Fifth Circuit: Accountable care organization not entitled to tax exemption under section 501(c)(4)

The U.S. Court of Appeals for the Fifth Circuit today affirmed an opinion of the U.S. Tax Court holding that the taxpayer, an accountable care organization (ACO), did not meet its burden of showing that it is an organization described under section 501(c)(4) qualifying for exemption from federal income tax under section 501(a).

The court concluded that the ACO's activities primarily benefitted its commercial payor and healthcare provider participants rather than the public, thus disqualifying it from the exemption.

The case is: Memorial Hermann Accountable Care Organization v. Commissioner, No. 23-60608 (5^th Cir. October 28, 2024). Read the Fifth Circuit’s decision.

Background

• The taxpayer, a nonprofit corporation formed under Texas law in 2012, participated as an ACO in the Medicare Shared Savings Program (MSSP). Approximately 10% of patients were part of the MSSP, 9% covered by Medicare Advantage Plans, and 81% by employer-sponsored health plans. Revenue from the MSSP varied significantly year to year.
• The ACO filed for recognition as a tax-exempt organization under section 501(c)(4), claiming it operates exclusively for the promotion of social welfare.
• The IRS issued a final adverse determination letter, concluding that the ACO was not organized and operated for promoting social welfare, thus denying the tax exemption.
• The U.S. Tax Court in May 2023 upheld the IRS’s determination, stating the ACO's non-MSSP activities primarily benefit commercial participants, constituting a substantial nonexempt purpose.

Fifth Circuit decision

The Fifth Circuit affirmed the Tax Court’s decision, concluding that the ACO was not entitled to a section 501(c)(4) tax exemption because it was not operated exclusively for the promotion of social welfare. The court found that an organization cannot qualify for exemption under section 501(c)(4) if has a “substantial nonexempt purpose” and rejected the taxpayer’s argument that a “primary purpose” standard applies for section 501(c)(4) status that is “looser” than the standard for section 501(c)(3) status. The court noted that “§ 501(c)(3) and (c)(4) both use the crucial phrase ‘operated exclusively,’” and thus that the same “substantial nonexempt purpose” test “applies under both provisions.”       
 

For more information, contact your usual KPMG tax professional or one of the following Washington National Tax professionals:

Ruth Madrigal | ruthmadrigal@kpmg.com

Preston Quesenberry | pquesenberry@kpmg.com