The adoption of the Patient Protection and Affordable Care Act (“PPACA”),1 recent
health policy discussions and Medicare demonstration projects underscore a shift in focus away
from volume-based payment for healthcare services to payment based on quality or outcomes.
Yet, hospital systems attempting to respond to these incentives and directives by structuring
quality or productivity incentive payments to physicians face familiar legal compliance issues:
The broad reach of the Civil Money Penalties statute prohibiting payments to reduce or limit care
to Medicare beneficiaries;2 Anti-Kickback Statute3 implications and safe harbor requirements;
Stark Law4 restrictions and complex exceptions; and guidance offered by the Department of
Health and Human Services (“DHHS”) Office of Inspector General (“OIG”) in these areas.5
Tax-exempt entities face special issues relating to private inurement and excess benefit
transaction excise taxes in structuring incentive compensation. The consequences of a misstep
under the federal reimbursement and referral laws may be magnified in light of recent
Pub. Laws 111-148 and 111-152.
42 U.S.C. § 1320a-7a(b).
42 U.S.C. § 1320a-7b(b).
42 U.S.C. § 1395nn.
Incentive compensation paid by hospitals to physicians may also implicate various state laws, including state selfreferral laws, which are beyond the scope of this paper.
amendments broadening the reach of the federal False Claims Act6 as well provisions of PPACA
strengthening various fraud enforcement measures, including the Anti-Kickback Statute.7
This paper will address the federal referral law and related legal issues to be considered
in structuring incentive payments to physicians in the context of various service relationships
with hospitals and health systems, including employment relationships; professional and
administrative services delivered under independent contractor relationships; payments to
hospital-affiliated group practices; and similar arrangements. The issues surrounding sharing of
hospital savings with physicians are also addressed. A checklist of points to be considered in
structuring physician incentives is set out below.8
Government healthcare reimbursement programs assume a certain basic level of quality
and service by the healthcare service provider. For example, in certain cases involving adverse
patient conditions, the government has pursued False Claims Act actions against nursing home
providers on the theory that the services furnished were worthless due to failure to deliver basic
care, and the OIG has imposed quality of care corporate integrity agreements upon providers
considered to be substandard.9 Further, CMS has relied on its authority under Section 5001(c) of
the Deficit Reduction Act of 2005 (Pub. L. 109-171) (the “DRA”) to deny certain payments to
As modified by the Fraud Enforcement and Recovery Act of 2009, False Claims Act liability may be premised on
the knowing and improper avoidance or decrease of an obligation to repay the government, even if no false record is
used. 31 U.S.C. § 3729(a)(7).
PPACA § 6402(f).
For a discussion of recommended processes in working with physicians to define and implement quality targets,
see Reinertsen JL, Gosfield, AG, Rupp W, Whittington JW, Engaging Physicians in a Shared Quality Agenda, IHI
Innovation Series white paper, Cambridge, Massachusetts: Institute for Healthcare Improvement; 2007 (available
on www.IHI.org).
See Testimony of Lewis Morris, Chief Counsel to the OIG, May 15, 2008, “In the Hands of Strangers: Are
Nursing Home Safeguards Working?” available on the OIG website at www.oig.hhs.gov.
providers for categories of conditions classified as “never events,” that is, events constituting a
basic failure of care.10
CMS has shown substantial interest in collecting data regarding providers’ quality of care
by implementing incentives for physicians and hospital to report data related to quality.11 Prior
to PPACA, CMS explored programs to adjust provider reimbursement based on quality factors,
including a hospital value-based purchasing program.12 The ongoing Hospital Quality Incentive
Demonstration project, involving approximately 250 hospitals in 38 states, has tracked hospital
performance based on multiple nationally standardized quality measurements in five clinical
areas (heart attack, coronary bypass graft, heart failure, pneumonia, and knee and hip
replacement). According to a 2009 CMS report, HQID hospitals raised their overall quality
scores an average of 17 percentage points.13 CMS has also awarded over $25 million to five
large physician practices participating in the Physician Group Practice Demonstration, based on
their performance on multiple quality improvement and cost containment measures.14
PPACA carries this further by requiring that CMS implement a value-based purchasing
program for hospitals and other providers. The hospital value-based purchasing program, to be
established by 2013, will provide value-based incentive payments based on quality and
efficiency measures that cover at least acute myocardial infarction, heart failure, pneumonia,
surgeries, and healthcare associated infections.
These incentive payments will, in turn, be
financed through incremental reductions in base operating DRG amounts, culminating in a 2.0%
See, e.g., Medicare National Coverage Determinations Manual, Chapter 1, Part 2, Section 140, available at
See, e.g., the discussion of the incentive payments available for physicians reporting data under the Physician
Quality Reporting Initiative (“PQRI”) at the CMS website, www.cms.hhs.gov/PQRI.
Efforts by CMS over the past few years to implement a value-based purchasing program are described in CMS
“Report to Congress, Plan to Implement a Medicare Hospital Value-Based Purchasing Program,” November 21,
2007, available at www.cms.hhs.gov.
Information regarding the Premier HQID project is available at www.cms.hhs.gov.
Information regarding the Physician Group Practice Demonstration project is available at www.cms.hhs.gov.
reduction for 2017 and after.15 In addition, the Secretary is required to develop value-based
purchasing programs for skilled nursing facilities, home health agencies and ambulatory surgery
centers,16 and establish a value-based payment modifier for under the physician fee schedule by
Finally, various provisions of PPACA require or encourage the development of
innovative care delivery and payment models that are intended to move providers from a
volume-based reimbursement system to a system focused on care coordination across provider
settings, practitioners and suppliers; quality monitoring; and rewarding improved outcomes and
cost efficiencies. These include the following:
Accountable care organizations (“ACOs”) that meet certain quality and cost
savings benchmarks established by the Secretary for the Medicare beneficiary population
assigned to the ACO will be eligible to earn shared savings payments.18
A bundled payment pilot program authorized under PPACA19 will provide a
comprehensive payment to an entity comprised of hospitals, physicians and post-acute providers
that, among other responsibilities, agree to be measured against certain quality and efficiency
The Center for Medicare and Medicaid Innovation (“CMI”) authorized under
PPACA20 will study a number of care delivery arrangements focusing on quality monitoring and
PPACA § 3001.
PPACA § 3006.
PPACA § 3007.
PPACA § 3022. For MedPac’s discussion of accountable care organizations and medical homes, see Chapter 2 of
“Report to Congress: Improving Incentives in the Medicare Program,” Medicare Payment Advisory Commission,
June 2009, available at www.medpac.gov/documents.
PPACA § 3023.
PPACA § 3021.
The Secretary is directed to established a national strategy to improve the delivery
of healthcare services, patient health outcomes and population health through a transparent,
collaborative process to identify national priorities and formulate a comprehensive strategic plan;
and is further required, in consultation with the Agency for Healthcare Research and Quality and
CMS, to identify gaps where no quality measures exist and existing quality measures that need
improvement.21 In addition, the law provides for the establishment of an Interagency Working
Group on Health Care Quality to be convened by the President, the purpose of which will be to
achieve collaboration, cooperation and consultation between federal departments and agencies,
avoid inefficient duplication of quality improvement efforts and resources, and assess alignment
of public sector and private sector initiatives.22
The position taken by the OIG with respect to the scope of the Civil Money Penalties law
(the “CMP”)23 and “gainsharing” has been a significant impediment to payment of incentives to
physicians based on hospital cost-savings. As defined by the OIG, the term “gainsharing” refers
to an arrangement under which a hospital shares with physicians a portion of the cost savings
realized by the hospital attributable in part to the efforts of the physicians. A number of different
programs have been characterized as gainsharing, from payments made to reward reductions in
average costs per case below certain targets, to incentives encouraging the use of clinical
protocols that reduce hospital costs or the selection of certain medical devices and products that
are less expensive.
The OIG has long taken the position that gainsharing arrangements implicate the CMP.
The CMP prohibits a hospital from knowingly making a payment to a physician, directly or
PPACA §§ 3011 and 3013.
PPACA § 3012.
42 U.S.C. § 1320a-7a(b).
indirectly, as an inducement to reduce or limit items or services furnished to Medicare or
Medicaid beneficiaries. The statute also prohibits a physician from knowingly accepting such a
payment. A penalty of up to $2000 per person for each individual for whom such a payment is
made may be imposed for violation of the CMP. In July 1999, the OIG issued a Special
Advisory bulletin taking the position that gainsharing not only implicated the Anti-Kickback
Statute but was barred by the CMP; and relief from the CMP prohibition could only be
accomplished by legislation.24
Beginning in 2001, the OIG has issued a series of favorable advisory opinions finding
that certain gainsharing proposals incorporated sufficient safeguards that the OIG would not
impose sanctions under either the Anti-Kickback Statute or the CMP despite the fact that the
arrangements implicated both statutes. The types of cost-saving proposals involved in the
favorable opinions included opening packaged items only as needed; substituting less costly
items for those currently in use; limiting the use of certain medications or supplies; performing
certain procedures only as needed; and product standardization of certain devices (such as heart
valves, stents and balloons).25 In certain cases, proposals for product substitutions not involving
pharmacy items, or recommendation regarding opening certain packaged items such as surgical
trays, were not considered to implicate the CMP.26 The OIG’s review of gainsharing proposals
has focused on substantial safeguards against abuse, including measures that promote
accountability and transparency, quality controls, and safeguards against payments for referrals.
Although most of these proposals were limited in time to one year, the OIG has also approved a
The 1999 Special Advisory Bulletin is available at the OIG website, www.oig.hhs.gov. The OIG has consistently
distinguished arrangements implemented as part of risk contracts that are governed by the rules applicable to
physician incentive payments in the context of Medicare managed care programs (42 C.F.R. § 417.479). See
correspondence of Lewis Morris dated August 19, 1999, available at www.oig.hhs.gov.
OIG Advisory Opinions 01-01, 05-01 through 05-06, 06-22, 07-21, 07-22, 08-09, 08-15, 08-16, 08-21 and 09-06.
See, e.g., OIG Advisory Opinions 05-01, 05-03, 05-06, 06-22 and 07-21.
multi-year proposal (see OIG Advisory Opinion 08-15). The following detailed safeguards with
respect to the CMP have been cited as material in the OIG’s determination not to impose
sanctions on these arrangements: Transparency of the arrangement, allowing for public scrutiny
and physician accountability; credible medical support to assure that the measures undertaken do
not adversely impact patient care; establishment of a baseline threshold beyond which no savings
would accrue as a safeguard against inappropriate reductions in services; assurance that aside
from product standardization recommendations, the same selection of devices/supplies remain
available to physicians; and reasonable limits on the duration of the program. The following
safeguards with respect to the Anti-Kickback Statute were cited favorably in these advisory
opinions: Participation was limited to physicians performing procedures that were the focus of
the cost savings efforts and who were already on the hospital’s medical staff; participating
physicians were responsible for the change in practices/protocols that were the subject of the
program and, therefore, carried exposure to liability for these actions; cost savings were
distributed to physicians on a per capita basis; payments were limited in amount and duration;
participation was limited to single specialty practice physician groups, thereby minimizing the
risk of rewarding physicians who refer to the participating groups and physicians; and limitations
were set on the level of governmental program patients that could be considered part of the
program in order to assure no incentive to increase program referrals.
An advisory opinion issued in 2008 also approved a hospital sharing with participating
physicians a portion of certain bonus payments received from a private insurer under a pay for
performance program based on meeting certain standards of quality and efficiency (OIG
Advisory Opinion 08-16). The quality targets for which a bonus could be earned were among
those described in the Specifications Manual for National Hospital Quality Measures,
representing the joint effort of CMS and the Joint Commission to publish a uniform set of
hospital quality measures. The participating physicians were members of a physician entity
formed to undertake various tasks to ensure that the quality targets were met in the hospital, in
exchange for which the hospital would pay the physician entity a portion (not to exceed 50%) of
the bonus compensation earned by the hospital from the insurer. Although ultimately issuing a
favorable advisory opinion, the OIG did conclude that the proposed payment might implicate the
CMP because one of the quality targets required that a prophylactic antibiotic administered
before surgery be discontinued within specified times -- a standard that might cause physicians to
cease administration of the antibiotic sooner than they would in the absence of the bonus-sharing
arrangement. This finding that the CMP may be implicated based on a CMS-approved hospital
quality measure illustrates the rigidity of the CMP as viewed by the OIG.
Gainsharing is currently under review in ongoing demonstration projects designed to
study the association between quality and payments, and PPACA authorizes an extension of this
process.27 Section 5007 of the DRA required the Secretary of DHHS to establish a qualified
gainsharing demonstration project under which hospitals would make payments to certain
physicians representing a share of the savings resulting from collaborative efforts between the
hospital and the physicians to improve quality and efficiency.28 Section 5007 of the DRA
includes an express waiver of CMP and Anti-Kickback Statute penalties for qualified
demonstration projects. Twelve New Jersey hospitals were approved to carry out these projects.
In addition, pursuant to Section 646 of the Medicare Prescription Drug, Improvement and
Modernization Act of 2003, the Secretary of DHHS implemented the Physician-Hospital
Collaboration Demonstration to test gainsharing models involving collaboration among hospitals
PPACA § 3027.
Solicitations and other information relating to these demonstration projects is found at the CMS website,
working with physicians in a single geographic area to improve quality and efficiency. This
demonstration project involves long term follow-up to assure both documented improvements in
quality and reduction in overall costs of care, including tracking patients well beyond a hospital
episode to determine the impact of hospital-physician collaborations on such factors as
preventing short-term and longer-term complications, duplication of services, and coordination
of care across settings.
Finally, the ongoing Medicare Acute Care Episode (“ACE”)
demonstration project also includes a gainsharing component. The ACE demonstration project is
a broader project providing global payments (including hospital and physician fees) for acute
care episodes, focusing on select orthopedic and cardiovascular inpatient procedures at
participating sites known as “Value-Based Care Centers.” The project involves sharing of
savings with beneficiaries, as well as an optional gainsharing components for providers. Five
hospitals in Texas, Oklahoma, New Mexico and Colorado began the three-year demonstration
project in 2009. Each of these projects set out provider incentive/gainsharing rules and program
requirements that echo many of the protective standards cited in the favorable OIG advisory
opinions and that emphasize the need for transparency in identifying the actions expected to
result in cost savings.29
The federal statute prohibiting “illegal
remuneration,” known as the Anti-Kickback Statute,30 makes it illegal for any person to
knowingly and willfully solicit or receive any remuneration (including any kickback, bribe or
rebate), directly or indirectly, overly or covertly, in cash or in kind, in return for referring an
individual for goods or services payable under a federal healthcare program, including Medicare
See, e.g., the “Provider Incentive, or Gainsharing, Program Rules and Proposal Requirements” for the Acute Care
Episode Demonstration project, available at www.cms.hhs.gov.
42 U.S.C. § 1320a-7b(b).
and Medicaid. Violation of the statute is punishable by fines of up to $25,000 and imprisonment
for up to 5 years, and may also result in the imposition of a civil money penalty or exclusion
from participation in the Medicare and Medicaid Programs.31 Under PPACA, liability under the
Anti-Kickback Statute does not require proof of knowledge of the law; and a violation of the
Anti-Kickback Statute may serve as the basis for a false claim under the federal False Claims
Act.32 The Anti-Kickback Statute includes limited exceptions; in addition, regulations define
certain voluntary “safe harbor” transactions that will not be subject to sanction33, and the OIG
offers guidance in the form of advisory opinions.
The breadth of the Anti-Kickback Statute was demonstrated recently in U.S. ex rel Fry v.
Health Alliance of Greater Cincinnati, in which the hospital system was alleged to have engaged
in a kickback scheme not through payments to physicians, but by rewarding referring
cardiologists through allocation of time to use the hospital’s outpatient testing unit.34 After it
was unsuccessful in having the case dismissed on a variety of grounds, the hospital entered into a
settlement agreement with the Department of Justice to dismiss the case.35
The Employee Exception. The Anti-Kickback Statute includes a statutory exception for
employment arrangements.
As set out in 42 U.S.C. 1320a-7b(b)(3)(B), the statute is not
implicated for “any amount paid by an employer to an employee (who has a bona fide
employment relationship with such employer) for employment in the provision of covered items
or services.” The safe harbor regulations (42 C.F.R. § 1001.952(i)) further provide that the term
“remuneration” as used in the Anti-Kickback Statute does not include:
42 U.S.C. § 1320a-7b(b); 42 U.S.C. § 1320a-7a(a)(7).
PPACA § 3402(f).
42 C.F.R. § 1001.952.
S.D. Ohio, No. C-1-03-167.
“Christ Hospital of Cincinnati, DOJ Settle Anti-Kickback Lawsuit Alleging Incentives,” BNA’s Health Care
Fraud Report, Feb. 10, 2010.
any amount paid by an employer to an employee, who has a bona fide
employment relationship with the employer, for employment in the
furnishing of any item or service for which payment may be made in
whole or in part under Medicare, Medicaid or other Federal health care
programs. For purposes of paragraph (i) of this section, the term employee
has the same meaning as it does for purposes of 26 U.S.C. 3121(d)(2).
Unlike the Stark exception for employment relationships, the Anti-Kickback employment
exception on its face includes no express fair market value standard or restrictions on structuring
of employment compensation.
Practically, however, evaluation of a provider-physician
employment arrangement must include compliance with the Stark Law also, and for tax-exempt
entities, the rules governing payments to employees (see discussion below).
Agency commentary on this exception is limited to a short discussion in the preamble to
the 1991 final rules promulgating the ten original safe harbor provisions (see 56 FR 35952, July
29, 1991). Some additional commentary is found in the 1999 final rule that offers clarification
on the initial OIG safe harbor provisions and establishes additional safe harbor provisions under
the Anti-Kickback Statute (64 FR 63518, Nov. 19, 1999). The OIG commentary confirms that
the term “employee” is defined by reference to the IRS definition, as codified in its regulations
and developed by both agency and court rulings.
A few questions have arisen periodically regarding the scope of the employment
exception, including the following.
Compensation of employees for the delivery of “covered items and services.” OIG
Advisory Opinions have not always been clear whether employee compensation protected under
this exception is strictly limited to the delivery of “covered items and services.” For example,
see OIG Advisory Opinions 98-9, 07-03, 09-02, 04-09, some of which address incentive
payments to support personnel and others for administrative as well as clinical work.
The case often cited for a narrow reading of the exception on this point is U.S. v. Starks,
157 F3rd 833 (11th Cir. 1998).
In Starks, the government criminally charged defendants
Andrew Siegel, president of a drug treatment provider, and Angela Starks, Florida government
employee, for soliciting and accepting kickbacks for the referral of Medicaid patients to the drug
rehabilitation center, Future Steps, Inc. Starks claimed to be a Future Steps employee and thus
exempt from the Anti-Kickback statute under the employee exception. However, the Eleventh
Circuit held that because Starks was not employed by Future Steps for the purpose of providing
covered items or services, the employment exception did not apply.36 The facts in that case,
however, showed that the payments in issue were made in cash in a clandestine manner designed
to avoid detection, and that a state government employee was not able to accept outside
compensation or employment as claimed by Starks.
Part-time employment. In the preamble to the final rules published in 1999 (64 FR
63518, Nov. 19, 1999), the OIG responded to an inquiry regarding part-time employees paid on a
commission-only basis, stating that “[a]s long as a bona fide employer-employee relationship
exists between the part-time employee and the employer, such a relationship falls within the
scope of th[e] [employee exception] provision.” More recently, the OIG’s Advisory Opinion 0822 issued in December 2008 concluded that the part-time employment of two physicians by a
physician group to perform endoscopy services (paid for in whole or in part by Medicare,
Medicaid or other federal healthcare programs) on the physician group’s premises would not
generate prohibited remuneration under the Anti-kickback Statute. The requestor of the opinion
Note that the OIG took a similar position in a footnote in a December 22, 1992 letter to the IRS, stating that
“while the anti-kickback statute contains a statutory exemption for payments made to employees by an employer,
the exemption does not cover any and all such payments. Specifically, the statute exempts only payments to
employees which are for ‘the provision of covered items or services.’ Accordingly, since referrals do not represent
covered items or services, payments to employees which are for the purpose of compensating such employees for
the referral of patients would likely not be covered by the employee exception.” Letter from D. McCarty Thornton,
OIG, OIG-RPT, Compliance-Rptr ¶530,004, n. 2 (December 22, 1993).
was a tax-exempt corporation established for the purpose of employing physicians. Each of the
physicians maintains a separate medical practice, at separate premises, at which s/he would
continue to accept patients outside of the proposed part-time employment relationship. The OIG
discussed the statutory employment exception and the regulatory definition of “remuneration”
and determined that the arrangement would not violate the Anti-Kickback Statute so long as the
employees (i) were bona fide employees pursuant to the IRS definition and (ii) would be paid for
professional services they personally perform. However, the OIG noted that the arrangement
would also need to be analyzed under the Stark Law, for which fair market value is a criterion.
Personal Services and Management Contracts Safe Harbor. In those contexts in which
the employment exception is not applicable (such as independent service contractor
relationships), the safe harbor most likely to be applicable to incentive payments would be that
for personal services and management contracts.
This narrow safe harbor (42 CFR §
1001.952(d)) requires that all of the following conditions be met to protect a payment made by a
principal to an agent or contractor for services of the contractor:
The agreement is set out in writing and signed by the parties;
The agreement covers all of the service the contractor provides for the
principal for the term of the agreement, and specifies the services to be provided by the
If the services are to be provided on a periodic, sporadic or part-time basis,
the agreement specifies exactly the schedule of such intervals, their precise length and the
exact charge for such intervals;
The term of the agreement is for not less than one year;
The aggregate compensation paid over the term of the agreement is set in
advance, consistent with fair market value in arms-length transactions, and is not
determined in a manner that takes into account the volume or value of any referrals or
business otherwise generated between the parties for which payment may be made in
whole or in part under Medicare, Medicaid or other federal health care programs;
The services performed under the agreement do not involve counseling or
promotion of a business arrangement or other activity that violates state or federal law;
The aggregate services contracted for do not exceed those reasonably
necessary to accomplish the commercially reasonable business purposes of the services.
Although several of these safe harbor elements are also included in many of the Stark
Law compensation exceptions (discussed below), the safe harbor standard that aggregate
compensation over the term of the agreement must be set in advance is very limiting and often
prevents arrangements that meet its other terms from qualifying for protection.
The Stark Law,37 together with its implementing
regulations,38 prohibit a physician who has a financial relationship with an entity from making
referrals to that entity for furnishing certain designated health services (“DHS”) reimbursed by
Medicare, including inpatient and outpatient hospital services. The law also prohibits the DHS
entity from presenting a claim or otherwise billing a third party for DHS furnished pursuant to a
prohibited referral. The Stark Law imposes civil monetary penalties of up to $15,000 for each
violation of the statute, recoupment of amounts billed improperly, and potential exclusion from
participation in Medicare and Medicaid.39 Payments by a hospital system to physicians that are
based on quality targets or productivity may possibly qualify for protection under one of the
42 U.S.C. § 1395nn.
42 C.F.R. Part 411, Subpart J.
42 U.S.C. § 1395nn(g)(3).
general exceptions for financial relationships (such as academic medical centers, found at 42
CFR § 411.355(e)), or one of the exceptions for direct or indirect compensation exceptions (42
CFR § 411.357).
The Employee Exception.
As one of the exceptions for direct compensation
arrangements, the Stark Law includes an exception for bona fide employment relationships (42
C.F.R. § 411.357(c)), which excepts remuneration paid by an employer to a physician (or
immediate family member) who has a bona fide employment relationship with the employer for
the provision of services if the following conditions are met:
The employment is for identifiable services.
The amount of the remuneration under the employment is—
Consistent with the fair market value of the services; and
Except as provided in paragraph (c)(4) of this section, is not
determined in a manner that takes into account (directly or indirectly) the
volume or value of any referrals by the referring physician.
The remuneration is provided under an agreement that would be
commercially reasonable even if no referrals were made to the employer.
Paragraph (c)(2)(ii) of this section does not prohibit payment of
remuneration in the form of a productivity bonus based on services
performed personally by the physician (or immediate family member of
the physician).”
The Stark Law defines the term “employee” to mean an individual who meets the definition of
“employee” as decided by the application of the common law rules relevant to determining the
employer-employee relationship under IRC § 3121(d)(2).
The bona fide employment
relationship is generally determined in accordance with the test applied by the IRS.40
CMS offered guidance on the employment exception in the preamble to the final Phase II
Stark rules (69 FR 16054, 16086-16087, March 26, 2004). The agency clarifies that productivity
See IRS Publication 15-A, 2009 Edition p. 6, available at http://www.irs.gov/pub/irs-pdf/p15a.pdf.
bonuses may be paid to employed physicians for personally performed services including
services that constitute designated health services; however, “[w]hat the statute does not permit
are payments for an employee’s productivity in generating referrals of DHS performed by
others.” With respect to “personally performed” services, the definition of the term “referral” in
the Stark rules (42 CFR § 411.351) specifies that “a designated health service is not personally
performed or provided by the referring physician if it is performed or provided by any other
person including, but not limited to, the referring physician’s employees, independent contractors
or group practice members.” The CMS commentary to these 2004 Stark rules provides guidance
on additional issues related to the employment relationships exception, including:
Quality Measures. Employers may pay employed physicians based on quality or
patient satisfaction measures, as long as all conditions of the exception are satisfied (i.e.,
the overall compensation is fair market value and not based on the volume or value of
DHS referrals). However, if the payment incentivizes a physician to reduce the volume
or value of DHS, then it must be a qualified physician incentive plan payment under the
personal service arrangement exception or must fit the prepaid plans or risk-sharing
arrangement exception. For example, the agency specifically declined to extend these
regulations to allow payment of incentives to employed physicians based on meeting
hospital or drug utilization targets outside the specific statutory terms applicable to
services provided to enrollees of certain health plans (69 FR 16088).
Flat fee compensation for physician supervision.
Employers may pay an
employed physician a flat fee for each mid-level provider s/he supervises, as long as the
compensation is fair market value for actual time dedicated to the supervision of services
and independent of the volume or value of DHS referrals generated by the physician.
Scope of the employment exception. CMS notes that the employment exception
only applies if the employer is the direct provider of DHS, and otherwise the arrangement
must be analyzed as an indirect compensation arrangement (consistent with the “stand in
the shoes” rules described below). In its Phase II commentary, CMS also declined to
expand the definition of employees to include leased employees as defined by state law.
Rather, a leased employee may be an employee for Stark purposes if the employment
arrangement meets the IRS employee test.
Other Exceptions for Direct Financial Relationships. As noted above, the employment
exception applies only to direct employer-employee relationships. In considering other available
Stark Law exceptions, a threshold issue is whether the compensation arrangement under
consideration is a direct or indirect compensation arrangement, since different exceptions apply.
Direct Financial Relationships and SITS. A “direct” financial relationship exists
under Stark if “remuneration passes between the referring physician … and the entity furnishing
DHS without any intervening persons or entities” between them (42 CFR § 411.354(a)(2)). For
purposes of determining the presence of intervening entities between a physician and a hospital
or other DHS entity, the “stand in the shoes” rule has the effect of disregarding certain types of
entities, thereby creating a direct financial relationship between the physician and hospital or
other DHS entity. Direct compensation relationships must be protected under an exception
applicable to such arrangements; the indirect compensation exception (42 CFR § 411.357(p))
does not apply to direct compensation relationships.
A physician is deemed to “stand in the shoes” of his or her physician organization and to
have a direct compensation relationship with a DHS entity if the only intervening entity between
the physician and the DHS entity is his/her physician organization, and the physician has an
ownership or investment interest in the physician organization (42 CFR § 411.354(c)(1)(ii)). A
“physician organization” is defined to mean “a physician, a physician practice or a group
practice that meets the terms of § 411.352” (42 CFR § 411.351). This SITS rule does not apply
to a physician whose ownership or investment interest is titular only. For these purposes, a
“titular” ownership or investment interest is “an ownership or investment interest that excludes
the ability or right to receive the financial benefits of ownership or investment, including but not
limited to, the distribution of profits, dividends, proceeds of sale, or similar returns on
investment” (42 CFR § 411.354(c)(3)(ii)). The SITS rule also does not apply to academic
medical centers meeting the terms of 42 CFR §411.355(e).
In the context of incentive payments made to physicians who are not employees, the
direct compensation exceptions most likely to be helpful include those for personal services (42
CFR § 351.357(d)) and fair market value compensation (42 CFR § 351.357(l)).
exceptions require the following conditions to be met:
The arrangement is set out in writing and signed by the parties;
The writing specifies the services, compensation and timeframe. The
personal services exception is more onerous in requiring that all services be specified in
the agreement or that multiple agreements for services cross-reference each other or a
centralized list;
The arrangement is for a term of at least one year. Under the fair market
value exception, the arrangement can be for less than a year and also can be renewed any
number of times if the terms of the arrangement and the compensation for the same items
and services do not change.
Under the personal services exception, a holdover
arrangement on the same terms and conditions is allowed for a period up to 6 months
following the expiration of a compliant agreement in effect for one-year or longer;
The compensation must be set in advance and consistent with fair market
Under the fair market value exception the compensation may not be
determined in a manner that takes into account the volume or value of referrals or other
business generated by the referring physician; under the personal services exception,
compensation may not be determined in a manner that takes into account the volume or
value of referrals or other business generated between the parties;
Under the fair market value exception, compensation for rental of
equipment may not be determined using a formula based on a percentage of the revenue
raised, earned, billed, collected or otherwise attributable to the services performed or
business generated through the use of the equipment, or per-unit of service (“per click”)
rental charges, to the extent such charges reflect services provided to patients referred
between the parties (the same restriction with respect to space and equipment rental
payments appears in the space and equipment leasing exceptions and the indirect
compensation exception as set out in 42 CFR §§ 411.357(a), (b) and (p));
The arrangement must be commercially reasonable and further the
legitimate business purposes of the parties;
The services performed under the arrangement must not involve the
counseling or promotion of a business arrangement or other activity that violates a federal
or state law. The fair market value exception requires in addition that the arrangement
must not violate the Anti-Kickback Statute or any federal or state law or regulation
pertaining to billing or claims submission.
The personal services exception specifically allows certain “physician incentive plans”
between a physician and an entity or downstream contractor that may have the effect of reducing
or limiting services furnished with respect to individuals enrolled with the entity, and that may be
determined in a manner (through withholds, capitation, bonus or otherwise) that takes into
account the volume or value of referrals or other business generated between the parties, if
certain conditions are met. Those conditions include compliance with federal rules concerning
incentive plans if the physician is placed at substantial financial risk as defined in 42 CFR §
422.208 (pertaining to Medicare Advantage programs).
Agency comments in the preamble to the issuance of the final Stark Phase III rules in
September 2007 confirm that under the personal services exception, “compensation related to
patient satisfaction goals or other quality measure unrelated to the volume or value of business
generated by the referring physician and unrelated to reducing or limiting services would be
permitted … provided that all requirements of the exception are satisfied (for example,
compensation to reward physicians for providing appropriate preventive care services where
arrangements are structured to satisfy the requirements of the exception … )… .”41
Indirect Compensation Arrangements.
Payments that do not create direct
financial relationships under the rules set out above may give rise to “indirect” relationships,
which could be either an “indirect compensation arrangement” falling within the Stark rules
requiring compliance with the indirect compensation exception, or an indirect relationship that
does not meet the Stark definition of an “indirect compensation arrangement” and falls outside
the coverage of the Stark Law and its referral prohibition.
72 FR 51046, Sept. 5, 2007; see also 69 FR 16091, March 26, 2004.
A payment made from the hospital to a physician entity could give rise to an “indirect”
compensation relationship falling within the coverage of the Stark Law and requiring that an
exception be me if -(a)
There is an unbroken chain of financial relationships between the hospital
and physicians;
The aggregate compensation received by the physician “varies with, or
takes into account, the volume or value of DHS referrals or other business generated
[including non-DHS and private insurance paid] between the referring physician” and the
hospital [analyzing the compensation relationship closest to the physician]; and
The hospital has actual knowledge of, or acts in reckless disregard or
deliberate ignorance of, the fact that the physician receives compensation that takes into
account the volume or value of referrals to the hospital.
42 CFR § 411.354(c)(2).
For purposes of applying this definition, the special rules on
compensation of the Stark rules do not apply (see 42 CFR § 411.354 and discussion below).
Thus, the interpretation of the concept “take into account” becomes a key point in this
determination. The concept of “take into account” was determined to mean compensation above
fair market value, or factors having a variable effect on the physician compensation, as
considered by the court in United States ex rel. Villafane v. Solinger, 543 F.Supp.2d 678, 693
(W.D. Ky. 2008) (“. . . the Court is convinced that when, as here, the faculty salary paid to the
physician is initially set at fair market value and where the faculty salary does not vary once set,
this requirement is easily met.”) In U.S. ex rel Drakeford v. Tuomey Health System, Inc.,42 both
the government and the hospital were denied summary judgment on the issue of whether or not
an “indirect compensation arrangement” covered by the Stark Law existed between the hospital
U.S. District Court, D.S.C. Case No. 3:05-CV-2858.
and certain part-time physician employees of a hospital affiliate. The jury in that case found in
favor of the hospital on the False Claims Act allegation but found that the hospital had violated
the Stark Law. Among the arguments made by the government was that the compensation paid
to the physicians exceeded fair market value, was not commercially reasonable, and was
determined in a manner that took into account the volume or value of referrals to the hospital’s
ambulatory surgery service.
Support Payments; Payments to Hospital-Affiliated Physician Practices. It is also
not uncommon in certain hospital systems, particularly nonprofit systems and academic medical
centers, for funds to be transferred throughout the system to support or subsidize mission
activities that do not generate sufficient revenue to cover costs. If support payments are made by
a hospital to an affiliated physician practice entity within the system, such payments would not
neatly fit into the specifications of the direct compensation exceptions set out above for
employment, personal services or fair market value contracts. For this reason, objections were
raised to the original version of the SITS rule as contained in the Stark Phase III rules (72 FR
51012, Sept. 4, 2007), which was not limited to physician owners and applied on its face to
nonprofit integrated health systems and academic medical centers. The effective date for the
SITS provisions of Stark Phase III rules was delayed as applied to academic medical centers and
nonprofit integrated health systems due to concern about protection for support payments (72 FR
64161, Nov. 15, 2007). In the preamble to the 2008 final rules limiting the reach of the SITS
rule to physician owners and exempting qualifying “academic medical centers” from the SITS
rule (73 FR 48434, 48696, Aug. 19, 2008) CMS noted that it declined to adopt a specific
exception for support and similar payments. Therefore, support payments made outside the
context of a qualifying “academic medical center” must rely on another structure to avoid the
application of the SITS rule, as well as an analysis such as the indirect compensation analysis
outlined above as a basis for exception from the general Stark Law referral prohibition.
Academic Medical Center.
For hospital systems, faculty practice plans and
affiliated organizations that qualify as part of an “academic medical center” within the meaning
of the Stark rules (42 CFR § 411.355(e)), certain conditions must be met with respect to
compensation received by the referring physicians in order to meet the terms for this exception
from the general Stark Law referral prohibition. Specifically, compensation paid to the referring
physician (a) must be set in advance; (b) in the aggregate (considering compensation paid by all
components of the academic medical center) must not exceed fair market value; and (c) must not
be determined in a manner that takes into account the volume or value of the physician’s
referrals or other business generated with the academic medical center.
Compensation within a Group Practice. With respect to payments made by a
group practice to its member physicians, the Stark rules governing a “group practice” (42 CFR §
411.352) set out detailed requirements for organization and operation of the practice, including
organization as a single legal entity, requirements designed to assure substantial professional
participation in the group by its members, and standards directed at operation as a unified
business, including requirements relating to distribution of expenses and income. Within the
context of a “group practice,” compensation may not be directly or indirectly “based on” the
volume or value of DHS referrals, except certain payments for (a) productivity bonuses, not
directly related to DHS referrals (unless incident to DHS personally performed by the physician);
and (b) shares of overall profits (from Medicare/Medicaid DHS) of the group, not directly related
to DHS referrals. Certain compensation methodologies specifically approved in the regulations
can be used to gain assurance that compensation is not “directly related.” These include per
capita distribution of overall profits, or an allocation based on physician’s other services that are
not DHS payable by federal programs or private payors. A de minimus exception also applies if
Medicare/Medicaid DHS revenue is less than 5 percent of overall group revenues, and less than 5
percent of each physician’s compensation.
Special Rules on Compensation: Set in Advance; Volume/Value of Referrals; Percentage
Payments. Special rules apply in defining certain terms and standards used throughout the
compensation exceptions in the Stark rules. Compensation will be considered to be “set in
advance” if the aggregate compensation, a time-based or per-unit of service based (whether per use or per-service) amount, or a specific formula for calculating the compensation is set in an
agreement between the parties before the furnishing of the items or services for which the
compensation is to be paid (42 CFR § 411.354(d)(1)). In addition, under this rule the “formula
for determining the compensation must be set forth in sufficient detail so that it can be
objectively verified, and the formula may not be changed or modified during the course of the
agreement in any manner that takes into account the volume or value of referrals or other
business generated by the referring physician.” Certain compensation -- namely, unit-based
compensation (including time-based or per-unit of service-based compensation) -- will be
deemed not to take into account the “volume or value of referrals” if the compensation is fair
market value for services or items actually provided and does not vary during the course of the
compensation arrangement in any manner that takes into account referrals of DHS (42 CFR §
411.354(d)(2)). Finally, unit-based compensation (including time-based or per-unit of servicebased compensation) will be deemed not to take into account “other business generated between
the parties” if the compensation is fair market value for services or items actually provided and
does not vary during the course of the compensation arrangement in any manner that takes into
account referrals or other business generated by the referring physician, including private pay
health care business (except for services personally performed by the referring physician) (42
CFR § 411.354(d)(3)).
The Stark rules have been refined over the years to address the agency’s discomfort with
percentage-based compensation. Stark exceptions for space and equipment rental, fair market
value compensation and indirect compensation arrangements were amended in 2008 to prohibit
use of a rental formula based on a percentage of revenue raised, earned, billed, collected or
otherwise attributable to the services performed or business generated in the office space or
equipment that is the subject of the arrangement; or use of per-unit of service rental changes, to
the extent that such charges reflect services provided to patients referred between the parties (42
CFR § 411.357(a), (b), (l) and (p)). This narrowly crafted final rule followed a proposed rule
published as part of the CY 2008 Physician Fee Schedule proposed rules (72 FR 38184) in which
the agency sought to clarify the definition of “set in advance” by specifying that compensation
based on a percentage-based formula could be used only to pay for personally performed
physician services, and must be based on the revenues directly resulting from the physician
services rather than based on some other factor (such as a percentage of the savings by a hospital
department not directly or indirectly related to the physician services provided). In responses to
public comments published with its final amendments to the Stark rules in the August 19, 2008
Federal Register (73 FR 48433, 48711), CMS addressed concerns regarding the broad reach of
its proposal, including the potential impact on payments made based on achieving quality
measures, patient satisfaction, or efficiencies, and other integrated care delivery models based on
sharing of revenue. The agency responded to these comments by noting that the concerns had
been addressed by finalizing “a narrow, targeted approach” that does not require percentage-
based formula used to determine physician compensation for personally performed service to be
based on the revenues directly resulting from the physician’s services rather than based on some
other factor, such as a percentage of the savings by a hospital department. The agency also
pointed to its proposed rules that would create new exceptions for certain incentive payments and
shared savings programs (73 FR 38548). On a cautionary note, the agency further noted its
comments in the proposed rules regarding whether shared savings payments would meet the fair
market value standard (73 FR 38551), and that the agency would continue to monitor
percentage-based payments to determine if abusive arrangements in the industry required further
changes to these narrow final rule adopted in 2008.
Fair Market Value and Commercial Reasonableness. The Stark Law definition of the
term “fair market value” (42 CFR § 411.351) is as follows:
“The value in arm's-length
transactions, consistent with the general market value.” In turn, the term “general market value"
is defined to mean:
the price that an asset would bring … or the compensation that would be included
in a service agreement as the result of bona fide bargaining between wellinformed parties to the agreement who are not otherwise in a position to generate
business for the other party ... . Usually, the fair market value is the price at which
bona fide sales have been consummated for assets of like type, quality, and
quantity in a particular market at the time of acquisition, or the compensation that
has been included in bona fide service agreements with comparable terms at the
time of the agreement, where the price or compensation has not been determined
in any manner that takes into account the volume or value of anticipated or actual
Special guidance is also offered with respect to application of this concept to leases (42 CFR §§
411.354(a) and (b)).
The prohibition on taking into account referrals is echoed in the concept of
“commercially reasonable,” which is found in several compensation exceptions.
responses to public comments as set out in the preamble to the Stark Phase II rules rejected the
assertion that the “commercially reasonable” concept represented an unwarranted subjective
element in the standards for these exceptions, noting that “[a]n arrangement will be considered
‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial
sense if entered into by a reasonable entity of similar type and size and a reasonable physician …
of similar scope and specialty, even if there were no potential DHS referrals” (69 FR 16093,
March 26, 2004).
Assessment of the fair market value of compensation paid to physicians as employees or
contractors is key to management of compliance risk, since fair market value payment is a basic
element for compliance with the referral laws (as well as the rules surrounding tax-exempt status,
to the extent applicable, as addressed below). In working with an expert in assessing the fair
market value of compensation, it is important to address a few key concepts:
Define each category of service to be provided by the employed physicians. These
may include, for example, clinical, administrative, teaching and research.
comments in Stark Phase III rules regarding valuation of different types of services
(72 FR 51015, 51016, Sept. 5, 2007:
“We note that the fair market value of
administrative services may differ from the fair market value of clinical services.”)
Cover in the fair market value review all related services -- including incentivized
activities -- to be expected of the physicians.
Assess the appropriate physician specialty required for service (which impacts the
appropriate rate of compensation to be applied).
Articulate performance standards expected for base pay.
Review incentives for compliance with referral laws (see discussion of Stark Law
exceptions), the CMP and other Medicare mandates, and tax-exempt standards, if
applicable to the organization (see discussion below).
As evidenced by recent litigation, close review and documentation of fair market value of
compensation paid to physicians is particularly important. The government intervened in the qui
tam action in U.S. ex rel Drakeford v. Tuomey Health System, Inc.43 and argued that the hospital
violated the Stark Law by implementing a part-time employment arrangement under which
certain physicians were paid at unreasonably high levels. In U.S. ex rel. Kosenske v. Carlisle
HMA, Inc., the hospital lost its motion for summary judgment to dismiss the qui tam action since
the court found that the written agreement between the hospital and an anesthesiology group had
not been updated to cover the later provision by the anesthesiology group of exclusive pain
management services in a new hospital-owned facility, and such exclusive use constituted a
benefit to the physicians.44 Failure to qualify for the Anti-Kickback Statute personal services
safe harbor and Stark Law exception precluded dismissing the case at the summary judgment
stage. In August 2009, Covenant Medical Center and Wheaton Franciscan Healthcare-Iowa
entered into a settlement agreement with the Department of Justice to resolve allegations that the
hospital had violated the Stark Law and the False Claims Act by paying certain employed
physicians excess compensation.
Proposed Stark Exceptions for Incentive Payment and Shared Savings Programs. In the
CY 2009 proposed Physician Fee Schedule rule (73 FR 38502), pursuant to its statutory
authority to adopt by rule exceptions for financial relationships that do not pose a risk of program
or patient abuse (42 USC § 1395nn), CMS proposed to add to the Stark rules exceptions for
554 F.3d 88 (3d Cir. 2009); US District Court MD PA, Civil Action No. 1:05-CV-2184.
shared savings (i.e., gainsharing) and incentive payment (e.g., hospital-sponsored pay-forperformance) programs that offer financial incentives to physicians intended to foster high
quality, cost-effective care. In the final CY 2009 Physician Fee Schedule rule (73 FR 6979369798, Nov. 19, 2008), the agency did not finalize these rules but sought further public comment
on whether a “standalone” exception for these arrangements was required in light of the
availability of the employment, personal services, fair market value, indirect compensation and
academic medical center exceptions.
Further, with respect to specific requirements to be
included in any new exception for incentive payment or shared savings programs, the agency
requested additional public comment on a number of points raised in the proposed rules,
including the following:
Alternatives to proposed requirements that such programs to be supported by
objective, independent medical evidence (e.g., CMS’ Specification Manual for
National Hospital Quality Measures) and undergo assessment by an independent
medical reviewer;
Alternatives to proposed requirements that these programs include pools of 5 or more
participating physicians, that payments be distributed to the pool on a per capita
basis, and that all participating physician must have been members of the hospital’s
medical staff at the commencement of the program;
Methods for assuring that physicians receiving payments contribute to the program;
Whether a cap should be placed on incentive pay, and whether the duration of the
program should be limited to 3 years or some other time period, and whether other
steps should be taken to assure that payments are not made for previously achieved
goals, and that physicians are not rewarded for increased government program
Whether the exception should protect payments for global improvement in patient
care quality instead of individually identified and tracked measures;
What types of medical evidence should support quality measures;
How to assure that the quality targets to be rewarded relate to and substantially
benefit the hospital’s patients;
How quality baselines should be set and quality improvement should be measured;
Whether quality targets should reflect regional, national or some other data;
Whether different payments should be made for quality improvement and quality
maintenance, and how to distinguish between these; and
How to prevent payments when programs are not achieving quality goals or their
goals result in a diminution in patient care quality.
TAX-EXEMPT STATUS ISSUES. IRC § 501(c)(3) standards for tax-exempt status prohibit
the inurement of the exempt organization’s net earnings to private individuals (or insiders), and
require that the organization pursue charitable purposes with only incidental private benefit.
These standards do not prevent the payment of reasonable compensation for services provided to
the organization45 (The 2000 Exempt Organizations Continuing Professional Education Text
(“2000 CPE Text”) sets out IRS policy with respect to review of compensation paid by exempt
organizations.) The IRS suggested conflict of interest policy for 501(c)(3) exempt organizations
includes a provision to the effect that physicians who receive compensation from the
organization, whether directly or indirectly or as employees or independent contractors, may not
See Rev. Proc. 2001-4.
serve as members on any committee whose jurisdiction includes compensation matters. This
does not preclude any physician from furnishing information to any committee regarding
physician compensation.46
Payment of incentive compensation by an exempt entity to its employees is subject to
various conditions designed to protect the charitable mission of the organization and to assure
compliance with the private inurement and private benefit rules. The factors to be taken into
account in evaluating an incentive compensation plan are summarized in the 2000 CPE Text, and
include the following:
Whether total compensation (base + incentive) is reasonable
Whether the compensation has been approved by an independent board or committee
Whether the incentive compensation is subject to a reasonable ceiling on overall
compensation that precludes a windfall
Whether incentive rewards are tied to services actually performed by the physicians
Whether the incentive serves real business purposes of charitable organization, or has
the potential to reduce charitable benefits and services
Whether the incentive advances quality and patient satisfaction
Whether the incentive is structured as a device to distribute profits, or otherwise
effectively creates a joint venture
Finally, payment of compensation in excess of fair market value to a “disqualified
person” can result in the imposition of significant excise taxes upon the disqualified person and
organization managers approving the excess benefit transaction.47
Physicians may be
“disqualified persons” with respect to an exempt organization if they exercise “substantial
Instructions for Form 1023 at www.irs.gov; 2000 CPE Text at 25, 30-33.
26 U.S.C. § 4958; 26 C.F.R. § 53-4958-1 et seq.; 73 FR 16519-01 (Mar. 28, 2008).
influence” over the organization.48
The statute and regulations set out a procedure for
establishing a rebuttable presumption that a transaction is not an excess benefit transaction.49
See Reg. § 53.4958-3 for the definition of a “disqualified person,” and examples 10 and 11 in that regulation
relating to the status of physicians.
See Miller, Rebuttable Presumption Procedure is Key to Easy Intermediate Sanctions Compliance, available at the
IRS website, www.irs.gov.