Signaling a new flexibility, the Internal Revenue Service last week gave its blessing to a Medicare pilot program under which unidentified hospitals in Illinois, Michigan and Ohio would reward physicians for reducing hospital costs, a practice known as gain-sharing.
In 1999, the HHS inspector general said in a bulletin that the practice of gain-sharing could violate sections of the Social Security Act that prohibit paying doctors to reduce services to Medicare and Medicaid patients (July 12, 1999, p. 12). The bulletin indicated such arrangements could subject physician and hospital joint venture partners to civil fines and a tax liability.
The IRS released an "information letter" about the Medicare pilot program, known as the Medicare Participating Centers of Excellence Demonstration. Gain-sharing is a key element of the program, which was mandated by the Balanced Budget Act of 1997 and approved earlier by the Centers for Medicare and Medicaid Services.
Under the program, participating hospitals, which must apply to be considered, receive global payments for all Medicare Part A and Part B services that hospitals and physicians provide on an inpatient basis. The program uses bundled payments for high-volume, high-cost cardiovascular and total joint replacement procedures to "align the incentives of hospitals and nonemployee (staff) physicians to work together to provide coordinated, cost-effective care," according to the IRS letter.
From the global payments, the hospitals pay incentives to doctors who assist in improving efficiency, according to monitored quality-of-care standards.
In approving the arrangement, the IRS relied on a series of guidelines examining relevant compensation factors. Marvin Friedlander, manager of a technical group within the IRS' exempt organizations division, signed the eight-page letter. Unlike private-letter rulings, upon which taxpayers can rely for guidance, an IRS information letter is advisory only and is not binding on the IRS.
"This is a positive step forward for the IRS," said Thomas Hyatt, a healthcare tax lawyer with the Washington office of Ober, Kaler, Grimes & Shriver. "The service recognizes that these programs can be consistent with the charitable status of nonprofit organizations."
The letter is significant because it shows a willingness to look at the facts and circumstances of specific cases when examining gain-sharing arrangements, he said. And it is useful to providers because it reveals the IRS framework for analyzing the issue of reasonable compensation for physicians. The IRS had been reluctant to issue private-letter rulings on gain-sharing, after the HHS inspector general's warning and concerns raised by the CMS.
"But now the inspector general, the CMS and the IRS are saying that under the proper circumstances, they're OK with that," Hyatt said.