IRS reaffirms "friendly doctor" transaction can transfer tax ownership
Professional corporation includable in consolidated tax return
TAX ALERT |
Authored by RSM US LLP
In PLR 202049002 (Dec. 4, 2020) the IRS ruled, in line with a 2014 Private Letter Ruling, that entering into a management service agreement (MSA) between a Professional Corporation (PC) owned by a professional and a management service organization (MSO) can result in transfer of ownership in the PC for tax purposes, despite the retention of legal ownership by the professional.
Introduction to the issue
In most industries, when a buyer desires to acquire a target business, the buyer purchases the target stock or assets outright. However, in the case of professional practices such as medicine, state law often limits ownership of a PC to a licensed practicing professional. If the buyer cannot legally own the business under applicable state rules, the PC and an MSO entity owned by the buyer often enter into an MSA to achieve the desired economics. Under many of the MSA arrangements, while the professionals retain legal title to the PC, economic benefit and voting control is transferred to the MSO. In the context of medical practices, this is known as the “friendly doctor arrangement.”
As discussed previously in our article Who really owns that medical or professional practice?, mere retention of legal title to property does not represent ownership for tax purposes. As a result, the owner of property (e.g. stock in the PC) for tax purposes can be different than the owner for legal purposes. In essence, whether an MSA transfers ownership to the MSO does not depend on legal title, but turns on whether the benefits and burdens of ownership have been transferred (beneficial ownership).
In PLR 202049002, Parent and Sub were, respectively, the parent and member of a consolidated group, and Sub owned an MSO, an LLC. While the MSO performed all administrative and support services on behalf of PC, a Professional Corporation, the PC’s shareholder retained legal title to the PC shares. The MSA between the parties transferred the PC’s voting control and all economic benefit to MSO.
The MSO and the PC entered into agreements that included the following provisions:
- The PC shareholder was prohibited from transferring any shares of the PC stock, and if he were to do so, the stock would automatically transfer to a transferee designated by Parent for a nominal cost.
- The PC shareholder was prohibited from declaring a distribution with respect to the PC stock or from issuing additional equity interests.
Parent made several representations, including that:
- The legal arrangements were legally valid and enforceable.
- Applicable state law only prohibited the Sub from practicing the PC profession, controlling the PC’s professional decisions, and from legally owning the PC stock, but did not prohibit Sub from beneficially owning the PC stock.
Based on these facts and representations, the IRS ruled that the PC was owned by Sub. The PC was therefore a member of the Parent-Sub consolidated group.
The conclusion reached in this PLR is based upon well-established principles of tax law developed over decades, which conclude that ownership for tax purposes is determined based upon all facts and circumstances, and not legal title to the property. Also important to note is that while the PLR involved a question of filing a consolidated tax return, the question of whether the agreements between the parties transferred ownership has far-reaching effects beyond the consolidated return context. Whether to file a consolidated return is elective, whereas determining whether a transaction transferred ownership of an entity is not elective.
The inclusion by the PLR of a representation that, under the facts at hand, state law did not prohibit beneficial ownership appears based upon FSA 199926014 (July 2, 1999) where state law apparently both restricted the transfer of beneficial ownership and would nullify the transaction. While taxpayers entering into similar transactions need to consult with legal counsel, we understand that very few states restrict the transfer of beneficial ownership.
Friendly doctor and similar arrangements crafted to transfer economic ownership of a PC to an acquiring MSO via an MSA deserve scrutiny to determine tax ownership. Legal title to the shares of the PC is but a single, and not persuasive, factor. Decades of case law and rulings surrounding ownership for tax purposes dictate that all facts and circumstances as to which party holds the benefits and burdens of ownership control.
Call us at +1 213.873.1700, email us at firstname.lastname@example.org or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Nick Gruidl, Joseph Wiener and originally appeared on 2020-12-10.
2020 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Vasquez & Company LLP can assist you, please call +1 213.873.1700.
Subscribe to receive important updates from our Insights and Resources.