There are few stereotypes more accurate than the stereotype that tax lawyers appreciate order, continuity, familiarity, and certainty.  We are constantly trying to fit a particular fact pattern nicely and neatly into guidance prescribed by the IRS. This is especially true in determining whether a management contract under which a service provider operates a business in facilities that have been financed with tax-advantaged bond proceeds satisfies one of the IRS “safe harbors” from private business use or, failing that, whether the contract results, under a facts-and-circumstances analysis, in private business use. The complexity of hospital operations makes this issue especially thorny in tax-exempt bond financings for hospitals. Hospitals, perhaps more than almost any other issuer or borrower of tax-exempt bond proceeds, may enter into complex management contracts that occasionally do not fit neatly within the safe harbors. Certain contractual arrangements are driven by state law considerations, others are motivated by the need to hire qualified professional service providers, and others are motivated by cost-saving initiatives, which are becoming increasingly popular as healthcare costs continue to rise.  This post will highlight a few of the private business use considerations that are often at issue in hospital tax-exempt bond financings.

Employee (W-2) or Independent Contractor (1099)

Tax practitioners have not been concerned that employee use of a bond-financed facility gives rise to private business use of the bond proceeds that financed that facility.[1]   In many financings, the overwhelming majority of service providers are employed by the issuer or borrower (in a conduit financing), which largely alleviates any private business use concerns in respect of such use.  However, for a number of reasons and in some cases for state law reasons, hospitals often eschew the employer/employee relationship with physician providers.  Instead, many hospitals contract for the provision of professional services either pursuant to a contract that the individual physician has entered into with the hospital or, more commonly, as part of a professional service agreement that the hospital has entered into with a physicians group that, in turn, either contracts with or employs the physician.  Any agreement between a hospital and a physicians group or an independent contractor physician for the performance of services in a bond-financed facility needs to be analyzed to determine whether the agreement results in private business use.  The same is true of any subcontract entered into by a party that contracts with a hospital in order to discharge its obligations under the contract with the hospital.  This is true even where the physicians group is a subsidiary or affiliate of the hospital (unless, of course, the physicians group has, like the hospital, obtained 501(c)(3) charitable status and does not subcontract in order to fulfill its obligations under the agreement with the hospital).

Physician Contracts and Cost Saving Initiatives

The variety of physician contracts that one will find in any given hospital adds to the complexity of a hospital financing.  The variety is undoubtedly driven by the practical complexities of operating a hospital and influenced by certain non-tax federal and state laws such as the Stark Law (42 USC 1395nn) (which very generally prevents physicians from referring patients to receive treatment that will financially benefit the referring physician) and other anti-kickback laws and regulations.  The Patient Protection and Affordable Care Act (“PPACA”) added yet another layer of complexity to the compensation structure of physicians.

Generally, if the physicians group shares in the net profits of the bond-financed facility, then the physicians group’s use of the bond-financed facility will be treated as private business use. In IRS Revenue Procedure 97-13, the principal source of current IRS safe harbors from private business use, the IRS indicated that a contract would not be treated as a sharing of net profits when the compensation is based on a percentage of gross revenues or a percentage of expenses but not both.   Hospitals seeking to comply with Rev. Proc. 97-13 frequently base all or a part of a physician’s compensation (especially productivity rewards) on a percentage of gross revenues.  The efficacy of this approach has come into question as a result of the implementation of Accountable Care Organizations (“ACO”), one of developments spurred by the PPACA.  The Centers for Medicare & Medicaid Services (“CMS”) website describes an ACO as follows:

  • 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 their Medicare patients.
  • The goal of coordinated care is to ensure that patients, especially the chronically ill, get the right care at the right time, while avoiding unnecessary duplication of services and preventing medical errors.
  • When an ACO succeeds both in delivering high-quality care and spending health care dollars more wisely, it will share in the savings it achieves for the Medicare program.

(Emphasis in original.) Put another way, a physician who participates in an ACO may receive a payment from CMS in exchange for a reduction in expenses (i.e., the physician will “share in the savings”).[2]  If the same physician is an independent contractor of the hospital and if all or a portion of the physician’s compensation is based on gross revenues, then the physician’s compensation based on shared savings, taken in combination with the physician’s compensation based on gross revenues, could potentially cause all or a portion of the physician’s contract to be based on net profits of the bond-financed facility resulting in private business use.

Those of you who are long-time readers of the blog would point me to this post, this post, or this post, each addressing IRS Notice 2014-67, which, among other things, provides guidance on how to apply the private business use limitations and the Rev. Proc. 97-13 safe harbors to ACOs.  Specifically, the Notice extends favorable treatment to shared savings payments received by physicians as a result of the ACO’s participation in the CMS Shared Savings Program.  However, the Notice only applies to ACOs that have been formally accepted into the CMS Shared Savings Program. Therefore, it does not apply automatically to state-sponsored programs, industry-sponsored programs, or plans sponsored directly by health care plans, all of which are becoming increasingly more common.  As a result, a hospital may find itself in a situation where it is a participant in two substantially identical ACOs with potentially different private business use ramifications because one ACO is a participant in the CMS Shared Savings Program but the other is not.

Another contractual arrangement that is experiencing a resurgence as a result of the recent emphasis on cost reduction, are physician-hospital organizations (“PHOs”).  Although not a product of the PPACA, PHOs are also intended to reduce healthcare costs by coordinating the efforts of physicians and hospitals to reduce the cost of providing care and by decreasing the price of negotiated health care premiums as a result of economies of scale.  PHOs have been around for a while; however, they fell out of favor in the 1990s when they failed to generate the intended savings.  With the enactment of the PPACA, hospitals and physicians groups are revisiting the PHO structure.  PHOs are typically for-profit, private organizations that could give rise to private business use if the PHO uses bond-financed space under an arrangement that is not properly structured to avoid the incidence of private business use.


This post on common private business use issues in hospital financings is not intended to be comprehensive, and you will no doubt rue the omission of a discussion on research contracts (what do we do with clinical trials or federally sponsored research or mixed-location research with shared IP?) and other tax concerns inherent in hospital tax-exempt bond financings.   The blogosphere has suggested that the ideal post takes no more than 7 minutes to read and is less than 1,600 words.  As I am approaching this limit, those topics will have to wait for another blog post for another slow news day.

Speaking of stereotypes for tax lawyers, I leave you with…..this…or….this.

[1]               See generally Treas. Reg. § 1.141-3(c) and (d).

[2] Sections 1899(d)(1)(A) and (B) of PPACA explain that shared savings payments are made if the “estimated average per capita Medicare expenditures under the ACO . . . is at least the percent specified by the Secretary . . . .”