Private Benefit Precludes Social Welfare Status for Accountable Care Organization, Government Argues

The Government argued before the 5th Circuit yesterday that the private benefit doctrine precludes exemption under IRC 501(c)(4) for an accountable care organization.  You can listen to the interesting oral argument here:  Memorial Hermann v. Commissioner

It sure sounds like the judges agreed with the Government and were not persuaded by Memorial Hermann's belated argument that the private benefit is qualitatively and quantitatively incidental. They didn't use the words and didn't seem aware that there is a whole body of murky law on the issue.  That argument seemed offered only as an afterthought and only because Memorial Hermann was forced into doing so by a really skillful argument delivered by DOJ Tax attorney Julie Ciamporcero Avetta. By night, Avetta doubles as an opera singer and even sings the national anthem at Major League baseball games. An oral argument is obviously nothing to her.   

Memorial Hermann's private benefit argument should have been offered in the case in chief instead of as what appeared to be a desperate attempt to salvage a sinking boat.  What the case boils down is whether a health care organization that serves only its members qualifies for tax exemption. Membership, by the way, is a primary method for cost containment in any sort of risk pool.  It is "incidental." Hermann Memorial's attorneys didn't recognize the issue, Avetta did and she made them confront it. She declined to make their argument for them when the judges asked her to do so. She knows something, trust me. She knows that the issue boils down to whether private benefit associated with a membership requirement is intolerable.  I always thought the answer was yes for (c)(3) status, no for (c)(4).  But the Government foisted the private benefit doctrine onto (c)(4) -- that seems a first to me -- and said the private benefit precludes (c)(4) too.  Hermann Memorial didn't understand the issue and so it could hardly offer the argument I would have.  That the private benefit is qualitatively and quantitatively incidental. That is the short version of this post.  

Here is the long version.  To be a social welfare organization, an organization must promote the “common good and general welfare of the people of the community.”  Memorial Herman Accountable Care Organization is essentially a managed care organization comprising all health care participants, not just an insurance company.  It works to incentivize costs savings in health care.  The hope is that increased efficiencies in health care will lead to increased supply and lower costs.  The accountable care organization is essentially a consortium:

Accountable Care Organizations (ACOs) are groups of doctors, hospitals, and other health care providers, who come together voluntarily to give coordinated high-quality care to the Medicare patients they serve. Coordinated care helps ensure that patients, especially the chronically ill, get the right care at the right time, with the goal of avoiding unnecessary duplication of services and preventing medical errors. When an ACO succeeds in both delivering high-quality care and spending health care dollars more wisely, it will share in the savings it achieves for the Medicare program.

If the ACOs meets efficiency benchmarks set by the social security administration, “they can receive a portion of the savings,” as determined by SSA.  "ACOs are rewarded when they lower growth in Medicare Parts A and Be expenditures (relative to their benchmark) while meeting quality performance standards:"

The term ACO was originally coined by researchers and policy experts to describe entities that consist of responsibly integrated healthcare providers who all are working toward achieving a common clinical goal and outcome: efficient, high-quality patient care while utilizing a common clinical pathway that incorporates principles of treatment and therapeutic modalities in a multifaceted provider setting. There are three core Accountable Care Organizations principles:

1. Provider-led organizations with a strong base of primary care that is accountable for the quality and per capita costs

2. Payments linked to improvement in quality and reduced costs

3. Reliable and increasingly sophisticated measurement of performance to support improvement and provide confidence care is improved, and cost savings occur.

As with traditional managed care organizations, ACOs have membership requirements that preclude their gaining (c)(3) status.  That’s why most non-staff model managed care organizations are (c)(4) organizations.  The membership requirement apparently implies impermissible private benefit even when an organization subsidizes membership fees for people who can’t pay the fee.  The cases that denied (c)(3) status in favor of (c)(4) status have never required a subsidized fee program as a condition of (c)(4) status.  But that, apparently, is what the Government is arguing as its basis for denying (c)(4) status to Memorial Hermann.  By limiting its direct impact to members – never mind that the aggregate effect of ACOs is a reduction in overall health care costs to the community – the ACO is operating for private benefit. 

It has never been the case that the private benefit doctrine has been explicitly applied to deny a health care organization (c)(4) status.  During oral argument yesterday, Avetta argued just that, and it sure sounds like the 5^th Circuit panel agreed.  The petitioners didn’t really catch on and respond to the argument until its five-minute rebuttal.  When it did, it nearly got to the gist of it but it never focused on the magic words, "qualitatively and quantitatively incidental."  To achieve a public good, private actors must benefit.  Some private benefit is indispensable to achieving public good, and it is that amount of private benefit that ought to be considered permissible. We call that qualitatively and quantitatively incidental private benefit.

Memorial Hermann, not understanding private benefit at all, got distracted over arguments about whether “primary purpose” has a different meaning than “exclusively organized and operated." Semantics only lawyers would assert. I thought that was a waste of time and Avetta all but said so.  The judges appeared to agree.  So Memorial Hermann  never got to its best argument that the private benefit inherent in ACOs is qualitatively and quantitatively indispensable to promoting the common good and general welfare of the community. 

darryll k. jones