exempt private-activity bonds to finance projects take certain steps to implement President Obama's health care reform law, their bonds will not become taxable.
NABL made the request in a letter, memo and exhibits sent on Monday to Vicky Tsilas, a Treasury associate tax legislative counsel, James Polfer, an IRS branch chief within the chief counsel's office of the financial institutions and products division, and Tim Jones, who works for Polfer. The letter is signed by NABL president, Scott Lilienthal, a partner at Hogan Lovells LLP.
"Fundamentally what we're trying to do is make sure the private use rules are not an obstacle to health care reform," said Richard Moore, a partner with Orrick, Herrington & Sutcliffe in San Francisco who worked on the NABL memo.
Under the Patient Protection and Affordable Care Act enacted in 2010, so-called accountable care organizations (ACOs) are set up to coordinate and manage health care to reduce costs while maintaining a certain level of quality health care.
The ACOs can be made of up tax-exempt governmental and non-profit hospitals as well as other health care groups that join together with private parties such as physician groups and suppliers. The tax-exempt and nonprofit health care providers typically have issued tax-exempt bonds to finance facilities and other projects.
But the federal tax code permits governmental and nonprofit organizations to issue tax-exempt private activity bonds to finance projects with only a limited amount of private involvement. For governmental issuers, PABs are taxable if more than 10% if the projects are used by private parties and more than 10% of the debt service is secured by payments from private parties. For 501(c)(3) nonprofit organizations, the private use and payment tests cannot exceed 5% for the bonds to have tax-exempt status.
The question is whether tax-exempt PAB issuers can join together with private parties in ACOs, without exceeding the private use limits.
"This has frankly posed some challenges," said Moore. "We expect to see more of this in the future," he said referring to the establishment of ACOs.
Some bond lawyers are telling their governmental and nonprofit issuers trying to join these ACOs to go slow until guidance is obtained on the tax ramifications.
"It didn't seem to make sense to deal with this on a private-letter ruling basis," said Moore, explaining why NABL is seeking broader guidance from the Treasury and IRS. PLRs typically are sought by issuers or their tax lawyers to obtain guidance on specific issues and are only supposed to be relevant for those that request them.
Under the health care law, ACOs are set up under a Medicare Shared Savings Program (MSSP) and are supposed to have contracts for periods of at least three years with Centers for Medicare and Medicaid Services (CMS), which also are set up under the MSSP.
There are tax rules relating to the private use that stems from management and service contracts. Under these rules, service providers such as doctors' groups, cannot be compensated based on the net profits of bond-financed facilities or this creates private use that counts toward the 5% or 10% limits.
In addition, a 16-year old revenue procedure, Rev. Proc. 97-13, that was drafted long before ACOs were ever thought about, sets forth the kinds of compensation packages that will not give rise to private use.
NABL has asked Treasury and the IRS to issue a notice or rule stipulating that no private use would be created by a tax-exempt governmental or nonprofit entity's participation in an ACO if three conditions are met.
First, the tax-exempt organization's participation in the MSSP through the ACO would be set forth in advance by a written agreement negotiated on an arms-length basis.
Second, the CMS would accept the ACO into, and would not terminate the ACO from, the MSSP.
And third, any incentives for cost savings would be based exclusively on savings from operational costs and not from the capital costs associated with tax-exempt health care borrowers.
In addition, NABL wants Treasury and the IRS to create a safe harbor for a "Health Care Service Contract" between an ACO-member hospital or nonprofit and private medical providers such as doctors, with the idea that this kind of contract would not be considered to give rise to private use.
"The [new health care law] represents one of the most significant regulatory overhauls of the U.S. health care system since passage of Medicare and Medicaid in 1965 and has accelerated the restructuring of the payment model for health care services," NABL said. "The creation of ACOs and a dramatic increase in the number of management or service contracts that include incentives based on quality, efficiency, and expense control is a natural result of this overhaul. Such incentives will not transfer the benefit of tax-exempt financing to a private business and will not cause health care providers to be compensated based on a share of net profits."
The tax code does not currently address these types of arrangements, NABL said, adding, "We believe that enactment of the guidance requested ... would assure the implementation of the [new health care law] is not unintentionally impeded by the private business use rules as they currently exist."